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A case against the flat tax

Adam Newman | Wednesday, February 8, 2012

The discussion over the flat tax is always a very interesting one. Usually people who support it are heavy on details of its benefits and light on details of its negative consequences. But when examined closer, the negative consequences of a flat tax would make one wonder why anyone would support it at all.

Implementing a flat tax would mean eliminating most tax expenditures (tax provisions where the government returns money to people through deductions, exemptions or credits), raising massive amounts of revenue. Simultaneously, the many marginal tax rates (currently at six) would become one low, flat rate. If administered correctly, the loss of revenue from lowering and eliminating rates would be balanced by the increase of revenue through eliminating tax expenditures.

However, this balance is only in terms of the federal government’s finances; the tax burden on Americans would change drastically. For example, George, whose income is $10,000 and Jerry, whose income is $100,000, would pay the same tax rate. If the tax rate was 15 percent, George would pay $1,500 in taxes and Jerry would pay $15,000. Under the current system, both would pay 10 percent for their income from $0-$8,500, 15 percent for their income from $8,501-$34,500, etc. So under the current progressive tax code, George would pay $1,075 (compared to $1,500 under a flat tax) and Jerry would pay $21,615 (compared to $10,000 under a flat tax). What this analysis does not include are the tax expenditures Jerry and George could claim, which would probably lower both’s tax liabilities. As one can see, the main benefit of the flat tax is its simplicity. But that is no match for the negative consequences a flat tax would bring.

The first negative consequence of a flat tax is the tax burden would be greatly shifted from richer Americans to poorer Americans. Due to the progressivity of the tax code, bad economy and ability for lower and middle class Americans to take advantage of tax expenditures, roughly 50 percent of Americans do not have an income tax liability. (Note: this is for federal income tax only; poor and middle class Americans still pay federal payroll taxes, and state and local taxes.) Implementing a flat tax that ended many popular tax expenditures would mean most, if not all, Americans would pay some income tax, effectively raising the taxes on the poorest 50 percent of Americans. Simultaneously, a flat tax would give a huge tax break for the highest income earners. According to an analysis done by the non-partisan Tax Policy Center, a 15 percent flat tax would lead to an 11 percent tax break for those making between $500,000-1,000,000 and a 19 percent tax break for those making over $1,000,000. Raising taxes on the poor and middle class while drastically lowering taxes on the rich during a weak economy does not reflect America’s compassionate values.

The second negative consequence of a flat tax is that depending on the plan, it would increase the deficit. The devil is in the details when it comes to the flat tax, because the only way a flat tax plan would be deficit-neutral would be if it eliminated enough tax expenditures to make up the lost revenue from lowering and eliminating tax rates. The issue is many of the largest tax expenditures needed to make a flat tax deficit-neutral are the most popular: the tax exclusion for health insurance, deduction for mortgage interest and deduction for charitable contributions. Newt Gingrich offered a flat tax plan that would lower the rate to 15 percent for individuals and 12.5 percent for corporations, but keeps these and other major tax expenditures in place. The Tax Policy Center, assuming that all Americans were taxed at the flat rate, found that in 2015 the plan would increase the deficit somewhere between 800 billion and 1.2 trillion.

A tax code must balance two principles: “equity,” by making people who earn more pay a higher percentage in taxes, and “efficiency,” in order to promote economic growth and prosperity for its citizens. The flat tax does not balance these goals, because its emphasis on efficiency shifts too much of the tax burden away from the wealthy and onto the poor. However, there is an option for tax reform that embraces these principles. By cutting the number of tax brackets, lowering rates and reforming tax expenditures, the tax code could be greatly simplified (something Republicans advocate) while increasing taxes on the rich (something Democrats advocate).

A flat tax is an idea bounced around by academics and fringe Republicans that may initially sound simple, but the simplicity it could bring to the tax code is not worth the massive shift in tax burden from wealthier to poorer Americans and the billions, if not trillions it would add to the deficit. But for some reason, people still cling to the flat tax. Those who continue to do so despite such negative consequences are, as Jon Stewart recently said on The Daily Show, “life support for bad ideas.”

Adam Newman is a junior finance major. He can be reached at anewman3@nd.edu

The views expressed in this column are those of the author and not necessarily those of The Observer.