Flat tax simplicity hides the further shifting of the tax burden to the poor and middle class

Holley Ulbrich is an economics professor emeritus and senior fellow at the Strom Thurmond Institute at Clemson University.

Albert Einstein said that "Everything should be made as simple as possible, but not one bit simpler." Good advice for people who want to redesign tax systems. It's true that there are now 24 countries with a flat tax, but none of them got there by scrapping an established progressive income tax system nearly 100 years old. Fifteen of these countries are formerly Communist countries of Eastern and Central Europe. The others are very small, ranging from Montenegro to Iceland. No major industrial nation has made that choice. There are good reasons for going slowly.

The attraction of simplicity hides a big change in the distribution of tax obligations among the poor, the middle class, and the rich. When think tanks like Cato and Heritage support changes that redistribute the tax burden in that way, they usually warn us of the evils of class warfare. But the proposed flat tax is, in fact, class warfare--yet another attempt to reduce the tax obligations of higher-income households in exchange for the unenforceable hope or promise that they might use the money to invest and create jobs, maybe even jobs in the United States.

Two considerations should give us pause before jumping on the flat-tax bandwagon. The first is the disruptive effect of eliminating deductions, credits and exclusions that benefit the middle class as well as the rich and that play important roles in our lives--pension contributions, employer-provided healthcare, and deductions for mortgage interest, property taxes, and charitable contributions that support everything from soup kitchens to education to the arts. Second is the role of our mildly progressive federal income tax in offsetting regressive taxes elsewhere in the system.

The first argument against the flat tax, one that resonates with homeowners, charitable organizations, and anyone with employer-provided health insurance or a pension plan, is the disruption that would come from trashing the current income tax system in favor of something untested and untried. We have all made decisions on the basis of the existing and long-standing tax rules. It's hard to get people to save for their retirement, but the tax treatment of employee pensions, IRAs, and 401(k)'s has played an important role. Would we have bought a house if we knew that we were going to lose our home-related deductions? Will charitable organizations that serve those who fall through the holes in the safety net and also enrich communities with education, religion, and culture lose financial support when charitable contributions are no longer deductible? And will we have to declare our employer-provided health insurance as taxable income?

Second, there's no concealing that the flat tax would radically redistribute the tax burden. Adam Smith, to whom economists always turn to for economic wisdom, observed, "It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion." The current U.S. tax system consists mainly of taxes on income (personal and corporate), payroll (Social Security), sales, and property. In 2007, these taxes provided 92 percent of federal income and 51 percent of state and local government income. Sales taxes are regressive--they take a higher share of low incomes than higher incomes. State and local income taxes range from flat to mildly progressive. Payroll taxes are moderately regressive because they fall on only wages and salaries and only up to a maximum of $106,800 in earnings. The distribution of the property tax burden is not clear, but the family home is the primary financial asset for most middle-income households. Property taxes are levied on homes, but rarely on other kinds of financial assets. State and local governments also depend on fees and charges for services, which fall heavily on lower-income households, for 44 percent of their revenue. So a moderately progressive federal income tax, with rates ranging from 15 percent to 35 percent, helps to offset regressive taxes elsewhere.

The rhetoric about ending double taxation ignores the fact that under a flat tax, wages would still be taxed twice, but dividends only once. Wage earners pay both payroll and income taxes. They've paid double taxes since 1935. Why should income from owning financial assets be treated differently--especially since most of that income goes to upper-income households?

A flat tax would shift tax obligations from the rich to the poor, and especially the middle class, and eliminate desirable tax incentives for retirement savings, home ownership, and charitable contributions. Simple? Yes. Efficient and equitable? Not so much.

Read why the flat tax is simply more fair, by Daniel Mitchell, senior fellow at the Cato Institute.

Available at Amazon.com:

The FairTax Solution: Financial Justice for All Americans

The Ultimate Cheapskate's Road Map to True Riches: A Practical (and Fun) Guide to Enjoying Life More by Spending Less


Personal Finance - Flat Tax Is Class Warfare

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