Preparing for the Flat Tax Assault
I see that Andrew Sullivan has made the flat tax his new pet issue, noting, among other things, that the Eastern European countries that have implemented the flat tax have all seen stunning rates of growth in recent years. Well, good for them. Since this issue is likely to come up sooner or later, though, here are a few initial, mostly scattered points:
It's unclear what's boosting those Eastern European economies, exactly. These are all countries that have emerged from communism, privatized industry, and seen an influx of western investment over the past decade. You'd expect them to grow quickly, no? I'd like to see more before ascribing magical powers to the flat tax. Slovakia, for instance, had 4.2 percent growth in 2003, "the strongest growth in Central Europe," right before it moved to the flat tax. Huh. And President Ivan Gasparovic has recently said that the wave of new foreign investors are attracted by the country's cheap labor costs rather than its flat tax rates.
Similarly, this IMF paper wonders whether Russia's boost in tax revenues following its flat-tax reform in 2001 were due to voodoo economics or merely to better enforcement. See also "Demythologizing the Russian Flat Tax" by Clifford Gaddy and William Gale.
Flat-taxers love to hype the simplicity of the "postcard size tax return," but as analysts have pointed since the days of Cain and Abel, the simplicity of a tax system has nothing to do with the tax rates. Progressive tax rates don't make our system complicated. Once you know your income, you can just as easily multiply it by 23 percent as by 17 percent with a calculator. Try it! The real difficulty comes in actually defining one's income and calculating all those deductions and exemptions. That will never be easy for some people, say, Dick Cheney, no matter what kind of tax system we have. We can still have a simplified tax code that happens to have different rates for different income levels. There are good and fair ways of doing this.
It's worth noting that when you add up all federal, state, and local taxes, this country already has fairly "flat" tax rates. According to CTJ, the top 20 percent of earners pay about 32 percent of their income in taxes, the next quintile 29.8 percent, the next quintile 27 percent, and the next quintile 23 percent.
Popular resistance to a flat tax, at least in the United States, will come from people who don't want to give up the concrete deductions and exemptions they currently have in exchange for theoretical future gains down the road (from supposedly higher economic growth). I have a feeling that this is a psychological phenomenon that's very difficult to get around.
Home values would very likely decline in the short term if we switched to a flat tax and eliminated all deductions, on the theory that right now, the home-mortgage deduction enables buyers to bid up the prices of real estate. The price decline wouldn't change anything on net, but people who currently own homes would obviously be screwed.
So, for that matter, would many large businesses. Some corporations get deductions for interest on loans that they've taken out to purchase new equipment, as well as deductions for the depreciation of current equipment. Businesses that have been borrowing and investing in new equipment aggressively would get a kick in the teeth if the United States eliminated all deductions and moved to a flat tax. I daresay that manufacturing would suffer the worst; just don't tell Clyde Prestowitz.
If Congress can't, for political reasons, eliminate all those deductions and exemptions, then the effective flat tax rate is going to be very, very high. Certainly higher than the 15 percent effective federal rate that about 60 percent of all taxpayers currently pay. Of course, those are the bottom 60 percent of income-earners, and they have precisely zero sway over the current Republican Party, so that's obviously not a political concern for anyone in power.
In theory it's possible to design a progressive flat tax, or simplify the tax code in all sorts of progressive and sensible ways, as Dick Gephardt has suggested. But that's not the flat tax that Andrew Sullivan, John Breaux, or George W. Bush have in mind. Any tax reform that lowers the rate on the wealthy will have to raise taxes elsewhere, obviously. There's no getting around this, except with deficits. If I had to bet, I'd bet that the GOP shies away from real flat-tax reform (for reasons #5, 6, and 7 above) this fall and instead just enacts further tax cuts for its allies. Democrats are in danger of coming to power soon; best to leave them a nice big deficit mess and let them reap the political whirlwind.