I’ve been an advocate for a flat tax since Steve Forbes first brought it to widespread attention in 1996, when his seemingly quixotic presidential campaign got surprising traction, thanks largely, I suspect, to the flat tax.
For liberals, of course, high marginal rates on the rich are part of their political religion and thus, like all religious beliefs, not always subject to ratiocination. But since politicians will always cater to the rich — for the same reason Willie Sutton robbed banks: that’s where the money is — high marginal rates in a democratic society will always be offset by loopholes so that the rich don’t actually have to pay those high marginal rates. This has been, at the least, one of the main engines behind the ever-increasing complexity of the tax code since it was first enacted in 1913.
It is also why tax revenues don’t rise much above 19 percent of GDP, whatever the bomfog coming out of Washington. The marginal rate (the tax on the last dollar of income) has been as high as 91 percent and as low as 28 percent. But the effective tax rate (the percentage of total income taxed away) has not changed much over the years since World War II, thanks to the loopholes and their partial elimination when rates were lowered.
If liberals would only abandon their fixation on marginal rates and look at the effective rate, they would love the flat tax. Because under a flat tax, the rich inescapably pay a higher effective rate. As Mike Pence pointed out, a flat tax consists of a generous personal exemption, no other deductions (and therefore no loopholes), and a flat marginal rate. To illustrate, say the personal exemption is $10,000 and the rate 20 percent. That would mean a family of four with an income of $40,000 would have an effective tax rate of zero percent ($40,000 minus exemptions totaling $40,000 times 20 percent equals zero). At an income of $50,000, the effective tax rate would be 4 percent, at $100,000, 12 percent. At $1 million, 19.6 percent. Liberals could still sock it to the rich by raising the personal exemption (thus eliminating any tax liability for many at the lower end of the income spectrum) and raising the flat rate. In a national emergency such as war, the personal exemption could be lowered and the flat rate raised, bringing a gusher of money into the Treasury (and damping down consumer demand at the same time).
Of course, along with loopholes, the flat tax would eliminate “tax expenditures,” by which politicians are able to hand out goodies while pretending to be deficit hawks. Under a flat tax, if the government wanted to, say, subsidize homeownership, it would have to send checks to homeowners instead of allowing them to deduct their mortgage-interest expense. The political class doesn’t like that idea one bit, evidence that liberalism in its latter days is really about furthering the interests of the political class, not the little guy.
The flat tax also has an enormous advantage over a frequently mentioned alternative — some form of national sales tax to replace the income tax. There is no way to easily transition from the current income-based tax system to a consumption-based tax system. Individual families, having made economic decisions (such as whether or not to buy a house) based on the current code, might be devastated by a sudden shift. Worse, there is no way to estimate even an approximation of what sales tax rate would be necessary to provide the same revenue as the current tax code provides. There are just too many variables, and human nature is too ineluctable. (How much of the economy would go underground, for instance, with barter replacing cash payments?) It would be a shot in the dark that might produce a very ugly surprise.
But with a flat tax, it would be easy. The revenues can be estimated with reasonable accuracy, and individual families could transition by being allowed to choose which system to file under. New tax filers would have to use the new system, however, and once a family filed under the new system, it could not return to the old. This has worked well in places like Hong Kong.
The flat tax has been on the political table now for 14 years. I can only hope that its time is coming soon. I can’t think of another reform that would be better for the American economy, or American politics, than the flat tax.