The International Writers Magazine: Death & Taxes
Flat Tax Revisited
The 2011 appointment of the Deficit Reduction Committee by President Obama suggests that after several years of complacency the U. S. government is finally seriously looking for a solution to the impending deficit and debt crises.
Ideas generated by the bipartisan committee and other legislators are now beginning to emerge. One suggestion that appears to have some support and merit is the introduction of a 6.5 per cent national sales tax, similar to Canada’s general sales tax and the value added tax (V.A.T.) levied by many European nations. To my surprise there has also been a suggestion that a flat rate personal income tax might also contribute toward additional revenue and therefore a reduction in America’s deficit and debt in the long run.
Although I have been aware of the flat rate income tax concept since my undergraduate days, it was not until the 2000 U.S. presidential election, or rather the “run-up” to the election, that my interest was reignited.
Some readers may recall that during the fall of 2000, a series of town hall meetings were held at which several candidates vying for the Republican nomination presented their respective platforms and responded to questions from the moderator and the audience.
At one of these meetings, held on October 28th, 1999 in New Hampshire, the moderator asked each of the six candidates to state their position on the flat rate income tax concept. To the surprise of many in the audience, each contender proclaimed his unequivocal support and several made strong statements advocating a complete overhaul of the personal income tax system. George W. Bush was absent from the debate but later proclaimed his support. One panelist, former Ambassador Alan Keyes, went so far as making a passionate plea for a total abolition of the personal income tax and replacing it with a sales tax on all financial transactions; a concept sometimes referred to as a consumption tax. But it was Steve Forbes, the final respondent, who in my judgement, provided the “coup de grace.” Mr. Forbes had run for the G.O.P. nomination during the 1996 primaries and was the only candidate who had spoken out in favor of a flat rate federal income tax. At that time most of his competitors regarded him as a member of the “lunatic fringe.” Mr. Forbes, with a wry smile, faced the audience and said, “so education works. Some are slower than others but they’re coming along. When I ran four years ago virtually every Republican candidate denounced the idea of a flat rate income tax.”
What is surprising to this observer is that in the ensuing years since that New Hampshire meeting, not one mention of the flat tax rate has been heard from Senators Orin Hatch and John McCain or any other members of that town hall meeting. Nor was there any comment from President Bush during his eight years in the White House. Has the issue simply “died on the vine?”
As a long time proponent of the concept I can only hope some “gutsy” members of the Congress will once again bring it to the forefront of the nation’s political agenda. If the Americans adopted the flat tax, it is likely we Canadians would follow their lead as we have done so often in the past.
While the personal income tax has never rated highly in popularity polls, rational people accept the notion that paying some portion of their income to support public services is both fair and reasonable. Why then, do we have a large “underground” economy, a significant lack of compliance with the law and an industry consisting of thousands of accountants, lawyers and estate planners whose primary function is to advise their clients on how to minimize paying their share of the tax burden. I suggest there are three fundamental factors that contribute to non-compliance, add impetus to the growth of the underground economy and support a legion of tax consultants.
Firstly, a significant proportion of the population is justifiably outraged by the waste and stupidity associated with many government initiatives and expenditures. This issue has been well documented and is not the focus of this article. It is obvious, however, that if one believes his or her taxes are being squandered on questionable projects and irrational uses, the desire to comply will diminish.
Secondly, to paraphrase Gertrude Stein’s supposedly erudite comment that “a rose is a rose is a rose;” income is income is income. This is the principal issue over which Mr. Forbes and I disagree. Income, regardless of whether it is derived from professional fees, wages, dividends, rental income or interest, should be treated as taxable income. Mr. Forbes’ proposal, however, would exempt income tax from such income sources as dividends and capital gains. The Forbes proposal would, I believe, give an unfair advantage to the wealthy and high income earners who are more able than the average wage or salary earner to acquire assets which would generate income exempt from the federal income tax. As long as different sources of income are taxed differently, dissatisfaction with the income tax will remain at a relatively high level, at least with a large majority of the nation’s taxpayers.
Thirdly, the sheer complexity of both the American and Canadian tax systems encourages non-compliance. Why should it be necessary to wade through a multi-page, complicated document that few understand in order to complete one’s annual income tax return? The U.S. Tax Code apparently contains in excess of seven million words and the Canadian Income Tax Act is not far behind. While high priced tax lawyers and accountants collect billions of dollars in fees from the existing system and therefore have a vested interest in maintaining the status quo, a simplified system would be welcomed by the vast majority of the citizens in both our countries. As Mr. Forbes suggested and Senator McCain concurred, filing could be completed on something no larger than a postcard. The only information required on the form would be the taxpayer’s name, address, telephone number, social security number, the amount of income earned from all sources the previous year, the amount of tax paid through either witholding tax or installment payments and either the balance owing or refund claimed. The process could be completed in less than ten minutes and without the assistance of high priced professionals. Perhaps ten per cent of the returns could be randomly selected for audit. The penalties for failure to file and tax evasion should be made more severe. An added benefit would be the ability to reduce the number of bureaucrats employed by the I.R.S. and Canada Revenue Agency by probably 75 per cent or more and thereby save billions in salaries and employee benefits.
The large and growing underground economy clearly poses a threat to the I.R.S. and the C.R.A. Several years ago David Giles, a University of Victoria professor, developed a econometric model which, among other things, attempted to measure the magnitude of the underground economy. Due to the inherent secrecy associated with these transactions, precise measurement is, of course, not possible. Giles’model suggests, however, that the underground economy in the U.S. is about 10 per cent of G.D.P. whereas in Canada, where personal income taxes are generally higher, the corresponding number may be closer to 16.5 per cent.
I further agreed with Mr. Forbes’ contention that the progressive tax rate currently in place in both the U.S. and Canada is fundamentally unfair whereas the flat tax concept seems to me to be the epitome of fairness and equity. Applying Mr. Forbes’ proposed 17 per cent flat tax rate and incorporating my suggestion that all personal income be treated equally, the person earning $100,000 per year would obviously pay $17,000 in federal income tax. Another person earning $50,000 would pay $8500. In other words, a person earning twice the income of another would pay twice as much income tax. What could be fairer than that? It could also be argued that the progressive tax rate unduly penalizes an individual for achieving financial success. Detractors of course would argue that a progressive tax rate contributes to a more equitable distribution of income and is therefore more “socially responsible.”
In order for the flat tax system to be seen as fair and equitable, however, the multitude of tax shelters and “loopholes” in the current tax laws in both our countries would have to be eliminated.
If a flat tax rate was passed by the U.S. Congress or the Canadian Parliament; what should the rate be? Previous studies have suggested that a flat tax rate of something close to Mr. Forbes' proposed 17 per cent would generate at least the same amount of revenue as the existing system and probably more. The rate might also be variable. For example, during times of national crises such as large scale military offensives, the rate might be temporarily increased by one or two per cent. Conversely, a protracted period of economic bouyancy might justify a decrease of similar magnitude, at least in the short run. This idea might be particularly appealing to neo-Keynesians.
Like it or not, the personal income tax is not likely to disappear. It would be to both our nations’ advantage, however, if the level of taxpayer compliance could be raised. It would be significantly raised, I suggest, by adopting the flat rate principle, making all income, regardless of source, taxable and converting what is now a cumbersome and often costly process into a ten minute annual exercise.
© Barry W. Mayhew, Ph.D. May 2012