Blog 123. Is a flat tax freedom?

A flat tax is advertised as the “freedom tax,” in which everyone pays taxes at a fixed marginal rate—such as 10%. Salaried workers pay by withholding from each paycheck, and never have to submit a tax return. It sounds good because it’s simple, but is it good?

Most so-called “flat tax” schemes would assess personal income that exceeds a specified initial exemption. Likewise for business profits. As promoted, that might reduce the several-million-word tax code to a few pages. That’s good, but not a valid pitch for the flat tax because the tax code could be simplified without the tax rate becoming flat.

Advocates claim the current tax code retards economic growth by distorting economic incentives and encouraging tax avoidance. The parts about distortion and avoidance are certainly true. However, the complications of the code are political distortions, deliberately inserted into the tax code, which works to manipulate money as politically intended. The contorted code certainly generates growth in one sector of the economy. It has created a new business—the income tax business.  Other than that, trickle-down economics doesn’t work.

There is a devil in the details—details like who gets how much exemption and what expenses are deductible from which kind of income.

What would be different with a flat tax? Would Congress leave it flat, or would deductions and exemptions be adjusted and re-adjusted to again institute the distortions that were removed in the name of “freedom?” For example, would Congress again favor banks by making mortgages tax-deductible for borrowers? Would investment income again be taxed differently? The flat tax proposal isn’t defined until it specifies what is exempt and what is deductible and what is not.

There’s an even bigger devil beyond the details.

A flat tax is regressive. The flat tax puts a larger fraction of the tax burden on those who are less able to afford it, while reducing the tax to those who could devote the top part of their income without deprivation. The flat tax increases the rate at the bottom, decreases the rate at the top.

A marginal family spends all its income buying retail necessities: rent, medical care, food, automobile, and beer on Saturday if there is cash left over after sales tax on the necessities. With a flat tax, the lower classes would experience decreasing opportunity, while top money would be given freedom to make even more money. The wealthy gain while working folks lose and see no way out. That leads to a politics based on protest and resentment in an increasingly divided nation with many poor and a few rich.

In their review of history, the Durants [1] noted that inequality grows in an expanding economy, so that
a society may find itself divided between a cultured minority and a majority of men and women too unfortunate by nature or circumstance to inherit or develop standards of excellence … A failure of leadership may allow a state to weaken itself with internal strife …

Public education and income redistribution via the graduated tax are the major mechanisms our society has to relieve financial disparity. The Durants’ words describe what happens when there is no redistribution. The poor lose opportunity while the rich become richer. As demonstrated by current budget proposals, even the common air, water, and public lands can be lost in the process of minimizing tax at the top. The “freedom tax” does not make people free. It just frees the top money.

[1] Will and Ariel Durant, The Lessons of History, Simon and Schuster Paperbacks, 1968 and 1996. The Durants wrote a seminal series of eleven volumes covering the history of civilization. This little book presents their conclusions in a hundred pages.

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