A Case Against the Flat Income Tax

A Case Against the Flat Income Tax

                I’ll start with full disclosure; I’m a long time supporter of the FairTax.  Over the years, I’ve heard every possible objection to adopting it.  None of them dissuade me from my support.  We should always compare it to what we currently have and what other actual bills are in Congress, not someone’s idea of perfection. 

                Everyone agrees the tax code is a mess today.  The problem is choosing what will replace it.  Most proposed solutions revolve around continuing the taxation of income.  The greatest problem with our tax system is not the design of the income tax, but the base itself.  This can only be fixed by changing the base.  Following are six reasons I do not support a flat income tax.

Simplicity should not be the only goal

                While the flat income tax is simpler than the current system, so is a tax on breathing.  That alone does not make it desirable. In the original book “The Flat Tax” by Hall-Rabushka, the authors begin by saying “We want to tax consumption.”  They immediately move to a description of how to do so through an income tax base.  The problem is the starting point of income invites continued control over individual decisions by government and its agencies.  The individual must continue to report activities to the government and the government pulls the strings of taxation.  In other words, it continues the theme of drawing special interests to DC, central planning, and the people subservient to the government. 

                Tax Consultant Dan Pilla, in chapter two of his book titled “IRS, Taxes and the Beast”, describes the “Internal Revenue Strategic Plan” as stated in a 1984 IRS document 6941.  Among other objectives, Pilla states these three were included: “establish a paperless tax return system allowing the IRS to determine your income and expenses, compute your tax liability without the need of your filing an income tax return (a flat tax system), set up a cashless society in which the transactions of all could be closely monitored for evidence of hidden income.”  Policy has been moving in this direction ever since.  Interestingly, the year of this statement directive coincides with the name of Orwell’s book “1984.”  In this novel Orwell describes a system of government control, surveillance and misinformation.  These goals, which a flat income tax furthers, are almost “Orwellian” in nature.   A flat income tax may be simpler, but it is not consistent with the idea of liberty.

It is not a true consumption tax

                If the goal as stated is to tax consumption, why not simply tax consumption?  The short answer is there is a continued belief even by some conservatives that some things need to be engineered by government through the tax code.  They seem to believe the problem is who is doing the engineering.  This requires they begin with an income base. Remember, the tax code under President Reagan was reduced to two flat rates and half the deductions were removed.  According to CCH, the pages of tax rules in 1984 (before the Reagan simplification) were about 26,000.  Today there are over 72,000 pages of Federal tax rules.  Any tax on income will be filled with hundreds of special interest provisions before ever leaving the halls of congress.

The business portion is a VAT

                The most amazing thing is that flat income tax supporters commonly state the reason they don’t support the FairTax is that we may end up with both an income and consumption tax, like Europe.  Yet they clearly state in almost every proposal, the business side of the flat income tax is designed as a VAT, while the personal tax is on income.  It is both!  One of the main reasons for this is to make business taxes border-adjustable.  If it remains a business tax on income, the WTO will not allow it to be border-adjustable, putting US companies at a disadvantage.  So they must divide their base into two parts, one on personal income and one on business sales for WTO acceptance.  Business taxes are then passed to the consumer, laborer or investor.  Now it could be worse of course, because some in Congress would prefer to add another level of taxation on business that raises the pass through even further.  But that doesn’t change the irony of stating what you fear and then supporting that fear in a hidden form.  And let’s be honest, there is nothing that prevents Congress from adding a more straight forward VAT on top of a flat income tax.

The transition requires grandfathering and will continue special interests lobbying of the tax code

                This will be a particular issue with business interests, but also a factor with mortgages interest and other items that are deductible today.  Changing the rules of the income tax midstream will damage many companies because of past depreciation rules, requiring some grandfathering and special provisions for certain companies or industries.  This leaves the gates wide open to lobbyists and a blank slate to “play” on.  This always favors large companies over small business.  All income tax plans leave some special political interests in place.  It is a necessity when starting with one base and attempting to change into the form of another. 

                Two of the flat income tax plans don’t ever end the current system.  Instead they give you a choice of the current plan or the flat income tax.  This leaves both the IRS and those lobbying the tax code in place. 

                If we agree the proper base is consumption, we should quit using the façade of income for “political concerns.” 

The flat income tax advances class division

                One thing too many people don’t understand is the reason to exclude savings and investments from taxation.  That stems from the definition of wealth.  We tend to think of money as wealth, but money is only a medium of exchange used to obtain wealth.  We don’t eat it, drive it, wear it, or sleep under it.  It is used to buy goods we want and services we need.  Those items are the real wealth.  Until we withdraw our money and use it for consumption, others are taking advantage of it.  While it sits in the bank, it increases reserves the bank used to secure loans for other Americans.  While it sits in investments, it is used by companies to buy equipment, build factories, and otherwise expand their business, providing jobs and opportunity for all.  When government taxes these savings and investments before they are used for personal consumption they are reducing the money available to other individuals and businesses.  It is only at the point of consumption that wealth can truly be taxed.

                Most flat income tax plans remove the taxation of savings and investments, but don’t tax the money as used for consumption either.  So those living off of existing “wealth” will pay no taxes at the point of earnings or consumption.  Flat income tax supporters claim “investors are taxed by taxing businesses.  The tax on businesses reduces the dividends and capital gains paid to those investors.”  There are two problems with that claim.  First of all, business taxes can be passed to consumers and laborers as well.  There is no study that says all business taxes are always passed to investors or even most. 

                While a corporate tax return may reflect taxes paid and therefore reduced earnings to investors, the real incidence of the tax could easily have been on workers who didn’t get the pay raise they expected, or consumers who paid a higher price for the goods than they would have otherwise.   The actual incidence of corporate taxation is invisible and only known in theory.  What we do know is that capital is more mobile than labor.  That would imply the costs of corporate taxation are quickly spread away from capital to labor and consumers.  Second, even if true, those living off of existing wealth would never face a direct tax or need to file a return as the laborer would.  Either way, those with existing wealth would be treated by the flat income tax as a special class apart and above the worker. 

Few Americans know what the flat income tax is

                That is certainly understandable when the supporters in Congress don’t even agree on what it is.  Every two years it seems the old versions are re-introduced along with some new version, each significantly different from the others. From my conversations, I’m going to guess at least 80% of Americans have something else in mind entirely different from any of the proposals.  Just ask a number of average flat income tax supporters in your community, what the flat income tax rate is and what is exempted.  Every answer you receive is likely to be different.  It is common to hear “I think everyone should pay 10% in taxes, no exemption, no deductions.”  That description is closer to the FairTax than any flat income tax proposal. They support a concept that doesn’t exist and will not be introduced.  They don’t support the flat tax proposals as written.  Again, I’m not saying no one knows what is in one of the bills, but most do not, and with so many versions, no one can guess what the accepted bill would be.

Summary

                As stated initially, I support the FairTax.  There is no tax system that is perfect, and that includes the FairTax.  But because the FairTax begins with consumption, it is much simpler to put in place, leaving fewer transition issues and a tenfold reduction in tax compliance cost.   

                Every change from the existing system will leave some feeling they might lose and others feeling they might win, yet we all agree we need change.  That change should create a system that is simple without the ability for government to use that simplicity against citizens.  It should treat everyone equally, yet provide for citizens to meet their own basic needs before those of government.  It should make the cost of government clearly and equally visible to all and create an environment that leaves little room for lobbyists and legislators to game the system in favor of certain industries or companies over their competitors. No current legislation accomplishes those goals better than the FairTax.