Skip to content

Why a flat tax is a bad idea

2010 February 5
by Ian Welsh

An acquaintance asked me about this. Here’s the quick answer.

Virtually every tax in the US is regressive except income tax.  That is,the more money you make, the less money you you pay as a % of your income.  If you replace income tax, the only progressive tax (one where if you make more you pay a higher percentage) then you will have a strongly regressive system.  (The system is probably effecitively flat already when you add all taxes/fees together).

Not only does regressivity hurt poorer people, it reduces demand and it increases income inequality.  Income inequality is heavily correlated with all sorts of bad outcomes including lower lifespans, higher infant mortality, lower happiness and so on.

Lack of high level progressivity is also a major reason for the financial crisis.  What should be done instead of a flat tax is to tax all income over a million at 90%, all income over 5 million at 95%, closing loopholes and so on.  It is not a coincidence, or an accident that the US was highly progressive in the 50s or 60s, nor is it an accident that the countries in the world with the happiest citizens (aka. the nordic countries) have high tax rates.

The current system is not fair because of loopholes and special treatment, not because it’s progressive.  Those loopholes could be changed under any new tax system, whether highly progressive or flat.

14 Responses
  1. February 5, 2010

    Bring back Reagan, or better yet, FDR.

    If you want to know why the US is in decline, see here:
    http://www.truthandpolitics.org/top-rates.php

    Symptom, no cause.

  2. DWCG permalink
    February 5, 2010

    90% is a bit too “socialist” for some.

    55-60% for over 5 million and 50% over 1 million I can see folk living with. Couple it with a small cut in those making between $25-65K a year (the vast majority of Americans) and you’ve got an electoral winner.

    Add to that a release in the caps or create a tiered system on the wage taxes (Social Security and unemployment) thereby lowering them for everyone, go after the dividends and stock transactions, and yank up the estate tax (WTF ever happened to “not being able to take it with you?”). Then maybe we could begin talking about making public university free, universal health insurance, and creating a 21st century infrastructure.

  3. Ian Welsh permalink
    February 5, 2010

    Don’t negotiate with yourself. Start with 90% and be willing to move down, but never suggest upfront that you want less, because you won’t get it.

    Moreover, no one who would be against a 90% tax rate in Congress wouldn’t also be against a 60% rate, there is no marginal cost for asking for 90%.

  4. February 5, 2010

    If anyone wants to know just how regressive, wander by ITEP; they break it down, state by state.

  5. tjfxh permalink
    February 5, 2010

    The government should act with a purpose rather than arbitrarily. In a fiat system such as now exists, a monetarily sovereign government is not financially constrained in currency issuance and doesn’t need to “fund” its disbursements with taxes or “finance” its deficits with borrowing, unlike currency users, like households, firms and states in the US (and countries in the EU).

    A monetarily sovereign government such as the US government increases the net financial assets of non-government by disbursing funds through currency issuance and withdraws net financial assets through taxation. Debt issuance simply shifts the commercial banks’ reserves at the central bank that were created by government disbursements to another asset form, namely, government securities, draining excess reserves, which allows the central bank to hit its target rate in the interbank overnight market.

    This leads to the two principles of functional finance that Abba Lerner enunciated: 1) the government should only issue currency through disbursements to increase non-government net financial assets (NFA) and only tax to reduce NFA. 2) The government should only use debt issuance as a monetary operation to clear excess reserves, which is desirable if the central bank does not offer a support rate on reserve equal to its target rate.

    When this is understood, it becomes clear that the government has the prerogative and corresponding responsibility to manage the currency by injecting and withdrawing NFA in the proper amount to balance nominal aggregate demand or spending power with the real output capacity of the economy operating at full employment, neither injecting too much, so as to generate inflation, nor to little, so as to produce deflation and a consequent recession, with rising unemployment.

    Automatic stabilizes do this to a great degree, progressive taxation reducing NFA as the economy approaches full capacity, while the safety net and progressive taxation increase NFA as the economy contracts. Ideally, automatic stabilizers are all that is necessary if properly designed, because this removes the messy political process of adjusting fiscal policy.

    The central bank’s monetary policy is chiefly driven through its control over interest rates, which it uses to adjust the amount of bank money created in the commercial banking system through credit extension (loans create deposits). Everyone’s bank money is someone else’s loan, so all bank money nets to zero. The commercial system cannot increase of decrease non-government net financial assets.

    Fiscal and monetary policy that are arbitrary or ad hoc generally fail to balance nominal aggregate demand with real output capacity, so the economy swings between boom and bust.

    Looked through the lens of how the present system works, fiscal policy can be addressed appropriately. There is still room for more conservative and more liberal approaches to the details, e.g., the balance of disbursement to taxation and the % of the real output that the government should be directly involved with. But at least the debate will be on a sound footing instead of myths and idoelogy.

  6. John permalink
    February 6, 2010

    I think that the popularity of the flat tax arises from two motives. The ignorant who support it do not understand the regressive/progressive issue of taxation,but are drawn to the simplicity of the flat tax concept and equate simplicity with fairness. As in “everybody pays the same “.
    The oligarchs who support it, understand the issue very well and want it for their benefit.
    I would like to see progressivity in taxes partially achieved through a Tobin type tax on all financial transactions…and present it as just another sales tax like people are accustomed to paying. The everyday person is quite used to paying sales taxes and because of their simplicity are seen as ‘fair’
    Of course, the financial community will fight this tooth and nail. Given the banksters popularity now, it might be a good time to press for this. And it might also help to slow the flow of hot bubble inducing money.
    What would be the down side of such a tax?

  7. anonymous permalink
    February 6, 2010

    My job revolves around income taxes, so I get this kind of stupid questions all the time. Don’t answer them. It’s just a waste of time and breath. I use the edit/find/replace feature in my head. When they say “Don’t you think the flat tax would be much fairer?” I hear “I’m profoundly stoopid and intellectually lazy. Please never bother to aknowledge me again.”

  8. dude permalink
    February 6, 2010

    Well, as long as we hve come to accept corporations as people, tax them at Ian’s rate too, no exceptions.

  9. February 6, 2010

    We don’t have to argue from weakness on this point.

    The fact is that people who own more assets (property, stocks, bonds, CDs, etc.) use the functions of government more than those who own fewer assets. The court system, fire and police protection, roads and public transportation, even the education of those who work for their companies are much more important to them than to the less affluent.

    I broached this idea to Bill Gates, Sr. once at a meeting where he spoke for the Responsible Wealth Project, and he agreed with me. He said that instead of calling it a progressive tax, we should call it a proportional tax.

    Carolyn Kay
    MakeThemAccountable.com

  10. February 7, 2010

    What amazes me is that when people talk about this, they seem to have no idea how simple a progressive tax is to calculate. I tell them that it’s not the progressive nature of income tax that makes it complicated, it’s all the rules designed to shape how the economy works, like exclusions for municipal bonds but not other kinds, that sort of thing. Any eighth grader who can’t calculate a progressive income tax for a given income level needs to stop sleeping in class.

  11. Ian Welsh permalink
    February 7, 2010

    I once saw a Canadian income tax form from the early fifties. It was one double sided page.

  12. February 7, 2010

    The 1040NREZ form in the USA is kind of like that. Not that I would know or anything.

  13. February 8, 2010

    “90% is a bit too “socialist” for some.”

    “Some” are flat earthers. “Some” don’t “believe” in evolution. “Some” think we launched a dozen Saturn V just for show. “Some” cannot be part of any reasonable discussion for a sustainable, open society, because “some” will doom themselves, their children, and the innocent.

    As a marginal tax, 95+ percent is just right. The question is only, where is the threshold – how much income is taxed at (much less) than 95+ percent?

    They want 5 million? I give them 5 million. They want 10 million taxed at less than 95+ percent? OK. Just where would “some” draw the line? 100 million? 500 million? An annual billion? Two? Fifty years worth of minimum wage income?

    I think of inheritance as income: where is the threshold for inbred wealth? I would settle for a 100% tax on all inheritances and gifts above a lifetime limit equivalent to 50 years of minimum wage income. If this is to be a society based on merit, and an open society concerned about political power accruing at compound interest rates, then I think free university education and Fed-rate business startup credits in exchange for a hard limit on inbred wealth are perfectly reasonable propositions.

    Socialist? I have been told that 30 days of vacation, paid sick leave, the 40 hour work week, prohibitions on child labor, and cost of living adjustments are “socialist”. Yes, the USA is not a socialist country. That much is obvious. What is not so obvious is what concept, theory, philosophy or simply roadmap *is* the national consensus – possibly because there is neither one nor the other.

    So maybe “some” see it as “socialist or dead”. They need to make a choice, and they need to understand that their choice – or their dodging it – might result in their descendants pissing on their graves.

  14. February 13, 2010

    You left out my favorite reason: Because people with vast wealth have the power to corrupt the system in a way that ordinary earners do not and against which even the other 99% of the country together cannot fight back.

    It’s not simply a matter of getting the money from the people who have it, or “fairness”, or making the people who really get the most use out of public resources pay for them (Caro is quite right about that) – it’s quite specifically a matter of not letting anyone get that rich and powerful.

    The government is the only weapon the 99% have to protect ourselves from the predations of the 1% – but billionaires can bribe their way through the whole government and take it over before most people know it has happened. Such immoral levels of wealth are more powerful and more dangerous to a society (and its neighbors) than any nuclear device.

    No one should ever even be a billionaire – those kind of people simply have too much money to burn and are usually so insulated from what for the rest of us is reality that they don’t even remember what sort of effect the damage they are doing is having.

    Allowing wealth to accumulate in a small number of hands is a weapon of mass destruction against the society that permits it. Period.

Comments are closed.