Flat Taxes

Economically, it doesn’t matter that much how the government collects taxes. The tax system is almost entirely political: for example, the separation of social security taxes from other taxes is supposed to protect social security from meddling.

So given that, let me make a political case for something like a flat tax. There is no point in taxing below poverty income, so let’s give each household an exemption at 100% the poverty line. Under my minimum income scheme it should rise to 150%, which is when the minimum income is completely phased out, but without that, 100% is better. Above that, taxes should be flat.

Now, here’s the trick: the level of taxation shouldn’t be predetermined. Instead, it should be indexed to government spending. Every fiscal year, the government should collect in taxes exactly how much it expects to spend, plus or minus any correction from the previous year.

It politically underscores the point that cutting taxes is equivalent to cutting spending, and raising spending is equal to raising taxes. The only way to cut taxes under that scheme is to find places to cut spending. It’s up to the tax-cutting politician to then sell cuts in government spending to the public.

In addition, it encourages a lean government that has relatively little waste. Cuts in the most important government services, like health care, social security, and education, will be felt too immediately to be popular. “I’m going to cut your taxes by ending public health as we know it” isn’t a positive political selling point. In contrast, cuts in large subsidies nobody knows about or cares much for will produce sizable tax cuts without too much political opposition.

The American conservative movement has spent a lot of money on trying to convince people that their tax money goes to means-tested welfare and foreign aid. If I remember correctly, Americans think foreign aid is about 20% of the federal budget and want it cut to 10%; in reality, it’s about 0.6%. When they screw the social safety net and can’t reduce taxes by more than a percent, they’ll start losing steam.

In times of recession, it makes sense for the government to run deficits. That’s perfectly fine; I’m not talking about writing budget balancing into any constitution, only about reforming the tax system by statute. When it’s necessary, the government can pass an emergency stimulus bill, pegging the tax level to the spending level minus some deficit. Because it makes it clear that legislators are voting for a deficit, it will be hard to abuse when it’s not economically necessary.

The one drawback I can think of is that in the US, the poverty exemption will require the flat tax to be rather large. If I’m not mistaken, to be revenue-neutral with respect to both the income tax and FICA, it will need to be in the low 40s, and to close the deficit it will need to be at least 45%. Although the exemption will ensure that the lower classes and most of the middle class will receive a tax cut, the higher marginal tax will make it appear as if taxes are going up.

Still, the principle is the same: there are no free lunches. If you want to cut taxes, you have to cut spending somewhere. If you want to cut taxes without cutting spending, you have to openly declare being for an unbalanced budget.

One Response to Flat Taxes

  1. Carlos says:

    I’m sorry, but your post isn’t entirely clear to me. Do you propose making all taxes flat, or just ordinary income tax?

    If you mean only ordinary income tax, what do you think of capital gains such as interest and dividends?

    Thanks.

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