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Monday, March 20, 2006

Flat Tax

I attended a lecture today by Steve Forbes. For those of who don’t know anything about Mr. Forbes, he’s quite rich, runs Forbes Magazine, and ran for President in the Republican Primary in 1996 and 2000. His main issue was and continues to be to throw out the federal income tax code and replace it with a flat 17% tax. No itemized deductions, no tax breaks, no nothing, just a standard deduction for the first $46,000 you make.

After taking federal income tax last semester I became a flat tax convert, so I eagerly listened to what he had to say.

Here were some of his basic arguments:

  • The code is unbelievably complex and gets worse and worse every day. He pointed out that the Gettysburg Address was 200 words, the Declaration of Independence; 600 words, the Constitution; a few thousand words, the Bible; 700,000 words, and the tax code; 9 million words. A few years ago it was only 6 million words.

  • Since the code is so complex, the costs of complying with it are enormous. And no one really knows what they are taking about, even the so called “experts”. If you ask 45 experts about the same situation, you will get 45 different answers.

  • The tax code corrupts. Half of Washington exists just to get your company a tax break. Everyone wants to get ahead of their competition, so they try to influence tax policy to help themselves, often with absurd results. He gave a great example: A few years ago Congress passed some tax breaks for manufactures to help them out. It seemed like a good idea, to try to help out General Motors and other manufactures. But somehow Starbucks got into the tax breaks. Buried in the amendment was a 300 word footnote that defined “manufacturing” to include the “crushing of coffee beans”. That’s insane.

  • A flat tax will end up bringing in more money. Lower taxes in the end mean more growth which means more tax receipts. He cited examples where countries instituted a flat tax scheme and saw receipts skyrocket. Countries that have flat taxes include many Eastern European counties like Russia, Poland, Slovakia, as well as Ireland, which has gone from the worst economy in Western Europe to the best since they reformed their tax code.

  • He demolished the argument that a flat tax code with no deductions would reduce charitable donations. He said that it’s been proved time and time again that people give more money when they have more money, and give less when they have less. The tax code has hardly any effect.

The best part of the speech was watching my tax professor’s reactions to what Forbes said. Needles to say, she wasn’t smiling as he trashed her very existence for working.


I'm sympathetic to the flat tax in principle, but a couple of points about it:

Gross income would still need to be defined (It's not just salary), so things will not be quite that simple.

How would the flat tax handle business expenses and depreciation? I assume business expense would still be deductible.

Would there still be a Corporate Tax?

I believe that many of the countries that have seen a large rise in receipts have done so because of a jump in compliance. The U.S. already has a huge percentage of the population in compliance (filing returns annually), so that effect would be more muted here.

Good point on the special interest aspect of it all - my tax professor repeatedly made that point.

More random thoughts to follow.
Part of his plan would include the elemination of depriciation, he said that depriciation at this point is absurd and has no basis in economic realtity.

He defined gross income as as basically everything minus savings. Savings aren't taxed under his plan.

There would be a corportate tax at a much reduced rate.

Reciepts go up, not just from increased complience but from the general upswing in the economy that would result from a reformed tax scheme.
Further Comment:

Forbes's statement about charitable donations doesn't seem right - If its going to cost me to give $100 to charity instead of the $67 icosts me now, wouldn't I give less? Maybe not the full $33 less, but still, economically my costs should have an impact no? I don't see how you can have that much economic growth from his plan to offset the entire increase in the cost of charitable giving. Also - a good amount of charitable giving comes in the form of low-basis assets when the donation gets a step up. If there is no cap-gains tax, this goes out the window as well.

I assume by "Savings aren't taxed under his plan he means that there would be no capital gains taxes. Would this apply to interest income as well?

If he's eliminating depreciation does that mean that everything gets expensed? Since I don't see how you can get rid off business expense deductions altogether. If so, buying a capital asset would generate a huge immediate tax deduction - and I don't see how you would be taxed on the sale - unless basis would still be tracked even though depreciation was gone (I'm sure his plan addresses this to some extent - more wondering than objecting)

Ok - I think we've bored every reader of this site to death by now. Tax policy - slightly more exciting than watching paint dry!
A flat tax will end up bringing in more money.

Everything except the above sentence (which is debatable to say the least) could be solved just as easily by a simple progressive tax. i.e 17% for all income up to X dollars/year and 25% (or whatever) for any additional income.

I think it's kind of disingenous to conflate the "tax code is too complex" issue with the "we oppose progressive taxation" one.
Forbes is obviously not a proggesive tax fan, but he understands political reality. That's why his plan includes $46,000 standard deduction.

That's pretty progresive according to me.

Also, having a 17% rate up to X dollar and a higher rate for additional income is just not inline with his belief about what's good for the economy- We should be encouraging income production, and not penalize you for doing better than the next guy.

Tax rates influence people's actions- the extreme example is if the IRS taxed you %100 for work done on Monday and 0% for work done on Tuesday. Obviously soon no one would work on Monday even though the average tax rate is only 50%.
It's not penalizing and nobody's talking about a 100% rate on any income. The fact is, if you're earning $3 million a year, you can afford more than 17%. I would argue that in fact you owe more than 17%, since nobody earns money in a vacuum, but I suppose reasonable people can disagree about that.
Of course you can afford more than %17. If you're earning $3 million a year you could "afford" 40%, 90%, or even 10%. That's not the point. The question is - is it better for the economy to have lower or higher taxes? Forbes argues that it will improve the economy and thus tax reciepts will go up, despite the lower tax rate.
Pardon me if I'm a little skeptical of insanely rich people trying to keep more of their money by arguing that it will help the economy.
You have every right to be skeptial. That doesn't mean that it is or isn't true.
Well, sure, my personal skepticism doesn't affect the truth one way or the other.

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