The Flat Tax vs. the Fair Tax
If there’s a positive to the leftward economic lurch among our political class, it has to do with the certainty that the imposed initiatives will fail. No matter the political party or supposed ideology overseeing it, when politicians seek to share the gains of the productive, their efforts come up short. Simplified, collectivism applied is collectivism’s capitulation.
So while there’s good reason right now to be pessimistic, there’s also reason to be optimistic given the certainty that we’ll eventually move in the other direction. On the tax front, whatever the result of President Obama’s attempts to move the cost of success upward, his efforts insure a strong response from those eager to simplify the income tax, or abolish it altogether.
When it comes to tax simplification, the debate seems to come down to the merits and demerits of the Flat Tax and the Fair Tax. The former would tax income at one flat rate, while the latter would tax our consumption.
At first glance, it should be said that both tax solutions are dreamy when we consider their economic implications. Both, if applied correctly, would lead to the abandonment of all manner of deductions that distort behavior and retard economic growth. If either were passed, the economy would no longer suffer under economy enervating incentives that cause people to plow money into sinks of wealth like housing, not to mention the purchases of federal and municipal debt that would be much less attractive absent their tax advantages. For the abolishment of the various deductions alone, the economy would boom given the more rational path that capital would take in the direction of productive investment.
Regarding the flat tax, its greatest appeal is its simplicity. As its most prominent advocate (Steve Forbes) frequently notes, under a flat tax individuals could calculate what they owe the federal government on what would amount to a postcard. The potentially greater unseen here would be the economic boost that would result from smart minds producing, rather than evading the tax collector, not to mention all the money formerly consumed on lawyers and accountants that would flow into the productive economy.
Assuming these taxes weren’t withheld, but instead were paid on a monthly or quarterly basis, the dynamism of the flat tax would be even greater. Indeed, one problem with tax withholdings is that individuals don’t as much feel the sting of writing a check to the federal government with regularity. If this were to be implemented under a simplified tax code, Americans would become intimately aware of the cost of government, and hopefully ask for less of it in return for lower tax bills.
The obvious negative of a flat tax has to do with the basic truth that taxes on income are a price put on work. Work is penalized when income is taxed. And while the most productive among us would presumably embrace with vigor a lower, flatter rate, there is the problem that usually materializes under low rates of taxation whereby the rich provide the vast majority of federal revenues. In that case, it seems a flat tax perfectly applied would include a ceiling after which the rate would go to zero.
Considering a consumption tax, or what its advocates call the Fair Tax, if applied correctly this is surely the ideal tax. Rather than a system that penalizes work and savings, we should have a tax that only shows up when we consume. This would insure that more money would be saved and flow to productive investment, plus with each purchase, Americans would see up close the horrific cost of government.
It’s pointed out by many that a consumption tax would be more equitable for those in the underground economy paying their share of taxes given the difficulty of evading taxes assessed at the time of purchase. On its face this is a positive, but it could be argued that we shouldn’t cheer big increases in government revenues. We shouldn’t because rather than save those revenues for a rainy day, governments invariably use revenue spikes to create new programs that are difficult to sunset. Higher revenues could well be the result of flat or fair taxes, but this wouldn’t necessarily be a good thing.
Naysayers suggest that a consumption tax is regressive due to the reality that the poor almost by definition consume more of their total income. But those naysayers speak with a forked tongue. Indeed, out of one side of the mouth they decry regressive tax rates, but out of the other they frequently wail about what they deem the ‘wealth gap’.
The problem there is that the only way for an individual to amass wealth is if that individual saves. The beauty of a consumption tax is that it would drive incentives among the non-rich to save more, and in doing so, build their wealth. The alleged regressive nature of taxes on consumption would in fact reduce gaps in wealth. It says here the wealth gap is not a problem – if anything it’s a positive for the risk taking it engenders – but if a reduction of wealth inequality is the goal, a consumption tax is the answer.
Another potential negative of a consumption tax involves the certain frenzied lobbying that would ensue for exemptions. With “our children’s future” used as an excuse, the education and book publishing lobbies would seek exemption from the tax altogether. Following them outside the office of each legislator would be the lobbyists for every weak industry in the United States (think carmakers, airlines, newspapers to name three) looking for similar exemptions. The good would likely outweigh the bad, but it’s not unrealistic to fear that the imposition of a consumption tax would also lead to a process whereby exemptions would serve to prop up the weak, thus blunting the healthy process of Schumpeterian “creative destruction.”
Despite the negatives mentioned about both taxes, assuming either were a possibility, it would be foolhardy to let the perfect be the enemy of the good. At present, our wildly complicated tax code saps our productivity all the while driving massive amounts of precious capital away from the productive economy. Be it the Fair or Flat tax, either one would drive massive economy-wide gains alongside large wage increases for all.
So while things may look bleak today, the looming failure of our bipartisan flirtation with collectivism means that somewhere down the line there will exist the opportunity to right our economic course. Here’s hoping that when that day comes, the coalitions are in place to push through the very tax simplification that would forever discredit the impoverishing notion suggesting we’re better off economically when we penalize the work and savings of the productive.