Flat Rate Income Tax: A Simple Solution Essay, Research Paper
The current income tax system is in terrible shape. It is complex; unfair; inhibits saving, investment and job creation; imposes a heavy burden on families; and undermines the integrity of the democratic process. It cannot be repaired by any tinkering or fine-tuning; it must be completely repealed and replaced. The U.S. income tax code is a monument to unnecessary waste. The income tax system is so complex, the IRS publishes 480 tax forms and 280 forms to explain the 480 forms. The IRS sends out eight billion pages of forms and instructions each year which, if laid end to end, would circle the earth 28 times. Nearly 300,000 trees are cut down each year to produce the paper on which IRS forms and instructions are printed. But the administrative costs of the tax system far exceed those borne directly by the IRS. Each year Americans devote 5.4 billion hours complying with the tax code, which is more time than it takes to build every car, truck and van produced in the United States. The cost of complying with the tax system totals about $200 billion annually, or $700 for every man, woman and child in America. Americans spend 5.4 billion hours complying with the tax code. The main reason the tax code is so complex is the proliferation of deductions, credits and other special preferences in the tax law. Because of these loopholes, taxpayers with similar incomes can pay vastly different amounts in taxes. This uneven treatment of taxpayers is fundamentally unfair and is at odds with the American value of equality under the law. The American people are beleaguered by the highest tax burden in American history. Taxes represent a larger share of the U.S. economy than ever before. As the nearby chart shows, the typical American family now pays more in taxes than it spends on food, clothing, transportation and shelter combined. The tax burden on families with children has risen dramatically during the last few decades. High taxes have fueled unparalleled growth in government. The U.S. public sector is now larger than the entire economy of any country in the world except Japan and the United States itself. The tax code reduces incomes through punitive taxes on saving, work and entrepreneurship. It places multiple layers of tax on saving, thus reducing investments in new machines and technology that make American workers more efficient and competitive. High marginal tax rates (the tax rate on the last dollar earned) discourage work, saving and entrepreneurial activity, which leads to a smaller economy. By favoring certain economic activities over others, the tax code distorts financial decisions and reduces economic efficiency. According to a study by an economist with the Congressional Research Service, the corporate income tax costs the economy more in lost production than it raises in revenue for the Treasury. Dale Jorgenson, the chairman of the Economics Department at Harvard University, found that each extra dollar the government raises through the current system costs the economy $1.39. The tax code does more than complicate people’s lives during tax season and reduce living standards. It pollutes Washington’s political culture. As special-interest provisions have been added to the tax code, Washington’s lobbying industry has flourished. Washington’s lobbying industry, which is the largest private employer in the nation’s capital, generates $8.4 billion in revenue each year. If the lobbying industry were its own economy, it would be larger than the economies of 57 countries. While the thousands of lobbyists in Washington have prospered in an environment of tax favoritism, the typical taxpayer has not. The flat rate income tax, proposed by Dick Armey and Richard Shelby (H.R. 1040) does away with the entire income tax code and replaces it with a flat-rate income tax that treats all Americans the same. This plan would simplify the tax code, promote economic opportunity, and restore fairness and integrity to the tax system. The flat rate would be phased-in over a three year period, with a 19 percent rate for the first two years and a 17 percent rate for subsequent years.Individuals and businesses would pay the same rate. The plan eliminates all deductions and credits. The only income not subject to tax would be a generous personal exemption that every American would receive. For a family of four, the first $35,400 in income would be exempt from tax. There are no breaks for special interests or loopholes, just a simple tax system that treats every American the same. The flat tax replaces the current income tax code, with its maze of exemptions, loopholes, and targeted breaks, with a system so simple Americans could file their taxes on a postcard-size form. The Tax Foundation estimates that a flat tax would reduce compliance costs by 94 percent, saving taxpayers more than $100 billion in compliance costs each year. The flat tax will restore fairness to the tax law by treating everyone the same. No matter how much money made, or what kind of business, people will be taxed at the same rate as every other taxpayer. Because the flat tax treats all economic activity equally, it will promote greater economic efficiency and increased prosperity. When saving is no longer taxed twice, people will save and invest more, leading to higher productivity and greater take-home pay. When marginal tax rates are lower, people will work more, start more businesses and devote fewer resources to tax avoidance and evasion. And because tax rules will be uniform, people will base their financial decisions on common-sense economics, not arcane tax law. According to one study by a former chief economist for Congress’ Joint Committee on Taxation, under the flat tax the economy would be 5.7 percent larger after five years than under the current system. That translates into $522 billion in higher output, or $3,000 in higher income for the typical family of four. Michael Boskin, a former chairman of the Council of Economic Advisors, estimates that the flat tax would increase the size of the economy by ten percent.
Because of the high tax overpayment, there is room to provide tax relief. And the flat tax would provide significant tax relief. When the rate is reduced to 17 percent in the third year of the proposal, there would be significant further tax reduction. The bill is carefully designed to safeguard taxpayers against a return to budget deficits, however. Rigid spending caps are included in the plan. Coupled with the additional economic growth the flat tax will spur, the tight spending controls will ensure that the budget reaches balance by 2002. Under the flat tax, the more you earn, the more you pay. In fact, because of the high family exemption, the more a taxpayer earns, the greater the share of his income he pays in tax. As the chart shows, a family of four earning $25,000 would owe no tax under the proposal. A family of four earning $50,000 would pay only six percent of its income in income taxes while a family earning $200,000 would pay 14 percent. The flat tax eliminates the marriage penalty and nearly doubles the deduction for dependent children. By ending the multiple taxation of saving, the flat tax provides all Americans with the tax equivalent of an unlimited IRA. This will make it easier for families to save for a home, a vacation, a college education or retirement. The flat tax trusts average Americans by giving them the freedom to make their own economic decisions. In addition, the flat tax includes a special safeguard against higher taxes. It requires a three-fifths super majority vote of Congress to raise the tax rate, lower the family allowance or add loopholes. By eliminating itemized deductions and special breaks, the flat tax would have a chilling effect on special-interest lobbying and transform the political culture in Washington. Under a simple, transparent system that taxes all income one time–and requires a super majority vote to add a loophole–there will be far fewer lobbyists than under today’s special-interest, free-for-all tax system. According to a study by an economist at the Federal Reserve Bank of Kansas City, published in the Kansas City Federal Reserve’s Economic Review, the flat tax would reduce interest rates by 25 percent, or about two percentage points. Lower interest rates under the flat tax will not only reduce the costs of student, car and credit card loans, they will also offset the loss of the home mortgage interest deduction. According to reports by the Congressional Research Service and the Tax Foundation, the flat tax will have no meaningful effect on home values. Consider how a sharp reduction in interest rates would affect the average family that earns $50,000 and deducts $5,000 in mortgage interest. The home mortgage deduction saves this family $750 in taxes, where a 25 percent drop in interest rates saves it $1,250 in lower interest payments. That family is $500 better off under the flat tax with lower interest rates–even without the home mortgage interest deduction (and not counting the higher personal exemptions). Also, as incomes rise under the flat tax, so too may donations to America’s charities. In Conclusion, the flat rate income tax is the answer to most of the problems in our income tax system today. It would greatly simplify the tax system, saving taxpayers and businesses immense amounts of time each year. Most of all, it would make the system fairer by reducing deductions, exemptions, and loopholes. If this bill is put into place, doing taxes would be a lot easier and fairer to Americans everywhere.