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For
a number of years now, people have asked me whether I prefer a “flat tax” or a “fair tax.” Both are problematic.
The “flat tax” is
typically conceived as a
replacement for the existing personal
income tax. This is fine, but it ignores the payroll tax, which is really
just another form of income tax. So, it is
only half of an income tax reform.
In practice, quite a few countries have gone this route, beginning especially with Russia in 2001, and the results have been very good. These countries have generally replaced their income tax systems,
but have kept what amounts to relatively high payroll taxes.
I would like to see a top-to-bottom income tax reform,
which includes payroll taxes. Or, I should say, which does
not include payroll
taxes: I would like to see the payroll tax system eliminated entirely and integrated into a single income tax system. Neither Hong Kong nor Singapore, which are models of what can be achieved
with a flat tax system (or nearly so in Singapore), have a payroll
tax. The result is that taxation on the lowest incomes is very low,
and the overall system has a high
degree of progressivity despite modest top rates.
Hong Kong’s flat tax
system, with no payroll
or sales/VAT taxes, generates about 13% of GDP in revenue
per year, with a top tax rate of 16%. This is quite good, and shows excellent efficiency
and high compliance. However, 13% of GDP is still rather short of the 18.5%
of GDP that the U.S. Federal
tax system has generated
over the past several decades. So, we would have to decide either to reduce spending considerably — which might be
nice, but is a separate discussion — or
generate more revenue somehow.
Now we come to the
“Fair Tax,” a rather horrible name for a system which aims to generate all revenue from a single national VAT or sales tax.
This would be equivalent to a 30% sales tax
rate, as normally calculated
(exclusive method).
There are a lot of positive things to be said about the Fair Tax, especially
the elimination of the IRS and all of the intrusive
bookkeeping involved with the income tax. By maximizing the taxation
on consumption, we would be theoretically
minimizing the taxation on investment,
capital, and employment, with
potentially excellent results.
The problems are that many states already have a
sales tax (9.6% average
rate in 2010), which means that the combined rate would either be 39.6% or that states would have to generate income by some other means.
States also have income
taxes, which presumably would be eliminated
along with the federal income tax, thus generating
another revenue issue.
We end up with a rather impressively high sales tax rate, which raises the question of tax evasion — the higher the rate, the greater
the incentive for evasion
— and also the problem
of regressivity, putting the largest
burdens on the lowest incomes.
I have argued in the past
that conservatives should
adopt the principle of progressivity as much as
possible. The problem of “what
to do with the poor”
is as old as government itself. Instead of pretending the problem doesn’t exist, conservatives would do well to have their own, conservative-themed
solution. Democrats promise government
services and welfare, and we
should recognize that that has had some success.
So what should the
conservative solution be? Even
the most libertarian thinker can agree
that, if you have no better solution – don’t
take their money!
I conclude that the problem with the Fair Tax is
much the same as the problem with the Flat Tax — by itself, it can’t generate enough revenue without becoming a caricature
of the original principle.
Thus, it seems to me that the way forward would
be to combine each of these systems: a flat tax of about 16% with a basic
exemption that leaves the
lowest incomes tax-free; no separate payroll taxes; and a national sales tax
or VAT of perhaps 10%, which
would work out to more like 20% when you include state-level sales taxes. Yes, you would have some danger of rising tax rates over time, but every tax system has that danger.
Personally, I would go with a national energy tax instead of a national sales
tax: something in the realm of $1 per gallon of gasoline,
or the equivalent on natural
gas, coal and so forth. I calculate
that this would produce about $1,035
billion of revenue per year at
today’s rate of usage, or about 6.9% of GDP.
If we add that to Hong Kong’s 13%
revenue/GDP from its 16%
flat tax, we get 19.9% of GDP, which is pretty close to our 18.5% bogey. (In practice, higher
taxes on energy would result in less usage, so revenue would probably be a little lower.)
Yes, I know this is Al Gore’s idea. So?
One nice thing about an energy tax is
that it would reduce our reliance on foreign oil and environmentally-destructive energy
practices. The other nice
thing is that it is
easy to avoid – just use less energy. Those with the lowest incomes can find
a way to avoid much of it, by turning down their thermostat
and commuting by bicycle, while
those with higher incomes can keep their
heated swimming pools,
Range Rovers and private
yachts if they want to. Thus, I think it would have a natural progressivity, to counteract the regressivity inherent in a sales tax.
When you consider that people with lower incomes
would no longer be paying payroll taxes, would be partially
exempt from income taxes,
and would be able to easily avoid the energy tax, we
can see that their overall
tax burden could be significantly
reduced.
Another question is whether tax revenue of 26.9% of
GDP (federal, state and local) in the U.S. is really what
we want. Singapore gets by on 14.2% of GDP, but still
manages to provide all the services common to developed countries everywhere, including a universal health care system
for all citizens.
After experimenting with minimalist government in the 19th century,
and big government in the
20th, I think we will ideally migrate toward a solution that combines the best of both.
In simple numbers, it would mean tax
revenues of about 15%-20% of GDP. Let’s just take a midpoint
number of 18%.
Out of this 18%, about 6% would
cover state and local governments
(police, fire, schools, roads), and 12% would go to the
federal government. The federal budget would look something like this: 3% universal healthcare (the amount spent by Hong Kong and Singapore on their
universal healthcare systems), 3% senior income insurance (replacement of Social Security), 2% defense, and 4% everything else.
As the need to raise tax revenue diminishes, the tax systems and tax rates themselves can become simpler
and less burdensome.
Already Herman Cain is moving somewhat
in this direction with his “999 Plan,” which
he says is a combination of both “flat tax” and
“fair tax” ideas. I think it is still
a rather rough proposal,
but it is enough to start a discussion. Voters realize that, by the time it went through
Congress, some of the
more problematic elements
would be tweaked and fixed. The
important thing is that he would
be getting the process started. Maybe that’s why the pizza guy is rising in the polls?
Nathan Lewis
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