Why We Don't Need a Flat Tax

Why We Don't Need A Flat Tax

By Professor Holley Hewitt Ulbrich
1998

The flat tax idea, which surfaced in the early 1980s, is now a hot political campaign issue. But today's proposals look a lot like the original income tax, passed during World War I, with low rates and large exemptions.
Rates rose sharply to finance World War II, but Congress has been cutting rates and reducing the number of brackets ever since. These changes have been welcomed by most Americans. But just because a flatter tax has been better, it doesn't follow that flat is best.
A flat tax, as defined by most proponents, exempts a large base amount of income. The base exempt amount replaces the personal exemption and standard deduction. All income over that amount of the exemption is taxed at a single rate. Some flat tax proposals have no exceptions to the single exemption, single-rate provisions. Other versions retain deductions for mortgage interest and some charitable contributions. Republican presidential hopeful Steve Forbes' much publicized proposal of a $36,000 exemption and a 17-percent flat rate is in the first group. U.S. Senate Bill 488 is an example of the second type. It provides a lower exemption and a higher rate than the Forbes' proposal and offers some limited deductions in addition to the base amount.
The first problem with a flat tax has to do with rates and revenue. Neither the Forbes' proposal nor S.488 will raise as much revenue as the current income tax. Some critics claim that Steve Forbes' proposal will cut federal revenue by $200 billion a year, which is about one-sixth of the tax revenue raised by the personal income tax. Right now, for a family of four the base exemption is about $16,000. Above that amount, income is taxed at a rate of 15 percent, rising to to 36 percent for higher earners. If there is a high-base exemption, rescuing the average Joe from income tax, then that single flat rate would have to be a lot higher than 15 percent to raise enough revenue to finance the federal government.
A flat tax makes a false claim of greater simplicity. For most people who work for wages, pay by withholding, and fill out 1040A or 1040EZ the income tax is already simple. It's complicated for self-employed people because they have to keep track of their business expenses, but that won't change under a flat tax. It's complicated for higher income people, some of whom derive income from investments as well as work, because they want to take advantage of all the loopholes written into the law that ensure that they pay considerably less in taxes than the rate schedule might suggest. When legislation actually comes to the floor of Congress, special interests are going to try to get the lower flat rate without sacrificing their tax preferences that they worked so hard to get enacted in the first place.
The claim of greater fairness also rings hollow. Most observers who have studied the flat tax have concluded that it would result in a tax windfall for the very wealthy, with the tax burden shifted to the middle and lower income groups. The income tax as presently constituted has an important and useful role to play in the overall tax structure. It's at least somewhat progressive, taking a higher share of income from higher income households.
That quality helps to offset the unfairness of sales and excise taxes, mainstays of state and local governments. The jury is still out on exactly how the burden of property tax is distributed, but a case can be made that it falls more heavily on the lower to middle income groups. Social security taxes fall on wages, not on other income, and income in excess of $60,000 is exempt. So, these other taxes are all somewhat regressive, meaning the burden falls most heavily on the less well-to-do. The income tax in its present form plays an important balancing role in the tax system that would be lost under a flat tax.
Actually, we've been moving a bit in the direction of the flat tax for quite a while now. Rates are lower and fewer than they used to be. The personal exemption and the standard deduction have been increased. The itemized deductions have been chipped away at over the years. First to go was deduction for the gasoline tax. Then the state sales tax. Then interest on most loans, except for mortgages. Then Congress increased the amount of medical expenses and employee business expenses that must be incurred before deductions can be taken. So the average family has lost a good share of its itemized deductions, a piece at a time, while a higher standard deduction encouraged many taxpayers to give up itemizing. A basic principle in economics concerns increasing marginal cost or diminishing marginal benefit. In plain language, that principle means that a good thing doesn't get better by pushing it to its logical extreme. Logical extreme is what a flat tax would be after years of lowering tax rates and constricting brackets.
Americans have seen some important changes in the income tax over the last 30 years, beginning with the 1964 Kennedy tax cut. These changes have moved toward a larger base exemption, fewer and lower rates, and simpler tax filing for the great majority. The system can still stand some further tinkering and refinement, but a flat tax is an idea that needs to be sent back to the drawing boards.
Holley Ulbrich is coordinator of Community and Economic Development at the Strom Thurmond Institute of Government and Public Affairs at Clemson University where she is Alumni Professor of Economics.

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