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Thursday, June 01, 2006

The Flat Tax Yet Again...

Did you know that you aren't working hard enough? Once again, someone is trotting out the flat tax as a miracle cure for our ills. Impose a flat tax and people will work harder, save more, and the economy will take off and grow so much that taxes can be lowered even more -- the usual something for nothing promises that just happen to involve lower taxes for the wealthy. The twist this time is that the AMT is touted as a convenient means of implementing a flat rate:

An Accidental Tax Boon, by Robert H. Nelson, Commentary, Washington Post: Sometimes in Washington, good things are more likely to happen by accident... I'm thinking of one program in particular: the alternative minimum tax, or AMT.

The AMT is viewed by many as a bad thing. Yet, consider this: There is wide agreement among economists on the benefits of a federal "flat tax" on income that would apply a uniform rate to every taxpayer and eliminate most current deductions and tax credits. A flat tax would get rid of a large number of economic distortions resulting from the many tax "subsidies" that often benefit narrow interest groups. This is tax "pork," and Congress is as addicted to it as to the ordinary spending kind. ...

Tax revolutions are few and far between. ... That's part of the genius of the AMT. If it is left alone, it will move us gradually but steadily toward a flat tax on income... Some leading Republican conservatives have long advocated a flat tax. Yet few of them are speaking out vigorously for retention of the AMT. ...

Many Democrats are joining the calls for drastic cutbacks in the AMT. This shows a certain disregard for the fact that the existing system of tax subsidies is most generous to higher-income groups and does less for the bottom half of the income distribution -- their supposed constituency. ...

If the present AMT rates were applied as a universal flat tax -- and especially if the AMT exemption were reduced and certain remaining AMT exclusions eliminated -- the resulting federal revenue might even come to exceed current expenditure levels. The solution would then be to reduce the flat tax rate ... so that revenue and expenditures were brought back into balance. ...

I don't follow the logic behind the argument that Democrats should favor a flat tax because the rich get subsidies. If that's the problem, then eliminate the subsidies. In addition, it's possible to "eliminate most current deductions and tax credits" without giving up progressivity -- e.g. it's possible to have several different rates depending on income. This isn't the usual argument for a single rate anyway.

The argument for a single rate usually relies on a different types of inefficiencies besides those arising from deductions and subsidies targeted at rent-seeking special interest groups. The argument relies on two inefficiencies in the tax system. The first is that high marginal tax rates discourage people from working as hard as they might otherwise. Second, dividend taxes and capital gains taxes discourage saving and, along with the reduced work incentive, this harms economic growth.

However, as Paul Krugman notes in a 1996 New York Times commentary, the gains from overhauling the tax system are not large and could even be negative:

But how big would these gains be? ... The fact is that serious tax analysts believe that the net benefits from even a complete overhaul of the tax system would be modest -- almost surely less than a 1 percent increase in the nation's income, or about $60 billion a year -- and that while most people might gain, many would lose. In practice, the prospect of middle-class outrage means that schemes like the flat tax are usually sold with the promise of unrealistically low tax rates. And while a realistic flat tax might help the economy a bit, ... its promise to provide large tax cuts for the rich without any increases for the middle class would create a huge budget deficit, thereby doing the economy far more harm than good....

Then why propose a flat rate? Krugman has a theory about this:

I believe ... the political appeal of economic conservatism really has very little to do with the virtues of free markets. Instead, it is about the promise of something for nothing -- a rejection of the idea that taxes must be collected, that scarce resources must be conserved. The reason the electorate likes tax- reform schemes is that they always end up being tax-cutting schemes...

I'll add one more thing. People who work long hard days to support their families with little relief from the daily grind, some working multiple jobs just to survive might wonder why supply-side types think they are not working hard enough, that somehow a tax-cut would cause them to work even harder than they already do or allow them to justify saving more rather than meeting immediate and pressing needs. If the theory is not directed at workers, but rather at executives, CEOs, owners, etc., then they might also wonder why executives and others who are being compensated greatly for their supposed hard work and productivity need tax cuts as an inducement to work as hard as they must work day in and day out to support themselves and their families.

    Posted by on Thursday, June 1, 2006 at 12:06 AM in Economics, Policy, Politics, Taxes | Permalink  TrackBack (1)  Comments (37)


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    » AMT as a Stealth Flat Tax from Outside The Beltway | OTB

    University of Maryland economist Robert H. Nelson argues that the controversial Alternative Minimum Tax is a good thing because it is, in a sense, a stealth version of the flat tax. The AMT is viewed by many as a bad thing. Yet, consider this: There is... [Read More]

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