Beware the Flat Tax Sales Pitch
I had planned my next post to be about the work the Economic Policy Institute has been doing in the last few weeks, including an event on state and local budget relief and the release of a five-point plan for creating jobs and ensuring a robust recovery. But the recent post by YPNation contributor Ewan Watt on the flat tax is like a siren call to me, so respond I must.
Let’s be clear about what a flat tax would do. We currently have a progressive income tax, which means your effective tax rate (calculated as tax burden divided by income) increases as your income increases. Changing this progressive tax to a flat tax would cut taxes for the wealthy and raise taxes on the poor and middle class. I’m not editorializing here. By definition that is what would happen. Flat tax proponents don’t dispute this--they just choose to not mention it.
This is why I question Watt’s assertion that the flat tax “should form one of the central tenets of any prospective GOP platform on social justice." How raising taxes on the poor and middle class equates to social justice is beyond me. And if he means to only cut taxes on the rich and not increase taxes on the poor, this, of course, would lead to huge deficits, which if translated into budget cuts would also fall disproportionately on the poor and middle class.
Watt further claims that tax revenues will increase when you lower taxes, up to the point where the tax cut for the rich would pay for itself. Unfortunately, both economic theory and historical evidence say the opposite. Bush Jr. cut taxes on the rich, and revenue plummeted (adding about $1.7 trillion to the debt). The only reason rich people’s tax shares rose over time is because high earners are enjoying a larger and larger share of the nation’s income (so of course they would pay a larger share in taxes). This is a trend that started in the late 1970’s and continued through tax cuts and tax increases. High income taxpayers also paid more after the Clinton tax increases. It’s clear this trend has little to do with changes in tax policy.
Virtually no respected economist argues that lower marginal tax rates lead to higher tax revenues. Even the Bush Administration estimated its tax cuts for the rich would cost the Treasury about $1.5 trillion (pdf). Heck, even Bruce Bartlett, who was a staff economist for Jack Kemp, helped draft the Kemp-Roth tax cut, and later served as a domestic policy adviser to President Reagan agrees that tax cuts for the rich cost the government trillions of dollars. Bartlett also happens to support a flat tax, but in promoting it he sticks with economic arguments based on evidence, not faith.
Another claim you might hear from flat tax proponents is that it will somehow simplify the tax code and reduce loopholes. As anyone who has done his or her taxes knows, there are two steps to figuring out your tax liability. First, you need to calculate your taxable income. This means wading through a morass of deductions, exemptions, tax credits, and even a completely separate alternate tax system (the Alternative Minimum Tax). This step is either extremely difficult for taxpayers or, if you have a good enough tax lawyer, a great source of tax evasion and cheating.
The second step is then applying your marginal tax rates to your taxable income. This step takes about five minutes.
Flat tax proponents think a flat tax would somehow change the problems with the first step. But it wouldn’t! If you really want to make the code easier to comply with and more difficult to circumvent, then propose we eliminate tax deductions, exemptions, loopholes, and other tax preferences we give to individuals and businesses. You don’t even need to pair it with a flat tax, we could do it now. In fact, the political system does periodically clean up the tax code, which, inside the beltway, is called “comprehensive tax reform”. We most recently did it in 1986, and President Obama has proposed we do it again before the end of his first term. But it has nothing to do with tax rates.
Tax policy is a difficult and complex topic. But whenever I hear people advocate for the flat tax, it really just comes across as a Billy Mays pitch: It lowers taxes! It grows the economy! And it won’t cost the government a cent! The bottom line is if you hear about a policy that’s too good to be true, it probably is.
(Image by Sharese Ann Frederick)
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Ethan got told...
Flat tax for all
There are many proponents of a different form of flat tax. I believe in a flat 10% income tax above the poverty line, up until one hits three times the median cost of living in their area, beyond that there is a flat tax of 46% on all income above 3*COL.
I've grown accustom to your
I've grown accustom to your arguments - a fine balance of playing both the man and, occasionally, the ball. Not a school of debate I'm totally familiar with, but here goes...
Where to start.
I'm a tad perplexed that you would claim that "virtually no respected economist argues that lower marginal tax rates lead to higher tax revenues". So you're basically saying that the supply side movement never existed? Art Laffer? Did lower marginal rates not lead to increased revenues after taxes were cut under Kennedy, Reagan and Bush?
Yes, it would cut taxes for the wealthy (l'horreur!) but also add an incentive to stop wealthy individuals from off shoring and avoiding taxes, thus raising more revenue. I would also contest that this tax would be a burden on the poor. Amalgamating corporation, social security and payroll taxes into a single tax will actually help the poor through job creation. The cost of hiring is cut, and the cut in marginal rates increases bring home pay, creating an incentive for more productivity, innovation and higher wages. Higher payroll taxes stymie wage growth. More jobs help the poor. Obviously this position is advocated by those of us who want the poor to actually work and be independent of the state. It's also worth noting that last year earners over $100k were not subject to pay roll taxes - is this not regressive?
If we want to talk about a 'progressive' tax that hurts the middle classes, how about the AMT? 11m more Americans are going to be hit.
Regarding the Bush tax cuts, federal revenues exploded from 2004-2007 by $785bn. Even if they did pay more in tax because they were enjoying a large slice of the pie their share of taxation also increased. Surely this is a good thing? I also find your sudden concern about the deficit alarming, especially given your previous calls to increase the deficit through yet more stimulus funds.
Furthermore, just look at the boom in household net worth that proceeded the tax cuts. This was party down to the cuts in capital gains, investment in infrastructure and dividends. For one thing, it's a little alarming that you state that the "this trend has little to do with changes in tax policy." How? On what evidence? What else spurred the growth? So the boom from 1983 onwards was just a fluke? The increase in real median income was created by an act of God?
I certainly disagree with you on this, but I would never accuse you of supporting these policies on "faith".
I guess the "comprehensive tax reform" you speak of really depends on who's in government. As I already stated, the level of US corporation tax will struggle to keep the US competitive. Thus, we need more business friendly policies, not less. That's why I support removing these "preferences" and implementing a flat, transparent rate. Again with the "eliminate the loopholes". Whenever I speak to people who work in accountancy they'll say that closing a loophole is like a new challenge for them and near impossible to actually implement. So, as I've said, the solution is to make the tax system so simple and transparent the wealthy will no longer resort to tax avoidance.
I understand tax policy is a "difficult" and "complex" topic, and feel a little confused as to why you feel compelled to share that little tidbit with the rest of the world.
The Billy Mays analogy is interesting because from my experience the products actually work and make life just that little bit easier for millions of people. If that's what you think of the flat tax, then we're clearly on the same page.
*Sigh*
I think you’re missing the point of supply-side economics. Basically, supply-side economics says that marginal rates matter for long-term economic growth, and that by lowering rates, especially on the wealthy, we can induce more work and investment, thus boosting productivity and growing our economy. That is supply-side economics in a nutshell.
Recently tax cuts advocates have begun to argue that all tax cuts pay for themselves. When I hear this, I find it difficult to keep playing the ball because I wonder if the person saying this really is misinformed or knows perfectly well that they are wrong and is just trying to sell tax cuts. I’ll give you the benefit of the doubt and assume you don’t fall into the latter category.
That is not to say that tax cuts do not play a role in boosting economic growth, which then can be taxed. So let’s say you cut taxes by 10%--static analysis would assume then a 10% drop in tax revenues. What supply-side economics brought to the table was the insight that marginal tax rates matter to economic growth, and by cutting marginal rates, people have a greater incentive to work, and that work can then be taxed. So there’s a revenue feedback—but it’s not 100%, it’s probably anywhere from 0-30%, although it completely depends on what kind of tax is cut and whether it’s a temporary or permanent tax cut. Greg Mankiw, Bush’s Chairman of the Council of Economic Advisers, wrote a good primer on supply-side feedback effects from tax cuts, I recommend you check it out. The CBO (at the time controlled by Republicans) also did an estimate of those feedbacks from a 10% cut in federal income taxes, and found a 1 to 22 percent budgetary offset in the first five years and as much as 32% over the next five years. Keep in mind I think this is a very optimistic view (it was authored by Doug Holtz-Eakin, later McCain’s economic adviser), and there’s an argument to be made that a person will actually work less if their taxes are lowered because they don’t have to work as hard to get the same take-home pay. I also highly recommend reading Bartlett’s piece in the National Review (I'd include the links to all these references, but apparently you can't hyperlink comments).
A few more points:
1) You said the “progressive” AMT hurts the middle class. It is in fact a flat tax (about 28%). Labeling this a progressive tax is hilariously wrong.
2) The boom from 1983 onward was the fact that we were coming out of a recession! Isn’t it peculiar that you used 1983 as the beginning of your window, when the tax cuts were first implemented in 1981? In fact, in 1983 Reagan RAISED taxes to negate about a third of the ’81 tax cuts. And more had to do with the fact that Volker cut the federal funds rate by over half between ’81 and ’83, which had been high to break the back of the inflation in the 70’s.
3) You also didn’t mention that during the 80’s, the deficit and national debt more than tripled.
4) Comparisons to Kennedy and Reagan are attractive, but of limited use. Kennedy cut the top rate from 90% to 70%. Reagan cut it from 70% to 50%. They’re now at about 35%, slated to go back up to 39.6%. So the overall levels of the taxes—before and after the cut—matter because it determines where on the Laffer Curve you are. Was 90% too high? Yeah, probably. Is 39.6%? Doubtful. So no, Kennedy wasn’t a supply-sider, and his tax cuts didn’t prove that all tax cuts pay for themselves, just those that are cut from 90% to 70%.
5)You are right that past the $100,000 mark the payroll tax becomes regressive. Great, you just made my point that only the income and corporate tax is actually progressive, but the payroll tax isn't. In fact, if you total up all federal, state, and local taxes, you'll find that the total national tax rate is pretty much flat. The top 1% pays a 32.8% effective total rate, while the bottom 99% pay 29.4%. I can send you that link too if you're interested. But in other words, making the income tax flat would make the overall tax structure highly regressive.
Look, I’m not saying that there isn’t a valid case to be made for cutting taxes for the wealthy. I don’t buy it, but there’s surely a case there. But you’re WAY overstating it.
Even more...
Ok, I feel the previous comment might be seen as too much "playing the man". Let me make sure I've addressed your substantive points too:
1) You keep saying things like "Regarding the Bush tax cuts, federal revenues exploded from 2004-2007 by $785bn". But you're basically taking two points in time (selectively too, because most of the cuts were in 2001 yet your window doesn't start until 2004) and assuming they are related. You do understand that correlation isn't the same as causation, right? I mean, I could play the same game too! OK, lemme see if I get it right
"Clinton raised taxes in 1993 and then revenue grew by $870 billion AND the economy grew at an average 5.7%! That must mean tax increases boost revenue and economic growth, right?"
See, isn't that persuasive? But it's not evidence. There's much more to the economic boom of the 90's than just higher taxes. Like the internet, and globalization. Hell, it wasn't even all higher taxes--some taxes, like the capital gains tax, were even lowered, while others, like the income tax were higher. And between 2004 and 2007, wasn't there a housing bubble or something going on? Didn't we all then realize that that growth was unsustainable and based on monopoly money and fake prosperity?
My point is that there are a lot of things going on in an economy all at once. To use as your evidence that one caused the other because it came after the other and "makes sense" really isn't what I would call a solid argument.
2) Besides, you're 2004-2007 figure: is that inflation adjusted? Is that a total or the average yearly increase? Wouldn't it be better to use a percentage increase, because using dollar amounts means nothing to someone who doesn't know the overall starting level of budget receipts? By the way, according to OMB federal receipts increased by $688 billion, not $785 billion. Where did you even get that figure?
3) My comment about AMT being a flat tax was a cheap shot, but seriously, your argument was totally incomprehensible. So basically you're arguing that because the AMT is progressive (it isn't!) and middle class families are affected by it, then the middle class don't do better under progressive tax structures? If that's your argument, you're really not understanding how the AMT works. Right now it's hurting the middle class not because it's progressive, but because it wasn't index to inflation so it starts applying to more and more households that were previously excluded from it. It has absolutely nothing to do with the tax rate--hell, it could be a head tax and as long as it weren't indexed to inflation it would be increasingly painful to middle class households. So I don't really know how to respond to your argument because I really can't tell if that was a serious argument you were making or if you just were being cute. Either way, it's pretty wrong.
4) I just want to reiterate what I said about the Laffer Curve. Remember, it's a curve, so whether the budget feedback is high or low depends on where you are in the curve. If you're to the right of the curve, then revenue increases as you cut taxes. If you're to the left, it decreases. That's why I said that the starting level matters, so it matters that before Kennedy cut taxes the top rates were 90%, and before Reagan cut taxes they were 70%. That's why those examples (especially Kennedy!) aren't really analogous, and why I'm perplexed that you think all tax cuts pay for themselves. What if we had a 20% rate and you want to cut to 10%? Would that pay for itself? What about 10% to 5%? At what point do they stop paying for themselves?
A recent report out of the NBER (http://www.nber.org/papers/w15343) estimates that we're far on the left side of the curve, and could actually raise labor taxes by 30% and capital gains taxes by 6%. Only Denmark and Sweden have taxes so high that tax cuts might actually pay for themselves.
In concluding, I quote Alan Reynolds at the FREAKIN' CATO INSTITUTE: "No economist ever claimed that all taxes are so distortionary that increasing any tax rate would reduce revenue. Art Laffer never said that. Bob Mundell never said that. Larry Lindsey, Larry Kudlow, Craig Roberts, Steve Entin and Bruce Bartlett never said that. I never said that." He says tax increases and revenue reductions, but the same applies in reverse.
And here's Reagan's first budget director, David Stockman, who helped craft Reagan's '81 tax cut: "[T]he whole California gang had taken [the Laffer curve] literally (and primitively). The way they talked, they seemed to expect that once the supply-side tax cut was in effect, additional revenue would start to fall, manna-like, from the heavens. Since January, I had been explaining that there is no literal Laffer curve."
Manna from heaven. RIGHT.
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