For example, in 1997 Money took a survey of forty-five different tax professionalsi. They were instructed to figure the tax amount for a fictional family. When the survey was finished, Money had forty-five different results, with differences up to $50,000. None of these totals were the same result Money had figured. The Internal Revenue Code obviously has some problems. How can they be fixed? The simplest and most productive alternative is the flat tax. A flat tax would be greatly beneficial to both the citizens of the United States and to the country’s economy.
The income tax began long before the 16th Amendment was enacted. It was first used in this country to help pay for the Civil War, as Lincoln levied a tax with two brackets, 3% and 5%ii. The brackets were different levels of income tax paid by individuals based on their yearly earnings, and brackets are still used in the current system. Lincoln’s tax was in place until the end of the war, when it was dropped. However, it opened the door for future income taxes. The federal government levied an income tax again in 1894. It was small, and only incomes over $800 were taxed, but it was still a departure from the tax system of the Founders. The Supreme Court recognized this when it declared the law unconstitutional in 1895; however, the decision was reversed by the 16th Amendment in 1913, and the income tax has been in place ever sinceiii. The brackets have varied widely, from the beginning rate of 5% as the lowest bracket, to an all time high of 95% as the highest bracket during World War II. In 2004, the lowest was 10%, and the highest was 35%.
Is this system what the Founders intended? Thomas Jefferson said, “Having already paid its tax as Income, to pay another tax on the thing it purchased, is paying twice for the same thing; it is an aggrievance on the citizen, and contrary to the most sacred of the duties of a government.”iv Given the noticeable fact that they did not use an income tax when setting up the new government, it appears that the current system was not at all their original intent.
The Internal Revenue Code obviously has many problems, not the least of which is its complexity. While the Constitution itself has only some five thousand words, the Code has nine million. There are numerous loopholes, exemptions, and deductions. This explains how forty-six different results could be obtained for the same family. The average taxpayer does not have time to read through the whole document to find all the parts that pertain to the particular situation. Another difficulty with the Code is that it squelches entrepreneurs, loading them down with heavy penalties and taxing profit more than once. Currently, business equipment purchased by entrepreneurs cannot be completely written off taxes in the first year of purchase. Instead, they are written off over the course of several years, at their depreciating rate. This is a large deterrent for small businesses. The Code also has an anti-family bias, most obviously exemplified by the marriage penalty. It penalizes large families. For example, in 1998, a family in the top income tax bracket with ten children paid almost $200 more for every $2,500 of additional earnings than a two-income family with no children, in the same bracketv. This is not a good economic or social policy. It is not a good moral policy.
We obviously have a large problem. What could be done to solve it? There have been two options proposed. The first, and the one that this paper advocates, is the flat tax. In the next several paragraphs, we will study these and other benefits of a flat tax in more depth. The other option is a national retail sales tax. This will also be examined.
Two different flat tax plans have been seen in recent years. The first, put forth by flat tax pioneers Robert E. Hall and Alvin Rabushka, is a 19% flat tax, and is detailed in their book, The Flat Taxvi. Another, more recent plan is Steve Forbes’s. He campaigned for president on a flat tax base in both 1996 and 2000. His plan, based on a 17% tax rate, is given in the book Flat Tax Revolutionvii. This paper will use Forbes’s plan unless otherwise noted.
A flat tax would levy a single tax rate on individuals and businesses, with generous exceptions for families with children. Families with an income under the national poverty level would not be taxed at all. Currently, the poverty level for a family of four is an income of $19,350 or less. Under Steve Forbes’s plan, a tax of 17%, such a family would receive a $4,000 exemption for each child, as well as a refundable credit of $1,000 for each child under the age of sixteen. This would eliminate the penalty against large families. The marriage penalty would also be completely eradicated, further encouraging and enabling Americans to have and provide for bigger families. Also, all the time consuming paperwork necessary to file taxes under the Internal Revenue Code would be eliminated, and taxes could be filed on a postcard, according to some flat tax plans. This gives a much smaller margin of error, and greatly increases the efficiency of the government and the citizens. No more than one page of paperwork would be needed, and could be filled out in less than half an hour.
Small businesses would only be taxed on their profit, and be allowed to deduct all of an investment price in the same year it was purchased, rather than using a depreciation schedule. Loopholes like the infamous Starbucks provision, which was inserted into the Code because paid lobbyists secured a special tax break for Starbucks as a coffee “manufacturer,” will be gone, as will most other write-offsviii. This does not mean that small businesses are going to have more taxes to pay than before, however. Contrarily, they will be paying less, and only once. Under the current tax laws, profit made overseas is taxed twice. First, it is taxed by the country in which the company is working. Then, it is taxed again under the 35% rate in the United States. Companies which dislike paying two taxes on profits either evade the tax laws or stay out of the United States.
The other alternative to the current tax system is a national retail sales tax. While this would certainly help things, it has several problems that can be avoided through a flat tax. First, the 16th Amendment would have to be repealed. This is a very difficult procedure, as it should be. It takes a two-thirds vote from both the Senate and Congress, and then a two-thirds majority of the states. It would be a long, drawn out undertaking that would have many people frustrated with the new tax before it even took effect. Secondly, a national sales tax would be hard on people living on the poverty line or below. Since everything, including necessities, would be taxed, these people would have a hard time. Though proponents of this tax advocate a tax return to such people, this would create more trouble. Why take the money if it is going to be returned? It takes the long way around, which makes more rules and more hang-ups. With a flat tax, these people would not have to pay a federal tax at all. Third, a national sales tax would greatly increase the costs of government, which would increase the amount of tax on the people. What about all the military purchases the government must make? These costs are handed down to taxpayers, resulting in higher and higher tax rates. According to the Brookings Institution, maintaining current levels of government revenue over the next ten years would require a sales tax rate of 60%ix. These and other issues show that while a national sales tax would be much better than the current system, it would ultimately cause large problems.
What effect would a flat tax have on the economy? Could it generate enough revenue to maintain a balanced budget? Could it even do better and decrease the deficit? While these questions cannot yet be factually answered for the United States, we can look at what the flat tax has done in other countries. A major example is Russia. Under Communist rule, the tax system was a hopeless mess, inviting much evasion and corruption. Even after the USSR was dissolved in 1991, it remained a pitiable mess. However, Russia instituted a flat tax rate of 13% in 2001. In the first year, revenue increased by 25.2%, and increased over that each year thereafter. In 2004, the revenue increased by 26.1%, and overall, has increased by 105.6%x. The economy is growing by leaps and bounds. There is not as much evasion because of the simplicity of the tax code and the low rates.
Other countries have instituted a flat tax, and done very well. Ukraine, Latvia, and Estonia have all put their version of the flat tax into effect since 1995. China is also considering implementation of a flat tax.
Policy institutes have researched trends in the Unites States, and have made some educated guesses on the effects that a flat tax would have on the country. The National Center for Policy Analysis says that a flat tax rate would stimulate growth in the economy because it would give citizens more expendable income. Where there is more expendable income, there is more consumption of a variety of goods; therefore, the economy would begin to grow. Growth would be particularly high in the plastic, chemicals, manufacturing, food, and tobacco sectorsxi. Some opponents of the flat tax say that it will worsen the budget deficit. When the results of other nations are examined, however, this would not be the case. All the nations that have used a flat tax have increased their revenue, which, if their budgets did not overly expand, would shrink the deficit.
The flat tax would also stimulate citizens to work harder. The income tax punishes high achievers, as can be seen even in the case of Ronald Reagan. When he was a Hollywood actor, he found out that if he made more than two movies per year, he was going to be forced to give a larger percentage of his income to Uncle Sam. He refused, and only made two movies per yearxii. This same system is in effect today. Is it any wonder our society is no longer willing to work? Under a flat tax, no matter how much money a person made, the rate would stay the same. People would be encouraged to work harder and earn more.
There has been some concern expressed over the flat tax’s lack of write-offs for charitable givingxiii. However, throughout recent history, charitable giving has increased in accordance with tax breaks. With the flat tax, people would have more disposable income, leading to an increase in donationsxiv. While Hall and Rabushka suggest that there may temporarily be a small decline in giving, due to the current system’s high incentives for some donations, others believe there would be no lull in the amount of donations.
Clearly, there are many problems with the current Internal Revenue Code. Its complexity, unfair penalties against families and small businesses, and punishment of high achievers are far from the original intent of taxation as laid out by the Founders. The flat tax would eliminate these problems, while at the same time helping to shrink the national debt. It will also help America maintain its place as a world leader. The flat tax is truly the tax system for the twenty-first century.
iSteve Forbes, Flat Tax Revolution: Using a Postcard to Abolish the IRS (Washington, D.C., Regnery Publishing, Inc., 2005), 7.
iiEllen Terrell, “History of the Income Tax.” Library of Congress, http://www.loc.gov/rr/business/hottopic/irs_history.html.
iiiPollock v. Farmers’ Loan and Trust Co., 157 U.S. 429 (1895).
ivThomas Jefferson, in a letter, quoted in Steve Forbes, Flat Tax Revolution, 22.
vMichael Farris, “Fixing the tax code’s anti-family bias,” in The IRS vs. the People: Time for Real Tax Reform, ed. Jack Kemp and Ken Blackwell (Washington, D.C., The Heritage Foundation, 1999), 119.
viRobert E. Hall and Alvin Rabushka, The Flat Tax, 2nd ed. (Stanford University, Stanford, Hoover Institution Press, 1995).
viiForbes, Flat Tax Revolution.
viiiC. Eugene Steuerle, “Sisyphus Had it Easy: Reflections on Tax and Budget Reform,” Tax Policy Center, http://www.taxpolicycenter.org/publications/template.cfm?PubID=9202.
ixWilliam G. Gale, “A Note on the Required Tax Rate in a National Retail Sales Tax: Preliminary Estimates for 2005-2014,” The Brookings Institution, August 12, 2004, http://www.brookings.edu/views/papers/gale/20040812.htm.
xAlvin Rabushka, “The Flat Tax at Work in Russia: Year Four, 2004,” The Russian Economy, http://www.russianeconomy.org/comments/012605.html.
xiBarry J. Seldon and Roy G. Boyd, “The Economic Effects of a Flat Tax,” National Center for Policy Analysis Policy Report No. 205, June 1996, http://www.ncpa.org/studies/s205/s205.html.
xiiForbes, Flat Tax Revolution, 30.
xiiiDouglas Lederman, “Colleges Fear Forbes’ Flat-Tax Idea Would Discourage Donors,” The Chronicle of Higher Education 42, iss. 24 (Feb. 23, 1996): A33. http://www.proquest.com.
xivJohn S. Barry, “How a Flat Tax Would Affect Charitable Contributions,” Backgrounder 1093, The Heritage Foundation, http://www.heritage.org/Research/Taxes/
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