Marsh Business Advisors, LLC
"CAPITAL"
The Hidden Agenda Of The Flat Tax Is Revolutionary
By: Stuart Wm. Marsh
President, Genesee Capital, Inc.
March 1, 1996
How do you feel about the flat tax?
Wait! Let me predict your answer.
As an individual, you are in favor of the flat tax if you think your taxes will go down. You are against it if you think your taxes will go up.
As a businessperson, you are in favor of the flat tax if you think your income will go up. You are against it if you think your income will go down.
The flat tax is designed to achieve four goals, but most people are aware of only two of them: simplification and fairness. But it is important to understand the hidden agenda of the flat tax, because the other two goals will have the most profound impact, and will result in enormous power being taken away from politicians and returned to the American people.
Rep. Dick Armey and presidential candidate Steve Forbes both propose that the entire tax code for individuals be replaced with a single flat-tax rate. The rate being discussed is 17 percent; that is, every taxpayer earning more than some minimum amount ($34,000 is the current proposal) would multiply that portion of their income that exceeds the minimum by the flat-tax rate, and presto!, the taxpayer has computed his or her income-tax bill.
The tax computation can be done on the back of a postcard because there are no deductions other than the first $34,000 of income. There is no "standard'' deduction; you can't deduct your dependents, or interest paid on your mortgage, or property taxes, or contributions made to charities, or state and local taxes, or capital losses, and on and on. The current list of possible deductions is endless. (If you don't believe me, go read the IRS code. Call me in a couple of years when you're done.)
So, what is the first thing that has happened as a result of this revolutionary flat-tax proposal?
Lots of people have started screaming. Let's go through a partial list of screamers.
Liberals are screaming that the flat tax is not fair because it treats every taxpayer the same. (I repeat: "The flat tax is not fair because it treats every taxpayer the same.'' Hel-lo!)
Home owners are screaming because they fear their ability to deduct the interest paid on their mortgage and the property taxes they pay will be eliminated.
Charitable foundations are screaming because they fear that donations will shrink as donors' ability to take a tax deduction is eliminated.
Tax professionals are screaming because they fear their livelihood will be affected.
Governors are screaming because they fear that social-program costs funded by Uncle Sam will become the responsibility of their own state.
Why are these people screaming? What is it about this flat-tax proposal that has them so spooked?
The ideology of the Liberals is founded on the premise that wealthier people should pay not only higher taxes, but higher tax rates. Why? Because they can. Our current tax code is called "progressive,'' which has a nice, positive, forward-thinking sound to it. The truth is, the tax code is progressive: It's progressively worse the more money you make. Whereas a family of four earning $25,000 a year may pay only $1,275 in federal taxes (5 percent of their income), a family of four earning $200,000 might pay as much as $52,000 (26 percent of their income) in federal taxes. The second family earns eight times as much as the first family, but pays 40 times as much in taxes.
Liberals recoil at the flat tax because they would lose a portion of their constituency: Under the current progressive tax, a family of four earning $25,000 pays as little as $1,275 in federal taxes; under the flat tax, they would pay zero in federal taxes. Will this family vote Democratic in the next election after the Republican Congress completely eliminates their federal income taxes?
Home owners are screaming about losing their mortgage-interest and property-tax deductions, but are these really fair and equitable deductions? Why should middle-income and upper-income home owners have the ability to deduct much of the cost of their housing, when low-income people who cannot afford a home and live in apartments are unable to deduct the cost of their housing?
Charities are screaming because donors would lose a tax deduction. But do not be surprised if charitable donations actually increase. Americans are a very caring and giving people--witness the outpouring of money and assistance any time a natural disaster strikes.
If Uncle Sam lets taxpayers keep more of their hard-earned cash, some of this freed- up money will find its way into charities. Besides, many people are plain fed up with paying high taxes to support social-welfare programs that just aren't working. Private charities either accomplish their mission or go out of existence; this clearly is not true of government programs.
Tax-related professionals are screaming because they fear losing their jobs. Who will need a tax accountant or a tax attorney or H&R Block, if all you need is a simple pocket calculator to compute your taxes? (And let's not forget to pity all those IRS agents who also will be "downsized.'')
Unfortunately, no one has a guaranteed right to a specific job. From blacksmiths to buggy-whip makers to telegraph operators to steel workers to middle managers, many professions disappear as a result of the ever-changing dynamics of our economy. Tax-related professionals will undergo a career transformation just as millions of other people already have. The difference is, tax accountants and tax attorneys have advanced education and professional certification, something most displaced workers do not have.
Governors are screaming that state governments will be forced to pick up the tab of some federal programs as Uncle Sam runs out of money. This is not the real reason the governors are screaming. The real reason is that the deductibility of state and local taxes from federal taxes masks the burden of those state and local taxes. Eliminating the deductibility of state and local taxes will eliminate that mask. Governors in high-tax states (subliminal message: New York) will be held increasingly accountable for their high-taxation policies.
Because these people are screaming, they are getting headlines in newspapers and sound bites on TV, and they are making this flat-tax thing sound horrible. "The flat tax just won't work! Worse, it will cost you, the taxpayer, more in taxes because all your deductions will be taken away!''
The problem is, the screamers, all of whom have a vested interest in preserving the status quo, are dead wrong. If Dick Armey and Steve Forbes just wanted to drastically simplify the tax code and make it more fair, they would have proposed a flat tax with a rate of 24 percent to 27 percent on all income. (The effective rate for a family of four earning $200,000 with no deductions is 26 percent.) But part of the hidden agenda of the flat tax is to achieve a massive tax cut, and, hence, the proposed tax rate of only 17 percent on income in excess of $34,000.
There is wide agreement among partisan and non-partisan tax experts that virtually all individual taxpayers will pay less in income taxes, even though all their deductions will be eliminated.
The Institute for Research on the Economics of Taxation concluded: "The flat tax provides a net tax reduction for nearly all households.''
The Tax Foundation (which is backed by business) concluded: "The flat tax would lower taxes at all income levels,'' and as a result would "raise the deficit by $173 billion per year.''
The Citizens for Tax Justice (which is backed by organized labor) concluded: "The flat tax would lower taxes for all earning over $10,000 per year,'' and it would "add $210 billion per year to the deficit.''
And the American Institute of Certified Public Accountants concluded: "The flat tax appears to provide tax relief to nearly all individual taxpayers.''
Although there will be an increase in economic activity as people spend some of the money that they don't have to send to Uncle Sam, the net result will still be a reduction in taxes collected by the federal government. This will increase the federal deficit, right?
Everything else being equal, this is correct. But everything else is not equal. Existing "pay-as-you-go'' budget restrictions require that any tax cuts, new entitlement programs or expansion of existing entitlement benefits be offset by an increase in taxes or a cut in entitlement spending. Further, the Republican-controlled Congress is negotiating with the president to balance the budget within seven years. Moreover, one of the stated goals of the Contract With America is a balanced-budget amendment.
So by implementing this flat tax, and thereby implementing a tax cut, and with balanced-budget legislation in effect, Congress will be forced to cut federal spending.
Much tax legislation is passed by Congress, and accepted by Americans, because it taxes "someone else.'' Many people would favor a new government program if its cost was funded with new taxes that are paid by somebody other than themselves.
With a flat tax, it will be impossible for Congress to tax "somebody else.'' With Congress limited to spending only the taxes it collects, and barred from increasing the deficit, there will be only two ways to increase tax receipts: an increase in the incomes and/or the number of people who are working, or an increase in the flat-tax rate that everybody pays. No jiggering with exemptions or monkeying with deductions. No taxing one taxpayer over another.
So, the fourth goal, and the other half of the hidden agenda of the flat tax, is to prevent future tax increases. A Congress that raises taxes on everyone will be voted out of office and be replaced with candidates who pledge to lower taxes.
With a flat tax, Capitol Hill lawmakers running for re-election will face one very simple question: "Congressman, did you vote to increase the flat-tax rate from 17 percent to 22 percent?'' Accustomed to sidestepping issues with double-, triple- and quadruplespeak, they will panic, as the only two possible responses to this question are "Yes'' or "No.'' It will be impossible for them to say: "Yes, I did vote to raise taxes, but, no, I did not vote to raise your taxes.''
The flat-tax and balanced-budget legislation will shift enormous power away from Washington and back to Americans, because the coupling of these two simple and elegant mechanisms will force Congress to live within its means, and more importantly, will finally force Congress to be accountable for its spending.
Every single voting taxpayer in America can have this same conversation with his or her congressional representative: "If you spend too much, you'll have to raise my taxes. If you raise my taxes, I'll vote you out of office. I believe we understand each other, don't we?''
The impact of this revolutionary flat individual income tax on business, and that of an equally revolutionary proposal for reforming the corporate income tax, will be discussed in my next column.