Flat Tax Fantasies

Back in the halcyon days of yore, before the advent of Big Government, tax collection was one of the main places where the individual bumped up against the “powers that be.” In that distant past, tax collectors were called “publicans,” and they were generally despised. One exception, however, was a tax collector by the name of Matthew who was accepted into the bosom of a certain Nazarene you may have heard about. But in the main, folks really, really disliked the taxman, and they still do.

The issue of taxes arises in “High Sparrow,” Episode 3 of Season 5 of the HBO series Game of Thrones, when the usurper Roose Bolton, the new Warden of the North, and his son Ramsay discuss tax collection methods:

ROOSE: We can't hold the North with terror alone.

RAMSAY: We can't hold the North if we let these lesser Lords insult us.

ROOSE: I sent you there to collect taxes, not bodies.

RAMSAY: Lord Cowen refused to pay. Said the Warden of the North would always be a Stark, and he'd be damned if he'd kiss a traitor's boot.

ROOSE: He left you no choice.

RAMSAY: I flayed him living, along with his wife and brother. Made his son watch.

ROOSE: And...?

RAMSAY: The new Lord Cowen paid his taxes.

Nowadays, rather than getting flayed, or crucified, or drawn and quartered, tax cheats are usually just incarcerated and relieved of their property. Under the current regime, our main tax collector, the Internal Revenue Service, has been enlarged, given new powers, and seems to have become more corrupt. (Come June, the Supreme Court will tell us in King v. Burwell whether the IRS, rather than Congress, can award tax credits and write tax law.)

Americans understand that we need government and that taxes are the price we pay to have one. What they want from tax reform is for taxes to be less oppressive. Some tax reformers want to reduce the number of tax rates for the federal individual income tax. In 1986, the second big Reagan tax cut reduced the number of tax rates to two: 15 percent and 28 percent. But that didn’t last, and we now have seven rates. Some reformers today want just one tax rate; they are proponents of the “Flat Tax.”

In 2014, an unmarried taxpayer with a total income of $110,149 who was eligible only for the “standard deduction” would have had a taxable income of $99,999, leaving him with an individual income tax bill of $21,169. That is the highest tax bill one can have using the IRS’s 2014 Tax Table, and for our taxpayer it works out to an effective tax rate of 19.2 percent.

That 19.2 percent is just shy of President Obama’s effective rate for 2014, which happened to be 19.6 percent on an income of $477,000. It’s also close to the 19.8 percent effective rate of the top 0.1 percent in 2011. What’s interesting here is that a taxpayer whose income is low enough that he can use the 1040EZ form can have an effective rate comparable to those at the very top. What’s more, that unmarried taxpayer availing himself of the 1040EZ is paying an effective tax rate that is higher than the single tax rate advocated by some Flat Tax promoters -- 17 percent.

Here’s a short video of Dan Mitchell explaining the Flat Tax. Some of it is compelling stuff. But the 17 percent rate that he advocates is just too low. You see, some of the taxpayers at the top, those who account for most of the revenue from the individual income tax, are paying an effective rate that is higher than the 17 percent statutory rate that the Flat Taxers are promoting. In fact, the taxpayers at the top were paying a higher effective rate than the Flat Tax rate even before the “fiscal cliff” tax hike of 2012.

Let’s do some back-of-the-napkin math and see how much a single tax rate of 17 percent would “cost” the U.S. Treasury in lost revenue. The “fiscal cliff” tax hike affected all taxpayers in the top 1 percent, raising their top marginal rate by 4.6 percent to 39.6 percent. In 2011, before the fiscal cliff, the top 1 percent had an effective income tax rate of 20.3 percent, so now they might have an effective rate of about 24.9 percent. For convenience (after all, we’re just using a napkin), let’s round that up to 25 percent. That would mean a 17 percent Flat Tax might reduce revenue from taxpayers in the top 1 percent by about 8/25ths, or 32 percent.

Since the top 1 percent has supplied 30-40 percent of the revenue from the individual income tax for years now, we’re talking serious money. Let’s say the top 1 percent accounts for one-third of individual income tax revenue. In 2014, individual income taxes brought in $1.4T to the feds. One-third of that is $466B, and 32 percent of that is a revenue loss of $149B.

But the revenue loss might be higher because the fiscal cliff tax hike hit more than just the top 1 percent; some in the 99th percentile were also hit.

It should be obvious that any single tax rate would have to be at least as high as the effective rate of the top taxpayers, or you’ll lose revenue from that group. One way to offset that loss of revenue would be to raise taxes on everyone else, the bottom 98 percent. That will not sell well.

To ensure that the taxpayers at the very top who have been paying at more than a 17 percent rate actually pay at the 17 percent rate of a new Flat Tax system, we’d need to strip them of all their exemptions, not just some of them, as the Flat Taxers advocate. Otherwise they’ll pay at less than the advertised 17 percent.

What’s disturbing is that the average effective rate of all taxpayers is much lower than 17 percent. So to protect the bottom 98 percent of taxpayers from the ravages of a 17 percent tax rate, Congress would need to hike the value of their exemptions. Those at the top would lose their exemptions so that they would actually pay at 17 percent, while those on the bottom would have to get much larger exemptions so that they wouldn’t have to pay more. The taxes for those at the top would be simplified, and the taxes for those at the bottom would still be complicated. Why not simplify everyone’s taxes?

Sadly, the Flat Tax is the quadrennial darling of Republicans. Every four years some version of the Flat Tax is trotted out and then quickly forgotten. Even without running the numbers, Americans surely sense that this pet idea won’t simplify their taxes and would instead just rearrange the complexity. Forbes ran a fine article on March 23 by Tony Nitti that Flat Taxers really need to read, especially presidential candidates who advocate any reduction in the number of tax rates.

Americans don’t much fear getting flayed by tax collectors anymore, but they do want to get the IRS out of their lives. And the way to do that is through tax reform that radically simplifies the Tax Code. On Tax Day 2014, American Thinker ran an article that outlines how to do that.

Jon N. Hall is a programmer/analyst from Kansas City.

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