Flat tax is flat wrong

A topic near and dear to my heart, or rather, a topic the opposition to which is near and dear to my heart, is the much-vaunted flat tax. It hasn't really been visible in the blogosphere lately, but, today the Wall Street Journal carried a pro-flat-tax op-ed piece, which gives me the opportunity to express my opinion. Well, not my opinion but some facts (as is so often the case on these pages). But for those of you who don't have the time, I'll sum up in one sentence: The flat tax is not only bad, it is unfair. For those who don't know, the idea of the flat tax is that everyone pays the same percentage of their income in income tax, say, 15%. Currently, we have a graduated income tax, in which different levels of income are taxed at progressively higher rates. The appeal of the flat tax is two-fold. First, it seems more fair, because everyone pays the same percentage. Second, it seems simple because one need only multiply one's income by the tax rate to find the tax owed. Thus was born the idea of a tax return the size of a postcard. Let's examine these features. The second one first, because it is easier to dispel. The hard part in filling out tax returns is not figuring out the tax owed. It's figuring out taxable income. Take a look at a Form 1040. Go to line 42. That's were taxable income is finally calculated. It takes 42 lines to arrive there. Now go to line 43. That's were the tax owed is calculated. One line. Recall also that line 43 is found by looking in a large chart. No calculator necessary. So, a literal flat tax actually only saves you from having to look at a multi-page table of 8-point font. It hasn't addressed the previous 42 lines of figuring (or the following 12 lines for that matter). In other words, implicit in the idea of a flat tax is also a very large tax code simplification. But this tax code simplification could happen with or without a flat tax. Since with a flat tax, everyone pays the same percentage of their income in tax. it is perceived to be more fair. But is it really more fair? Well, an economic theory known as the declining marginal utility of money would say no. This theory says that the first dollar you earned has much more value than the last one you earned. If you need to earn $10,000 a year to provide basic shelter, food, transportation, healthcare, etc, to your family, but you earn $20,000 year, you value the second $10,000 less because it's not buying you a home, it's just buying you a nicer home. Consider an extreme example. Why do you think that the super-rich buy $100 hamburgers (or whatever else seeming waste of money you pull from the pages of People magazine). Because $100 means less to them than to the average person. That is why we currently have an income exclusion, and why we have a graduated tax. Another social theory, of which I have blogged in the past (see my Aug 6 post here), also says no. This theory says that higher income people actually derive more benefit from living in society than lower income people. Higher income people get better police protection, better roads, more tax breaks. This may seem false, but consider one example. What is the single largest deduction on a typical tax return? And what one deduction is the key to enable the average tax payer to itemize deductions so that they save more money than if they had taken the standard deduction? The mortgage income interest deduction. But to take this deduction, you have to own a house. And guess who don't own houses? The lowest income groups. So, in short, a massive federal benefit (subsidy in the form of a tax deduction) flows to the wealthiest groups at the expense of the poorest groups. Similar examples abound. My point in these two examples is that a flat tax is probably not fair (well, maybe fair, but not equitable). A flat tax is regressive, which means that it hits lower income people harder (as opposed to a progressive tax, which hits higher income people harder). The current income tax is progressive, and we want to keep it that way. Sale taxes, by the way, are regressive, as are property taxes and gas taxes. The Wall Street Journal piece says that with a flat tax, government revenues need not fall. But to ensure that, poor people would have to pay more in tax than they do now, while rich people would pay less. Not just more and less proportionally, but more and less absolutely. Worse yet, the income tax increase to the poor would be proportionally worse than the income tax decrease to the rich. Is that what we want as a society? For a more detailed discussion on the ills of a flat tax, see here.