Tuesday, 18 September 2012 16:41

When a Flat Tax Is Still a Progressive Tax

Written by  Laurence M. Vance

The U.S. tax code is a complex and burdensome maze of rates, exemptions, exclusions, credits, deductions, phase-out levels, and exceptions. People may not agree on anything else, but the nature of the tax code is certainly something that anyone of any political persuasion would agree on.

But with the expiration of the so-called Bush tax cuts looming on the horizon, the usual cries for reforming the tax code have been temporarily muted while attention is focused on renewing or extending the tax cuts; that is, keeping taxes from increasing on January 1, 2013.

If the Bush tax cuts are not extended, the current six tax brackets of 10, 15, 25, 28, 33, and 35 percent will decrease to five, with the rates increasing to 15, 28, 31, 36, and 39.6 percent, the child tax credit will decrease from $1,000 to $500, the maximum long-term capital gains rate will increase from 15 to 20 percent, qualified dividend income will be taxed as ordinary income rather than at the lower long-term capital gains rate, the section 179 expense deduction will decrease from a maximum of $250,000 to only $25,000, and the estate tax will increase with a vengeance.

But maintaining the status quo just averts a tax increase; it still leaves us with all the problems of the tax code.

The usual tax-reform idea, and the one that has been around the longest in a variety of incarnations, is the flat tax. Under a flat tax, there are no tax brackets and few or no tax deductions. The late economist Milton Friedman first proposed a flat tax back in 1962 when the highest marginal tax rate was 91 percent. The idea was resurrected in the 1980s by Hoover Institution economists Robert Hall and Alvin Rabushka, pushed by House Majority Leader Dick Armey in the 1990s, and then in the 2000s by former Republican presidential candidate Steve Forbes.

The Heritage Foundation, a conservative think tank, thinks it has an improvement over traditional flat tax plans. In Saving the American Dream: The Heritage Plan to Fix the Debt, Cut Spending, and Restore Prosperity, it proposes a “unified single tax rate” tax reform plan that “is far more comprehensive than previous well-known tax reform proposals.” Under the Heritage plan, the current system would be transformed into “a modern flat tax that taxes individual income only once and replaces all federal income taxes, all payroll taxes, the death tax, and virtually all excises.” A new flat-rate tax would be applied to income “after deducting all savings.”

What makes this flat-tax plan so unique is that it “folds today’s federal payroll taxes financing Social Security and Medicare into the new system.” Up until now, this was only suggested by the FairTax proposal for a national sales tax. Americans currently pay Social Security taxes of 10.4 percent (4.2 percent on employees & 6.2 percent on employers) on the first $110,100 of income plus Medicare taxes of 2.9 percent (split between employees and employers) on all income earned. But even though payroll taxes would be eliminated, “the revenues they would have raised are credited appropriately to the Social Security and Medicare trust funds.” Income tax withholding would continue as now.

The new Heritage tax system “is designed to raise a permanent revenue stream of up to 18.5 percent of the economy as measured by GDP.” To meet this target, Heritage estimates that “the statutory individual and business tax rates will likely be between 25 and about 28 percent under traditional scoring methods.”

The Heritage tax plan “ends the existing tax exclusion for employee compensation in the form of employer-sponsored health insurance. This means that the value of employer-paid health insurance premiums is included in the employee’s total taxable compensation.” The plan also includes as income not only all labor compensation, but “all net borrowings.”

Under the Heritage plan, there are only three available deductions or credits: higher education (up to the average annual cost at a four-year public college or university), charitable donations and other gifts, and home mortgage interest. To encourage seniors to stay in the workforce longer (as if that were a proper function of government), “the first $10,000 of a senior’s wages and salary is excluded from tax.” (There is also a “senior-specific” feature called a “senior’s standard exclusion” that would only apply during the transition period in the Saving the American Dream proposal to save and reform Social Security and Medicare.)

The Heritage intention of a tax rate between 25 and 28 percent for everyone is fiction, and not just because the deductions for education expenses, charitable giving, and mortgage interest will only be taken by select taxpayers.

The Heritage flat tax plan is a highly progressive tax plan just like our current Marxist tax code that punishes “the rich.” Who said progressivity requires graduated tax rates? And who said it is just Democrats that are obsessed with making “the rich” pay their “fair share”?

According to IRS figures for tax year 2009, the top 1 percent of taxpayers (in terms of adjusted gross income) paid 36.73 percent of all federal income taxes. The top 5 percent of taxpayers paid 58.66 percent. The top 10 percent of taxpayers paid 70.47. The top 25 percent of taxpayers paid 87.3 percent of the taxes, and the top 50 percent paid a whopping 97.75 percent. 

Nothing in the Heritage plan will change this disparity because it includes “protections for low-income working households.” Even though, as mentioned previously, “the value of employer-paid health insurance premiums is included in the employee’s total taxable compensation” (which primarily hurts middle and upper income taxpayers), taxable income “excludes all other cash and noncash benefits provided by the federal government through its anti-poverty programs, such as food stamps” (which primarily helps lower income taxpayers). The Heritage tax plan includes the Earned Income Credit (EIC) “as part of the overall system of financial support for low-income Americans.” There is no mention of what the amount of the EIC will be under the Heritage plan. Currently, for tax year 2012, the maximum amount is $5,891 (for three or more children) and the maximum income level is $45,060 ($50,270 for married filing jointly).

And then there is the new health insurance tax credit. Under the Heritage plan, there would be a credit of $2,000 for individuals and $3,500 for families used to “offset the cost of coverage offered through the workplace or to buy insurance outside the workplace.” However, “for upper-income households, the new credit is typically less and is reduced as income rises.” The phase-out range is from $50,000 to $90,000 for an individual and from $100,000 to $170,000 for a family. But what if a household has no tax liability? Never fear, “Financial assistance for purchasing insurance, equivalent to the tax credit, is made available to households with no tax liability and prorated to those households with a tax liability less than the value of the available credit.”

And is gets even worse for “the rich” who are on Social Security or Medicare. Under the Saving the American Dream proposal to save and reform Social Security, benefits are means tested. Those making between $55,000 and $110,000 ($110,000 and $165,000 for married couples) will receive a reduced benefit amount. Those making more than the income ceiling “will receive no Social Security payments.” The figures are the same for Medicare. Yet, because the Heritage plan “folds today’s federal payroll taxes financing Social Security and Medicare into the new system,” those who receive no Social Security or Medicare benefits will still pay the same 25 to 28 percent tax rate as those who don’t.

The government forcing “the rich” to pay more because of their ability and subsidizing “the poor” because of their need is simply putting into the practice the Marxist dictum: “From each according to his ability, to each according to his needs.”

If you want an example of a real flat tax, look no further than the 2.9 percent Medicare tax. Everyone pays 2.9 percent (split between employer and employee), on every dollar earned, no matter one’s marital status, number of dependents, or income level. Any flat tax not structured like this is still a progressive tax.

The progressive U.S. income tax system is a vast income redistribution and social engineering scheme. In his powerful pamphlet Common Sense, Thomas Paine remarked: “Government, even in its best state, is but a necessary evil; in its worst state, an intolerable one.” Although the federal government in the early years of the American republic may not have been government at its best state, the federal government as it exists today is certainly an intolerable one. It is intolerable because it embodies the role of government as described by Voltaire: “The art of government is to make two-thirds of a nation pay all it possibly can pay for the benefit of the other third.”

But of course, if government spending were strictly limited to only what is constitutionally authorized, there would be no need for an income tax in the first place, progressive or otherwise.


  • Comment Link Tom Wednesday, 19 September 2012 00:29 posted by Tom

    We need to permanently end the federal tinkering with the tax code, be it legacy, flat, Fair or otherwise by enacting The Neutral Tax. You can read more about it at http://www.neutraltax.com

  • Comment Link Mike Tuesday, 18 September 2012 20:40 posted by Mike

    I'm no fan of the income tax, the flat tax, or the so-called fair tax. Unconstitutional programs and spending must be reduced and eventually ended. Next, the 16th amendment (income tax) must be repealed. There should be NO tax on income. Income is simply an equal exchange of value. For example, a businessman wants a widget built in exchange for a payment to someone who can build a widget (value). A worker wants a payment in exchange for building a widget (reciprocated value).

    After repeal of the 16th amendment, a new federal revenue system should be implemented among the states similar to the way congressional seats are proportioned based on a state's population. In other words, the more citizens of a state, the more federal revenue that state must forward to Washington, D.C. But with a vastly smaller federal government, even the larger states won't be burdened. Each state can then determine how it will collect its share of federal revenue -- property tax, sales tax, income tax, etc. This will help the states exercise their original power over the federal government (along with the repeal of the 17th amendment -- direct election of senators).

    Until this happens (although it never will), the current income tax system can be easily reformed by Congress (although it never will). Here's my proposal: Individuals can deduct the out-of-pocket costs of ALL essential goods and services from gross income just like a business can. ALL of the following expenses are deductible without itemizing or meeting a threshold limit: rent; mortgage (including principal, interest, taxes and insurance); household maintenance; the costs to heat and cool a home; water, sewage and garbage; medical premiums, unreimbursed medical expenses (including over-the-counter medications); the costs associated with earning a living; clothes; food; and so forth. In other words, the costs of our basic everyday NEEDS. All that is required: keep your receipts and a one-page tax form (and that doesn't even require an instruction book). I know this will NEVER happen. It's too simple ... and it makes SENSE. The reason REAL tax reform will NEVER happen is this: What do we do with all the IRS agents, CPAs, tax form printers, the paper manufacturers, tax software developers -- just to name a few special interests interested in keeping the current system just the way it is or perhaps complicating it even more?

  • Comment Link Patrick J. Greene Tuesday, 18 September 2012 19:09 posted by Patrick J. Greene

    A flat tax with exemptions and behavior modification provisions is no flat tax at all.
    The article is right on. Why a mortgage tax deduction? Who does it benefit - certainly not the poor. Another crap sandwich rolled in glitter.

  • Comment Link Mikey-Pinkie Rings Tuesday, 18 September 2012 17:52 posted by Mikey-Pinkie Rings

    One major problem about any major national tax reform is special interest lobbying. Do we doubt for one moment that immediately after passage of a supposedly simple flat income tax that we wouldn't hear calls for exemptions for this or for that.

    After all, we want people to go to college right? (they say) So, let's just make exemptions for school related income, etc. It wouldn't take long. Just look at our current system.

    The best solution still remains to have the states receive a bill from the federal government (proportioned according to the number of people living there) and let them decide how to pay it. This was supposedly done-away with by the 16th Amendment which allowed for taxation without regard to 'apportionment.' Just because the odious 16th Amendment is there doesn't mean that we have to use its authority. Congress still can tax according to apportionment.

  • Comment Link REMant Tuesday, 18 September 2012 16:29 posted by REMant

    AFAIK flat tax proposals, while not keeping the odious middle-class expenditures for college, mortgages, and NGOs, have nearly always desired to exclude the poorest, in the manner of a negative income tax, also a Friedman proposal. And, of course, any flat tax rate is going to be progressive, ie, tax higher income more in absolute terms than lower income. It is not a poll or capitation tax. And an income tax is less regressive than a sales tax. From an economic viewpoint it is usually argued that sales and income taxes should be balanced to balance their effects on saving and consumption. The states already levy a lot of sales and property taxes which encourage savings. I am unclear what the foundation means by the phrase "after savings" tho. But it makes sense to fold the payroll taxes into a general income tax for this reason. The problem with income taxes is they are liable to inequities like the tax expenditures, supposedly prohibited by the Constitution. Tho, of course, the Founders recognized that all taxation independent of budgets and direct assessment was open to abuse, which is why even sales taxes were suspect and circumscribed by provisos, on the other hand, the argument for the Constitution in the first place was that ppl didn't want to pay their debts, if, as well, that that claim is open to debate.

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