In the ongoing babble about "tax reform," the "flat tax" is sure to come up.
While readers doubtlessly know what is meant by the "flat tax," the latent "professor" in me compels me to review some basic definitions.
The terms, "progressive," "regressive," and "proportional" describe the incidence of taxes, that is, who pays according to income classes. A progressive tax is one for which the average tax rate (taxes paid divided by income) rises with higher incomes. Higher marginal rates are assessed on increasing increments of income.
A regressive tax is one for which average tax rates fall as incomes rise. For example, a sales tax that includes taxes on food would be regressive because low-income people spend a higher proportion of their income on food than people with high incomes.
A proportional tax is one for which all income recipients pay at the same rate, or the same proportion of their income, for taxes. In common parlance, the proportional tax is called the "flat tax," in that the rate is flat for all incomes. Under a flat income tax, high-income recipients would pay more in taxes, but the rate, or proportion, of their income paid in taxes would be the same as for low-income recipients. For example, the multi-million dollar salaried CEO would pay more taxes, but at the same rate as the coffee shop waitress.
Which system is more desirable? This is where values come in. Proponents of the flat tax insist that it is more "fair," as everyone pays at the same rate. Many, if not most economists, including myself, prefer a progressive system, seeing it as more "fair," as it is based on ability to pay.
People with low incomes must first spend on the basics: food, clothing, shelter, and utilities. Then come expenditures on health care, transportation, education, and training necessary for employment. Only after those basics are met is there money for other costs of living, and for saving. The same 15 percent rate, for example, would surely be a much greater burden on the coffee shop waitress and auto mechanic than on the CEO making $10 million per year.
This is along the lines of the technical economic concept of - please forgive the jargon - "diminishing marginal utility." In plain English, an additional dollar received by the CEO is less useful to him/her than an additional dollar received by a coffee shop waitress or laborer earning minimum wage.
Granted, "utility" is impossible to objectively measure. And perhaps income is addictive - the Wall Street baron may be as obsessed with making an additional million as the working stiff is with making a couple extra bucks to pay the bills. Nevertheless, we who favor progressive tax rates believe that the wealthy heir and the CEO should pay at a higher rate than the guy on the shop floor, the construction worker, the schoolteacher, and the truck driver. We can still quibble about the rates and the degree of progressivity - more progressive or less progressive - a higher rate structure or lower rate structure.
Proponents of the flat tax assert that everyone should pay taxes and "have skin in the game." This argument misses the mark, as everyone pays taxes even if their incomes are low enough that they pay little or no income taxes. All employed persons pay social security taxes to build up their credits. All property owners, including low-income persons, pay real estate taxes. Everyone who drives a vehicle pays taxes on gasoline and tires. And even if food and a few other items are exempt from state and local sales taxes, virtually everyone pays sales taxes.
That said, there are still a lot of people who believe that there should be just one flat rate for all levels of income. Some believe that it is just plain "fair" that the movie star, professional baseball player, and CEO should pay at the same rate as the auto mechanic, the construction worker and the coffee shop waitress. Proponents of the flat tax assert that even a slightly higher marginal tax rate on super high salaried recipients would dampen their enthusiasm for work, and/or reduce their incentive to hire others to work.
A related school of thought sees progressive taxes as "punishing success." I would counter that workers in lower income occupations also work hard. Those enjoying the high incomes of more richly rewarding professions have the obligation of financing the system - the national defense, transportation, education, and all the rest of the public institutions and infrastructure under which they have prospered. But not everybody sees it that way.
Proponents of the flat tax often argue that it would "simplify the system." That is complete, total, utter nonsense. The various marginal rates have absolutely nothing to do with the complexity of the income tax code. A sixth grader of average IQ can be taught the simple arithmetic of computation using different marginal rates - that is, once the income number and rates are given - which illustrates the relevant point.
The much-maligned complexity of the income tax code has absolutely nothing to do with increasing marginal rates on higher incomes. The multiple hours it takes to prepare tax forms and determine income taxes owed is due to difficulty in arriving at income. It is not the differing marginal rates, but the various legitimate business expenses, legal deductions, credits, and other complexities that complicate the tax code, providing employment for accountants and attorneys.
When politicians and advocates of the flat tax, such as Dave Forbes, talk about a flat tax that would enable computing taxes on a post card, they are conflating marginal rates with complexity of the tax code involving deductions, credits, depreciation schedules and all the rest of it.
Simplifying the tax code has absolutely nothing to do with the flat tax.
Next week: More "tax reform" nonsense.
- John Waelti of Monroe can be reached at jjwaelti1@tds.net. His column appears each Friday in The Monroe Times. He is a retired professor of economics.
While readers doubtlessly know what is meant by the "flat tax," the latent "professor" in me compels me to review some basic definitions.
The terms, "progressive," "regressive," and "proportional" describe the incidence of taxes, that is, who pays according to income classes. A progressive tax is one for which the average tax rate (taxes paid divided by income) rises with higher incomes. Higher marginal rates are assessed on increasing increments of income.
A regressive tax is one for which average tax rates fall as incomes rise. For example, a sales tax that includes taxes on food would be regressive because low-income people spend a higher proportion of their income on food than people with high incomes.
A proportional tax is one for which all income recipients pay at the same rate, or the same proportion of their income, for taxes. In common parlance, the proportional tax is called the "flat tax," in that the rate is flat for all incomes. Under a flat income tax, high-income recipients would pay more in taxes, but the rate, or proportion, of their income paid in taxes would be the same as for low-income recipients. For example, the multi-million dollar salaried CEO would pay more taxes, but at the same rate as the coffee shop waitress.
Which system is more desirable? This is where values come in. Proponents of the flat tax insist that it is more "fair," as everyone pays at the same rate. Many, if not most economists, including myself, prefer a progressive system, seeing it as more "fair," as it is based on ability to pay.
People with low incomes must first spend on the basics: food, clothing, shelter, and utilities. Then come expenditures on health care, transportation, education, and training necessary for employment. Only after those basics are met is there money for other costs of living, and for saving. The same 15 percent rate, for example, would surely be a much greater burden on the coffee shop waitress and auto mechanic than on the CEO making $10 million per year.
This is along the lines of the technical economic concept of - please forgive the jargon - "diminishing marginal utility." In plain English, an additional dollar received by the CEO is less useful to him/her than an additional dollar received by a coffee shop waitress or laborer earning minimum wage.
Granted, "utility" is impossible to objectively measure. And perhaps income is addictive - the Wall Street baron may be as obsessed with making an additional million as the working stiff is with making a couple extra bucks to pay the bills. Nevertheless, we who favor progressive tax rates believe that the wealthy heir and the CEO should pay at a higher rate than the guy on the shop floor, the construction worker, the schoolteacher, and the truck driver. We can still quibble about the rates and the degree of progressivity - more progressive or less progressive - a higher rate structure or lower rate structure.
Proponents of the flat tax assert that everyone should pay taxes and "have skin in the game." This argument misses the mark, as everyone pays taxes even if their incomes are low enough that they pay little or no income taxes. All employed persons pay social security taxes to build up their credits. All property owners, including low-income persons, pay real estate taxes. Everyone who drives a vehicle pays taxes on gasoline and tires. And even if food and a few other items are exempt from state and local sales taxes, virtually everyone pays sales taxes.
That said, there are still a lot of people who believe that there should be just one flat rate for all levels of income. Some believe that it is just plain "fair" that the movie star, professional baseball player, and CEO should pay at the same rate as the auto mechanic, the construction worker and the coffee shop waitress. Proponents of the flat tax assert that even a slightly higher marginal tax rate on super high salaried recipients would dampen their enthusiasm for work, and/or reduce their incentive to hire others to work.
A related school of thought sees progressive taxes as "punishing success." I would counter that workers in lower income occupations also work hard. Those enjoying the high incomes of more richly rewarding professions have the obligation of financing the system - the national defense, transportation, education, and all the rest of the public institutions and infrastructure under which they have prospered. But not everybody sees it that way.
Proponents of the flat tax often argue that it would "simplify the system." That is complete, total, utter nonsense. The various marginal rates have absolutely nothing to do with the complexity of the income tax code. A sixth grader of average IQ can be taught the simple arithmetic of computation using different marginal rates - that is, once the income number and rates are given - which illustrates the relevant point.
The much-maligned complexity of the income tax code has absolutely nothing to do with increasing marginal rates on higher incomes. The multiple hours it takes to prepare tax forms and determine income taxes owed is due to difficulty in arriving at income. It is not the differing marginal rates, but the various legitimate business expenses, legal deductions, credits, and other complexities that complicate the tax code, providing employment for accountants and attorneys.
When politicians and advocates of the flat tax, such as Dave Forbes, talk about a flat tax that would enable computing taxes on a post card, they are conflating marginal rates with complexity of the tax code involving deductions, credits, depreciation schedules and all the rest of it.
Simplifying the tax code has absolutely nothing to do with the flat tax.
Next week: More "tax reform" nonsense.
- John Waelti of Monroe can be reached at jjwaelti1@tds.net. His column appears each Friday in The Monroe Times. He is a retired professor of economics.
