October 2007

The Flat Tax: A Shock and Awe Economic Plan That Works

by John R. Hendrickson

“The fairest society is the one that provides the most opportunities for people to succeed. In this sense as well, the current tax system is unfair to everyone. A low flat-rate tax system would allow people to succeed and to attain financial independence — and not punish them for doing so.” Paul Craig Roberts[1]

The flat tax, which was once considered to be public policy flummery, is actually creating an economic firestorm of prosperity and growth around the globe, including the former Soviet block. Estonia, Latvia, Lithuania, Russia, Serbia, and Ukraine, among many other nations, have all implemented a single flat tax rate. The flat tax is causing an economic shock and awe for these nations that were formerly under Lenin’s Five Year Plan. In an ever increasingly globalized and competitive economy, the United States needs to reform its massive and out-of-date tax code that hinders economic liberty and growth.

The flat tax is simply defined as “a tax system that taxes all income at the same rate.”[2]  In addition, a flat tax would end double taxation on savings and investments and “wipe out the special preferences, credits, exemptions, deductions, and other loopholes that cause complexity, distortions, and corruption.”[3]  A flat tax would provide “an enormous boost to the U.S. economy by dramatically improving incentives to work, save, invest, and take entrepreneurial risks.”[4] 

“The purpose of taxes should be to raise revenue to finance government expenses,” argued Milton Friedman.[5]  In addition, the Nobel Laureate stated: “A major purpose of taxes today is to enable Legislators (and Presidents) to raise campaign funds by inserting or removing loopholes in our present, obscenely complicated tax code.”[6]

A flat tax (or even a national sales tax) would clean up the current system and restore taxation as it should be, so the argument for the flat tax is based in morality as well as economics. “A single tax rate on all income (or consumption) above an exemption would restore the tax system to its proper purpose. It would make it difficult, if not impossible, to manipulate the tax code to favor, or punish, special interests, wrote Friedman.”[7] 

Around the globe some seventeen nations “have some form of flat tax, and two more are about to join the club.”[8]  A recent editorial by the Washington Examiner argued that it is time “for the U.S. to join the flat tax club.”[9]  “Here in the U.S., tax complexity will drain $1 trillion from our economy over the next seven years as time and money are wasted complying with a byzantine tax code that gets harder and harder to decipher,” noted the Examiner’s editorial.[10] 

Estonia, a former nation under the control of Soviet style Leninism and Stalinism, received a rank of twelve from the 2007 Index of Economic Freedom, which is published by The Heritage Foundation and The Wall Street Journal.[11] “Estonia is ranked 5th out of 41 countries in the European region, and its overall score is much higher than the regional average.”[12] Estonia has a flat tax rate of twenty-two percent.[13]   The flat tax and the free market is the key to Estonia’s economic success. As the 2007 Index notes, “Estonia scores highly in investment freedom, fiscal freedom, financial freedom, property rights, business freedom, and monetary freedom.”[14] In addition, “the top income and corporate tax rates are low, and business regulation is efficient.”[15]

Individual states have also been discovering the flat tax. “Before 2006, six states maintained flat-rate income taxes: Colorado (4.63 percent), Illinois (3.0 percent), Indiana (3.4 percent), Massachusetts (5.3 percent), Michigan (3.07 percent), and Pennsylvania (3.07 percent).”[16] In addition both Rhode Island and Utah recently approved flat tax rates.[17]

Two common flat-tax proposals that have been considered in the United States are Steve Forbes’ 17% proposal and the 19% rate proposed by Hoover Institution scholars Robert E. Hull and Alvin Rabushka. Under the 19% proposal, for example, all income would be taxed at that rate, and “it would permit a tax-free allowance of $25,500 for a family of four. The family would pay a tax of 19 percent on its earnings above that allowance.”[18] In addition Hull and Rabushka argue that their “flat tax adheres to the principle of a consumption tax: people are taxed on what they take out of the economy, not what they put in.”[19]

The benefits of the flat-tax are numerous and the result is more economic liberty for taxpayers, which translates into a better and stronger economy. The flat tax would also bring sanity to an overly complicated tax code by allowing taxpayers to file their returns on a postcard-sized return. In addition, a flat tax would illuminate the underground economy, eliminate or downsize the IRS, allow American businesses to be more competitive in a globalized economy, and most importantly, allow taxpayers to keep more of their income.

The flat tax can no longer be referred to as a policy concoction brewed in some musty economics department or in a center-right think tank. The idea works and the evidence is the seventeen nations that have made the flat tax the center of their respective economies. How much longer can the U.S. continue with high corporate and income taxes, the unfairness of the Alternative Minimum Tax, and an overall tax code that hinders economic liberty? 

John R. Hendrickson is a Research Analyst at Public Interest Institute. 

The views expressed herein are those of the author and not necessarily those of Public Interest Institute or Tax Education Foundation. They are brought to you in the interest of a better-informed citizenry. 

Endnotes:

[1] Paul Craig Roberts, The Supply-Side Revolution: An Insider’s Account of Policymaking in Washington, Harvard University Press, Cambridge, Massachusetts, 1984, p. 292.

[2] Ibid. ,p. 313.

[3] Daniel J. Mitchell, “The Global Flat Tax Revolution,” CATO Policy Report, July/August 2007, p. 1.

[4] Robert E. Hall and Alvin Rabushka, The Flat Tax: Second Edition, Hoover Institution Press, Stanford, California, 1995, p. vii.

[5] Robert J. Barro, Gary S. Becker, Milton Friedman, and others, “Why the Flat Tax Isn’t Nuts,” Hoover Digest, 1996, No. 1, p. 25.

[6] Ibid.

[7] Ibid.

[8] Mitchell, p. 10.

[9] “Time for U.S. to join the flat tax club,” Washington Examiner, July, 2007, p. 7.

[10] Ibid.

[11] Tim Kane, Kim R. Holmes, and Mary Anastasia O’Grady, et al., 2007 Index of Economic Freedom, The Heritage Foundation  and Dow Jones & Company, 2007, p. 171.

[12] Ibid.

[13] Mitchell, p. 10.

[14] 2007 Index of Economic Freedom, p. 171.

[15] Ibid.

[16] Robert E. Hall and Alvin Rabushka, The Flat Tax: Updated and Revised Edition, Hoover Institution Press, Stanford, California, 2007, p. xi.

[17] Ibid.

[18] Hall and Rabushka, Updated and Revised edition, p. vii.

[19] Ibid., p. viii.