The Flat Tax Miracle

Much of the political commentary and rhetoric of the past several years have featured variations on the same theme; the (pick your villain) poor people, union workers, public employees, illegal immigrants don’t pay taxes (or don’t pay enough). The next statement typically involves some mention of how any demand that successful individuals and businesses pay more in taxes, and thus subsidize the welfare of those lower people, is class warfare. Commentary on the benefits and fiscal logic of progressive taxation is, alas, fodder for another post. This post is specifically about the foundation for these political attacks.

Everyone pays taxes…the only things certain in this life, Franklin said, are death and taxes. In these United States, the majority of the taxes we the people pay fall into the conservative definition of a fair tax. With one notable exception, all of the institutions financed by these universal and absolutely flat taxes are in fiscal trouble. Social Security stands alone as a flat tax-supported program that is solvent. Its sister program Medicare, while supported by the same mechanism, finds itself the victim of the highest continuous single-industry inflation rate in the history of the world. State and local programs, financed almost exclusively by flat sales taxes, flat property taxes, flat fees, nearly or totally flat state income taxes, and various gambling schemes, are also on the outside of solvency looking in.

It is the political idea that flat taxes, were they adopted, would save the world, that I wish to focus on. Our politics are dominated by ideas of taxation that are not just unsupported; the evidence actually completely refutes them. At this minute, the U.S. Chamber of Commerce is ginning up a campaign to “create American jobs” by, you guessed it, lowering taxes. When the overwhelming majority of U.S. economists stated that this nation needed a large fiscal stimulus composed primarily of spending programs, the politicians and interest groups lined up to either support or oppose the idea based entirely on their preexisting ideology. When those same economists, using the same methodology, stated that ending the Bush tax cuts would have some negative effect on the recovery, the politicians and interest groups immediately lined up and jumped on board. The realities ignored by these groups contain the following:

  1. We have spent the last thirty years slashing taxes, and those same years have seen our greatest decline in jobs and industrial influence
  2. The largest tax cuts in history (so we were told) were passed immediately prior to the worst recession since 1929
  3. We already fund the bulk of our public spending via flat taxes
  4. When we, and I mean all of us, talk of the “good old days”, we are remembering times characterized by far higher taxes than we have now

These facts are apparently easy to ignore because tax cuts are, apparently, the wonder drug that works wonders. By extension, any talk of higher taxes, on any group, is political suicide. On this issue, party identity means nothing. Democratic Representative Phil Hare, desperate to save his job (representing the district I live in), attacked his Republican opponent for suggesting the very responsible notion that FICA taxes could be raised. (This political example of the fire hydrant pissing on dog brought to you by the insanity that was the 2010 midterm cycle.) Into the middle of this circular firing squad of fools walks the illegal aliens, working poor, and working class…those select few (half of the country, actually) who benefit from the “free ride” given by progressive taxation.

Lets take a look at the various flat taxes in our nation:

  1. Property Tax-Unless you are homeless, you pay property taxes. The taxes are built into the rental rates for apartment dwellers (same as any other cost), and are collected religiously on all other structures. These taxes pay the bulk of the costs for police, fire protection, and K-12 education in our nation, and everyone (yes, even illegal aliens) pays the bill.
  2. Sales Tax-Only a cheating merchant stands between every individual and the payment of this tax. This is also the best example of the regressive nature of flat taxes; working class families pay a much higher percentage of their discretionary income to sales tax than do professionals and the wealthy. It isn’t class warfare…the more you earn, the less of your earnings are devoted to the basics.
  3. State and Local Fees-The easiest way for local governments to increase revenue without being hammered politically is to increase fees and fines. A personal injury lawyer’s $250 speeding ticket is the same as a 0.3% tax on bad behavior. For a rookie cop, that same fine represents a 0.8% tax.
  4. Gasoline and Transit Fees-No progressive taxation here, the taxes that now support most of the road construction and maintenance in our nation (literally, our commercial arteries) are paid for via an instrument that punishes those without the means to purchase new vehicles and maintain them well. Once again, no one escapes this tax.
  5. FICA-The best for last; unless the employer of an individual is dirty, everyone (to include illegal aliens) pays 6.2% of the first $106,800 of their income to support Social Security. Everyone also pays 1.45% of all of their wages to support Medicare. Of course, if you were earning all of your income via interest or dividends, you would pay a 0% tax. Of course, those falling into that category (which includes most of the CEO’s and hedge fund managers of the world, pay only 20% in income tax…which is less than the rate paid by individuals earning $34,000 per year.)

It would take a book to investigate the realities of capital gains taxes (and the book will be ready early next year, by the way), so I won’t comment further on them here. It is instructive to look at the FICA tax in the context of working people and small local businesses. By working people, I am talking of the majority of the folks you know; teachers, police officers, soldiers, firefighters, electricians, salesman, retail managers, and bank tellers. All of those folks make less than $106,800 per year, and 90% of them make less than $84,000 per year. By small local businesses, I am not writing of the Mike Huckabee fantasy, where a small business is one that generates $1,000,000 per year or more in taxable income. This definition refers to those pizza parlors, barber shops, general contractors, car washers, and craft stores that are lucky to generate $100,000 per year in taxable income.

FICA is a good tax supporting good programs, but in comparison to big businesses and high-salaried individuals, it is every bit as desperately unfair to the little guys as Fox News would have you believe high marginal tax rates are to the rich. A small business like a convenience store (one with perhaps ten near-minimum wage workers) will pay nearly as much in FICA payroll taxes as their total after tax profits. The two numbers don’t cancel each other out, but the scale is instructive. The large, multinational firms whose campaign contributions have come to dominate both our politics and organizations like the Chamber of Commerce, pay a far lower percentage.

For individuals, I find the comparison equally enlightening. Picture a newly married couple in their 20’s; she is a rookie cop earning $30,000, he is a school teacher earning $25,000. They will pay 7.65% of their income ($4,208) for FICA. A young general practitioner, acting as the sole provider, might make $116,000 per year. That doctor would pay 7.2% of his or her income ($8,304) for FICA. As incomes increase, the discrepancy becomes greater. Of course, if you are fortunate enough to be member of the House of Representatives and earn $174,000 per year, you will only pay 5.3% of your salary in FICA ($9,145). That is what regressive means…the more you make, the less you pay.

It is a simple matter of math and reality to understand that our young teacher and police officer will live with much less of a margin than the doctor, and the flat taxes they pay will soak up a greater percentage of that margin.Out of curiosity, which household above is more important to our nation, the first or the last? That question is important when one is confronted with the idea that it is major business and the wealthy who “create” wealth and prosperity. All of the producers and consumers (the good working folks who make America great,) pay more of their take home pay in burdensome flat taxes than any of the top dogs who sit back and live on the residual. Consider that fact the next time some pundit tries to sell you on the miracle of the flat tax.

The Rational Middle is listening…

5 thoughts on “The Flat Tax Miracle

  1. Bill, you wrote “For example, I’d very much like to see a study of income tax paid vs. income. Without actual figures to cite, I’d be really amazed to learn that (as you suggest) higher income represents a higher % of tax paid than that of lower income.”

    I don’t follow your point here, perhaps you could clarify or state in different terms; I apologize.

    As to my estimate for a flat income tax needing to be “well into the 20% range”, I based that on a very quick look at the volume of incomes relative to federal spending, along with a much more simple number. Our nation has tended to run deficits when it has collected anything less than 20% of GDP in taxes (Republicans or Democrats…it makes no difference). It is, I think, a fair assumption that anything less than 20% on a flat income tax will not raise sufficient revenue.

    As to higher wages and the ability to take advantage of curiosities in the tax code, I think we agree. As wealth increases, the ability to push earnings into forms that approximate capital gains means that the effective rate on high earners is typically less than the capital gains rate.

    I am eager to continue this conversation…

  2. Honestly, I ask out of ignorance and I’m interested and therefore curious. Communism? Fairness is something quite different, isn’t it? For example, I’d very much like to see a study of income tax paid vs. income. Without actual figures to cite, I’d be really amazed to learn that (as you suggest) higher income represents a higher % of tax paid than that of lower income. And I’d like to know where the 20% figure comes from? Again, I only used 7% as a place holder out of ignorance. My thought is that someone on the higher end of the wage scale is also taking advantage of significant tax differals, benefits and loopholes due to the complexity of the code. It also doesn’t make logical sense to me to allow for exemptions for income even if it comes from dividends or or interest (which, by the way IS taxable income).

  3. On the surface Bill, as you say, it appears simple. I would call attention to a pair of points. First, restructuring income taxes into a flat tax form would not yield anything like a 7% rate; the number (to maintain current revenues) would be well into the 20% range. Second is the very real notion of discretionary income that many good folks (including, possibly, yourself) seem to miss. The folks who earn higher incomes will spend more than, as an example, our working couple from the post, but most basic costs in households do not increase in a linear fashion. Our couple will pay very nearly the same in health care costs as a the doctor above and his or her family. That doctor will spend more on the house (although both the house and cars will be purchased at lower interest rates), but utility bills will not be terribly different (indeed, the ability to spend more on capital items like homes and autos typically allows for the purchase of higher efficiency, and thus lower variable costs).

    When I write of progressive versus flat taxation, I am not writing of “fairness”; and neither were Adam Smith (the father of capitalism) or Thomas Paine. Those individuals and business interests who make more are able, while maintaining the higher standard of living they have earned, to support higher investments in the democracy ; investments that they reap great rewards from. The Communist nations, were everything was equal, have crumbled; why should America follow any part of their example?

  4. I’m not understanding. One the one hand, “That is what regressive means…the more you make, the less you pay.” But on the other, “Into the middle of this circular firing squad of fools walks the illegal aliens, working poor, and working class…those select few (half of the country, actually) who benefit from the “free ride” given by progressive taxation.” It appears that you’re saying the flat tax model (medicare, state and local programs, etc.) are failing. Why wouldn’t a flat FICA % allow those with lower incomes to actually pay less $ than they do today while substantially increasing the amount of tax collected? For example, 7% of $20,000 vs. 7% of $200,000. On the surface it appears so simple and balanced. Think of the tax code! Every one pays X% of their annual income, no matter where it comes from. How is it possible that this isn’t fair?

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