One tax rate for all, levied on gross income, with no deductions or exemptions—how simple, almost elegant, the flat tax sounds in its purest form. A flat income tax like that, or even that plan with a few modifications, could make the filing of one’s federal income taxes a snap—with no assistance required, not even a software program. If the flat tax rate were low enough, many people would willingly give up their tax exemptions and deductions. At least they think they would.
But the flat tax is a bad deal for several reasons. And would-be supporters ought to ask serious questions of anyone who proposes it, especially in an election year, when it is being offered to voters like a bag of candy.
The key question is: What is meant by gross income? Does the term mean wages only, or wages plus Social Security and pension and all other income—like cash or stock bonuses, interest, investment dividends and capital gains, inheritances and other valuable gifts? Could one still stash wealth, for example, in nontaxable municipal bonds? Some billionaires currently pay very low taxes because their wealth does not depend on wages but rather on other sources of income that is taxed at lower rates. If all sources of income are not included in a federal flat tax plan, then the major sources of income “earned” by the wealthiest Americans may not be subject to the tax.
That brings up the primary drawback of a federal flat tax: it cannot pass a fairness test. Consider a hypothetical case of two earners, one with a $50,000 annual income and the other with a $5 million income and a flat tax rate of 20 percent for both. The first earner would pay $10,000 in taxes; the second, $1 million. Yet the lower earner still carries the greater burden, because it is much harder to live on $40,000 a year after taxes than to live on $4 million. The price of a sack of groceries, a gallon of gas, a doctor’s visit or a new car does not vary much, regardless of the purchaser’s income. That is why consumption taxes and flat income taxes are both deemed regressive. A flat tax rate, many economists say, places a disproportionate burden on middle and low earners.
Catholic social teaching adds much to this discussion. The reflection “Towards Reforming the International Financial and Monetary Systems in the Context of Global Public Authority,” published by the Pontifical Council for Justice and Peace on Oct. 24, applies basic ethical principles to the global economy and the goal of the common good. It also notes that although the average per capita income has risen over the last 100 years, “the distribution of wealth did not become fairer but in many cases worsened.”
In their pastoral letter “Economic Justice for All” (1986), the U.S. Catholic bishops promoted commutative and distributive justice. The former pertains to fundamental fairness in agreements and exchanges, like that between employers and workers; the latter pertains to the allocation of income, wealth and power, judged in light of its effects on the poor (Nos. 59, 60). The bishops, concerned to remedy the “inequitable concentration of privilege,” supported the view that tax assessments should be based on the “ability to pay” (No. 72). Taxation, they wrote, ought to “raise adequate revenues to pay for the public needs of society”; follow “the principle of progressivity, so that those with relatively greater financial resources pay a higher rate of taxation”; and exempt those with incomes below the official poverty line. The bishops also noted that “most sales taxes and payroll taxes place a disproportionate burden on those with lower incomes” (No. 202).
But the Tax Policy Center found that Herman Cain’s 9-9-9 tax scheme would raise $300 billion less than the current tax system. Low revenue would force the government to cut services or to borrow, adding to the deficit, or to levy additional taxes like a V.A.T. or national sales tax. Governor Rick Perry’s flat tax aims to cut government services, which would exacerbate the “inequitable concentration of privilege.”
Since 1913, when the federal income tax was instituted, U.S. tax policy has followed the principles of progressive taxation, based on fairness and the taxpayer’s ability to pay. Without doubt, current tax policy has become overly complex and riddled with loopholes. The tax code needs to be simplified and reformed next year, when the Bush-administration tax cuts are set to expire (again). In fact, the tax rates are not nearly progressive enough, especially for high earners. The millionaire pays the same rate as the billionaire, even though the gap between them is enormous—a situation that cries out for adding more tax rates at the top end of the spectrum. But while tax reform and simplification are critical needs, these ought not be confused with untested notions like the flat tax and its various modifications. Better to simplify the current system and make it more progressive and more fair. At best, the flat tax is simplistic; at worst, it could prove devastating.