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Why The Flat Tax Isn’t Any Better

April 28th, 2007

Last month’s “Carnival Freak” is Praveen, who, for reasons unknown to all but himself, neglected to follow the Carnival’s stated rules, and submitted a column arguing in favor of the flat, national sales tax. He is solely responsible (and deserving of) any ridicule others may cause him to suffer. But I have better things to do than tear apart his naievète.

Ha! No, I don’t. But I’ll at least try and be civil about it

This will not be a column against the principle of taxation – that’s a much bigger beast to slay. Here I only endeavor to demonstrate that the “flat tax” is not nearly as charming as its proponents would have you believe. It should not be inferred that I favor the status quo over the flat tax. I hope to make a broader argument against the principle of taxation in the future, but for now, I’m only concerned with Praveen’s flat-tax proposal.

Assuming everyone has a basic understanding of how a flat-tax works, Praveen gives us two stunningly simple conclusions, the strongest of which is the first:

1. Having to set a high rate is not really a bad thing. The rate would show, transparently and in real-time, the true cost of government. It would provide an incentive to cut down government and make it more efficient, in order to lower the rate.

Praveen is seemingly unaware of the fact that governments the world over hide their true cost so that they can avoid raising taxes, or even lower them. They do this by monetizing their debt. But I’m willing to assume this away for continuity’s sake. From this we can infer that he understands that “taxes are necessary,” which follows from the proposition that government be the single provider of certain goods and/or services. The argument against this proposition, need not be shown here because (1) you’re probably fairly well-read, and (2) it’s not relevant.

Praveen and other flat-taxers are looking at something like: “The problem is taxes are too high,” or “the problem is taxes are unfair to some people,” or “the problem is taxes at present allow government to do all sorts of really nasty things.” It can be more elaborate, but all of the more specific problems have a common denominator: the problem is taxes. The fundamental problem in Praveen’s “analysis” is that he never gets this far, which is like a surgeon failing to diagnose a serious laceration, and then trying to scrub the bloodstains from his patient’s blouse. Having failed to recognize that, Praveen sets out like many others before him, to search for some subjectively better or different form of taxation. When an experiment is so constrainted, it should come as no surprise that any solution at which one might arrive will not be substantially different than the initial problem.

But it will be subjectively better or different, because if he didn’t think it was, he would’ve kept looking for a better solution, and also, who doesn’t fucking love their own ideas?

The second conclusion that Praveen draws for us, is that the current tax code’s regressivity is removed by a flat-tax:

2. The regressiveness is removed by the rebate. Using my rebate example numbers, all adults would get a tax rebate on the first $10,000 they spent. For someone making $15,000 a year, this means they would not be taxed for the bulk of their purchases…

I don’t need to go into much detail about the logistics of a pre-bate, but suffice it to say that if the taxes haven’t been collected, they certainly cannot be pre-bated. And because the government doesn’t have any money, its only recourse would be to monetize $510B worth of prebate money. The flat-tax is not off to a very good start. Not at all.

But even if this were not the case, it is not altogether clear that regressivity would be removed by the rebate, since the government would be the decision makers with regards to the rebate and individual tax liability. The flat tax, as well as the current system (or any system of involuntary contribution, for that matter) neglect to concern themselves with the qualitative differences between myriad individuals, which cannot be seen at an aggregate, macroeconomic level.

Consider two individuals, both of whom have an income of $25,000. Hardly a life of luxury in this country, but it is manageable. One of them is 23 and fresh out of college, working his first full-time job, renting an apartment with a roommate or a girlfriend or boyfriend. The other is 73 years old, and has lived in the same house for 40 years. He has owned it free-and-clear of all encumbrances (like mortgage payments) for the last 20 years. He doesn’t have a car payment, because he only drives to church and the market on Sundays, in an impeccably well-maintained 1978 Caprice – which has only 13,000 miles on it.

Clearly, these are two ends of a very, very broad spectrum. What if the college grad makes $40K a year? What if he has two kids to support? What if the retiree has exorbitant assisted living expenses? The point I’m trying to make here, is that it’s simply wishful thinking to postulate that a tax code can ever be applied fairly – that there is some magic black and white line that divides people as precisely as would-be central-planners envision.

The very idea of regressivity, however, is a “red herring.” The rich man, insofar as he complains about his “relative” burden, would not be any happier if he had to pay more, at a uniform, flat rate. The poor man’s complaint is that he’s being taxed too much; he cannot afford the levies upon him, and that therefore in order to maintain the same level of revenue (which also fails to identify the root problem, taxes in general) the rich, by virtue of their superior means, ought to pay more. But what is this argument except pure Marxist drivel, “from each according to his abilitity…”? Both rich and poor alike are upset at the amount of taxes, which is only sometimes related to the rate of taxation.

Furthermore, the proposed flat-tax does nothing, to remedy the fact that a very large proportion of the population will be net tax payers, while a handful of lucky individuals – mostly government employees and their contractors – will be net recipients. Their income is entirely derived from taxes paid by others. Insofar as these people “pay” taxes, their personal benefit is reduced, but it does not change the fact 100% of whatever they receive, was taken from someone else. In Power & Market, Rothbard describes such binary intervention:

[T]he thesis of a conflict of interest is true whenever the State or any other agency intervenes on the market. For then the intervener gains only at the expense of subjects who lose in utility… [A]s soon as intervention appears and is established, conflict is created, for each may participate in a scramble to be a net gainer rather than a net loser – to be part of the invading team, instead of one of the victims.” (12)

and quotes John C. Calhoun:

Such being the case, it must necessarily follow that one portion of the community must pay in taxes more than it receives back in disbursements, while another receives in disbursements more than it pays in taxes… This consequence is unavoidable. It results from the nature of the process, be the taxes ever so equally laid….”

Another significant hurdle that Praveen’s brief exposition neglects is this: Unless it were strictly codified – by which I mean a Constitutional Amendment, and nothing less (which presents problems in and of itself: the Constitution is a document that enumerates and limits the powers entrusted to the government, an act of positive legislation, e.g., the citizens must appears to be prima facie unconstitutional.) You may be wondering by now, why it would need to be set-in-stone. Allow me to explain: Anything less would lend itself to politicization.

There would be carve-outs on a massive scale, with all the lobbyists and special interests to ensure that certain industries or certain companies or certain geographic regions were exempt from collecting all or part of the tax. After all, that’s why grocery items aren’t subject to the sales tax today – someone decided it’s not fair, or whatever, to pay tax on diapers. Or milk. Or carrots. Consequently, the prices of those goods or services would be underpriced compared to the rest of the market. Rent-seeking and plutocracy ensue, with predictable results. Capital investment would be misdirected towards the procurement of such goods, and to the extent that some consumer surplus remained, consumption spending would also be diverted away from those goods and services that would otherwise be preferred. But an amendment would be a double-edged sword, which prevents the code’s alteration, but also places an impossibly high hurdle for its future eradication or diminution.

Additional problems not addressed or ignored by flat-tax proponents are too many to enumerate here, but suffice it to say that there are profound economic consequences of a flat-tax, which you, dear reader, can find in The Consumption Tax: A Critique, by Murray Rothbard. In the interest of ending your boredom, if you’ve made it this far, I’d like to reiterate that this is not an argument in favor of any system of taxation, but rather why this particular proposition is not necessarily better than any other. The case against the principle of taxation could fill volumes, and I will certainly try to do it some justice in the future. I’ll conclude with Rothbard’s damning critique:

The consumption tax… can only be regarded as a payment for permission-to-live. It implies that a man will not be allowed to advance or even sustain his own life, unless he pays, off the top, a fee to the State for permission to do so. The consumption tax does not strike me, in its philosophical implications, as one whit more noble, or less presumptuous, than the income tax.”

It does not strike me as such, either. Hopefully I’ve earned your concurrence.

Comments

3 Comments

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  • Praveen says on: May 23, 2007 at 3:45 pm

     

    Hi David,

    I’m sorry that I misunderstood the intentions of the carnival, and thought that an article about simplifying taxes would fit in.

    I’m glad it happened, though, since my post provoked your analysis, and I got a chance to find your blog, which is very interesting.

    I had a few comments:

    1. My post advocates replacing the current system with a sales tax because I believe it is simpler and less intrusive than the current system. I didn’t mean to imply that, if a sales tax is implemented, everything is great.

    I think Rothbard’s statement that the consumption tax is no more noble than an income tax is true when you talk about the broader idea of government forcibly taking private money to pay for collective things.

    However, if you have to have a tax, and the government collected the same net amount, I think we are better off not taxing capital gains and eliminating IRS monitoring and paper trails. Anonymity from government scrutiny in our daily life and business would be a big achievement.

    2. Having a high rate and regressiveness are common criticisms that I have read about the sales tax. I was simply trying to counter these arguments.

    For example, I meant to imply that a high rate for a sales tax is more transparent than the income tax, where the amount collected can be manipulated through credits, etc. I think it is easier for people to see through a sales tax than the income tax. Sure, a sneaky government (100% of them ;-) ) can still hide stuff in other places, like debt. But,for example, you would still want to light up a dark alley, even though the muggers could find other dark alleys. You deal with them one at a time.

    By eliminating regressiveness through a rebate, I did not mean to imply a sales tax is perfectly fair – I meant to address the regressiveness relative to an income tax. A common complaint is that a sales tax is more regressive than an income tax, and I think that the rebate goes towards eliminating that.

    I guess the basic philosophical difference between our views is that you believe that government and the market cannot coexist- like you say “no third solution”.

    So, you take a more revolutionary view, and think government / taxes are 100% too much.

    I am a big advocate of simplicity and minimalism in general – not just in government. I want to eliminate complexity, bureaucracy, micromanagement, and unattended consequences.

    I haven’t given up completely on government, though I think there is a good chance that you may be right.

    At this point, I believe government (and taxes) could easily be reduced 90%. I still believe, though, that there is a place for a small, venture-capitalist-like government that uses market principles to promote things in the public interest.

no third solution

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