I’ve always been profoundly suspicious of flat tax advocates. However, a post this morning by Graham Young on the OLO Forum has me intrigued. In fairness to Graham, I should point out that he’s only thinking aloud and not actually advocating a flat tax regime as such. Indeed he says quite specifically that the concept makes him uneasy. I’m uneasy about it as well, but interested enough to post a fairly extensive extract from Graham’s OLO piece here in the hope of soliciting feedback from readers with more economics knowledge than I possess (which is to say, most people):
It seems to me that Valerie is wondering whether you could replace income tax entirely with an indirect tax, or alternatively – what is the most efficient tax mix.
The graph from Forbes is very useful here. Each of the countries listed levies an income tax, although some of them apparently at very low levels. All but one of them – Mexico – levies company tax. In fact, looking at the graphs it would be interesting to know much more about Mexico, because not only does it have a low overall tax rate, but it appears to only charge three types of tax – income, sales and employer social security. I suspect that what we would find looking at Mexico is that the level of services provided by the government is quite low, leading to the conclusion that it is difficult to provide a high service government on an indirect tax base alone.
The reason for this is that there are some people in the system who simply cannot afford to pay for everything they use, so we essentialy excuse them from paying their pro-rata share of running the country via the income tax system.
The graph helps to put the task of moving Australia completely away from income and company tax into perspective. If you look at the bar for Australia, we pay 9% of GDP via sales tax and a combined total of 19% of GDP in income and company tax. So, this implies a GST at a rate three times what it is at the moment. This would need to be 30%. If we assume that someone on $20,000 per year spends all of their after tax income, then this would involve an increase in the GST that they pay from $1,572 p.a. to $4,718, or an additional $3,145.45 p.a. based on an after-tax income of $17,300 p.a. At the moment they pay $2,700 income tax p.a., so they would be $445 p.a. worse off.
Now, I’m not sure whether these figures are correct, because when I do the figuring on someone on $40,000 p.a. (which is around the average wage), they actually end up being around $3,200 ahead, so either there are a lot of people who are worse off, or my assumptions are wrong somewhere – someone might like to check this out.
One could always compensate low income earners via the social welfare system for the increase in their living costs – which would not be overly expensive on this example.
There certainly would be some benefits to doing away with company and personal income tax. Because the tax system would be collected entirely via payments for goods and services, there would be no need to file tax returns at all, which would be very efficient from the taxpayers point of view. However, there would also be no tax deductions for business type expenses like interest, rent, petrol etc. This might lead to distortions in the system, or stop government from encouraging certain sorts of activity. As we are now all collecting the GST through our businesses, it would certainly lead to an increase in efficiency on the collection side compared to now.
… [Y]ou would probably end up freeing up a huge percentage of the tax office’s budget because the ATO wouldn’t have a lot to do anymore.
There would also be some problems. Politically, how would you get people to accept a three fold increase in the GST, even if you did promise to compensate low earners.
John Quiggin once told me that taking into account government subsidies as well as taxes, that Australian tax rates were essentially flat. If that is the case, then maybe there is really nothing standing in the way of implementing your suggestion Valerie – we’d just be swapping one form of pro-rata payment for another.
It’s an intriguing idea, if one that I’m not totally comfortable with.