Flat tax

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.

About Ken Parish

Ken Parish is a legal academic, with research areas in public law (constitutional and administrative law), civil procedure and teaching & learning theory and practice. He has been a legal academic for almost 20 years. Before that he ran a legal practice in Darwin for 15 years and was a Member of the NT Legislative Assembly for almost 4 years in the early 1990s.
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John Humphreys
2022 years ago

It seems that your friend is talking about using only a consumption tax and abolishing the income tax. Another option is to retain the income tax, but make it flat.

What is the difference? Basically, a flat consumption tax is proportional while a flat income tax is mildly progressive (as it double taxes savings and rich people save more as a percentage of their income). Further, you can introduce a tax free threshold, which can make a flat income tax more progressive. Indeed, by getting rid of some more regressive taxes and some tax expenditures, a flat income tax with a decent tax free threshold may well be more progressive that the current system.

A flat income tax with few (if any) deductions would obviously be a lot more simple than the status quo, and arguably would have a lower administrative burden than a flat consumption tax. Done properly, you could effectively get rid of tax returns (or at least make them as big as a postcard).

The income tax policy of the Liberal Democratic Party is to replace the current tax system with a flat 30% income tax, with a $30,000 tax free threshold.

Ken Parish
Ken Parish
2022 years ago

John,

When you say “few (if any) deductions”. what do you actually mean? Do you mean that expenses incurredin gaining income would not be deductible? If so, you’re talking about a flat turnover tax rather than an income tax. That strikes me as involving massive problems and inequities. On the other hand, if you’re talking about net income (as with the current system), I don’t really see why that would be significantly simpler than the present system.

It was those sorts of problems with flat income tax that led to my being intrigued by Graham Young’s “all GST” suggestion.

Homer Paxton
Homer Paxton
2022 years ago

Ken,
There is a difference between a flat tax ( which is say 10% but has NO deductions) and a linear tax which is the same except it has a threshhold to make it progressive.
I actually favour it because:
1) deductions are highly correlated with income
2) it is damed hard to avoid
3) it is very simple
4) you can get accountants back to do the job they studied for rather than avoiding tax.

Of course there are other things to do like introducing a wealth tax, bring food back into the GST only getting States to tax payrolls without thresholds and land etc.

The Usurer
2022 years ago

I checked the original article – yahoo groups posts are available online. Here it is for everyone to read: http://groups.yahoo.com/group/OnLineOpinions/message/6936

It’s riddled with plenty of problems, with its figures being the least of its problems. Possibly the most notable of these is Young’s first complaining about distortion in the absence of tax and then in the very same sentence complaining about the reduction in the government’s ability to distort!

A technical query I have is the claim that subsidies make tax more flat. I have my doubts about this because of dividend imputation, though I haven’t done any sums. Since it is Professor Quiggin’s claim, maybe he might care to comment upon this?

The rest of what I have to say is available on my own page, but it is of course based on a radically different philosophical and political basis to Young’s, so it’s not going to be everyone’s cup of tea. http://usurer.ubersportingpundit.com/archives/002132.html

JJM

Jason Soon
2022 years ago

I favour a flat income tax for the administrative simplicity reasons cited by John. My ideal tax system would combine a flat tax with a high income threshold with heavy death duties to also compensate for loss of progressivity (which though introducing admin costs have less disincentive/deadweight loss effects than income taxes). As a tangent I would like to see policymakers revivbe the debate on death duties – they seem to me an almost ideal tax in reducing market distortions while collecting additional revenue. I can’t imagine people distorting their labour supply decisions substantially just to give their children a few more quid in the bank. One intriguing idea would be to give people the choice between leaving their legacy to a favourite charity and taxing them substantially lower or otherwise having this legacy taxed extremely heavily. I’d like some comments from people in the know on how much scope for tax evasion this would create or whether it’d be a viable system (personally if I end up rich I would leave my children my personal library and a good university education and basically nothing else, the rest of my legacy would go to my favorite research charity). I would also investigate the option of introducing carbon taxes – whatever additional revenue would be raised by carbon taxes would be used to lower rates on other taxes which are more distortionary of work incentives. A carbon tax set at an appropriately low level is one of the few taxes which does not create an economic deadweight loss (unless one wants to argue unconvincingly that the current levels of pollution are optimal).

John Humphreys
2022 years ago

Ken, I would retain deductions necessary to determine profit (to ensure it was not a turnover tax). For more information on the total amount of tax expenditures you might like to check the government publication – Tax Expenditure Statement (released yearly, I think it’s on http://www.budget.gov.au). There are thousands of tax expenditures, totaling over $30 billion. Just like spending programs, they are easy to introduce and near impossible to get rid of.

I think Jason and I have a very similar idea of a good income tax. I think the both of us would also supliment the income tax with a negative income tax.

Jason, on death duties – I imagine they would pretty easy to get around. Wouldn’t people simply transfer money/assets into other people’s name before their death. Also, I don’t see why you say they are more efficient. A 100% death duty would certainly change my spending and saving behaviour as I got older. I don’t see why giving money to your children should be treated differently if you do it the day before or the day after you die. Or would you ban gifts?

On the carbon tax – I’m not sure. I think a broader environmental tax may have something going for it, replacing current petrol excises. Haven’t finalised my thoughts on it though.

Homer Paxton
Homer Paxton
2022 years ago

Jason,
you make a lot of good points and I must admit death duties are my favourite form of wealth tax.

John,
since you would need less people in the ATO on income tax you could put them onto death duties.As Jason says they are bad on the adminstration stakes but that is something you must live with. I also suspect Jason would have gift duties to assist.

A minimum income was always a favourite of Friedman who championed flat taxes and negative income tax is a necessary part of that.

Wallace
2022 years ago

Although I have no hard data to support it, I’ve always thought that a pure flat tax, with no deductions, would actually raise more funds than our present system [in the U.S.], be infinitely more fair and obviously simpler. And I’m one who benefits from major deductions…being in the oil business.

The flat tax also has no chance in hell of ever passing for one simple reason…..special interest lobby groups.

Tiu Fu Fong
Tiu Fu Fong
2022 years ago

Re: death taxes – I understand these were once hugely unpopular, but I suspect perhaps that reflects previous generations’ attitudes towards the right to pass on substantial wealth to their children. With the baby-boomers approaching retirement, I wouldn’t be surprised if they would be more accepting of death taxes on the basis that they intend to spend it all on themselves until they die, perhaps just leaving the roof over their heads and whatever is left of their “I didn’t get around to spending this before the Grim Reaper turned up” money.

As a man still in his 20’s, I must admit a deep-seated prejudice against the baby boomers which may have tainted my comment above.

Tiu Fu Fong
Tiu Fu Fong
2022 years ago

To add some further thoughts/questions on death taxes, what do you guys think the equity principle is underlying them?

On the one hand, I can see potential objections on the basis that the deceased has already paid tax during their life and the assets of their estate were acquired with post-tax dollars. Why tax them again?

On the other hand, inheritance in unearned wealth, so what is the objection to taxing it?

On the death-tax dodging front, I’d expect to see people vesting their property in company trustees administrating discretionary family trusts to avoid death taxes. The beneficiaries would include those who would otherwise inherit the wealth directly. When the deceased dies, he or she dies with no assets (as all are vested in the trust) and hence there is nothing to tax.

In Australia, death taxes could be introduced easily under the CGT regime. Just remove parts of section 128-15 of the Income Tax Assessment Act 1997 which knocks out the capital gains (or losses) that would otherwise arise on a transfer of assets from the deceased to the legal personal representative and then from the legal personal representative to the beneficiaries of the deceased’s estate.

mark
2022 years ago

Some people seem to want their earthly remains to go to relatives, friends, etc., Tiu. At least, that’s the theory I’ve come up with to explain the popularity of wills.

I suppose it’s possible those people would object to having the $1,000 they were going to leave their kids reduced to $750 and given to the govt to hand out to $deity-knows what evil welfare cheat comes along, or something along those lines.

(Yes, I’ve definitely become a left-wing nutter. It’s time to get more sleep.)

Jason Soon
2022 years ago

John
I should clarify – we’re not talking about leaving money to actual children. Most people do not die when their child is below 18. There could be some way of taking that into account – for instance we wouldn’t tax their life insurance policies for dependents. However I don’t see why anyone would be particularly motivated to work more just for the opportunity of giving his adult children more money. Hell, I’d go out of my way to ensure my adult children didn’t become spongers which is why I’d leave them nothing. Given that a certain amount of revenue must be raised and given that income taxes are distortionary of labour supply decisions and thus create social deadweight losses, these can be reduced by flattening and lowering rates of income taxes and passing the burden on to less distortionary taxes – one of which is inheritance (a very specific form of consumption, taxing inheritance is like taxing consumption of a good called ‘passing on $$$ to your adult children’, which doesn’t translate into a substantial restriction of consumer sovereignty), taxing negative externalities, and taxing economic rents (e.g, land taxes, mining royalties)

Jason Soon
2022 years ago

John
re your other question – there would be a limit to the extent to which people would try to evade death taxes by passing on money to their children before they die – namely, they wouldn’t want to end up being dependent on the gratefulness of their children by giving away too much and not leaving enough for their consumption for their remaining time on earth.

John
John
2022 years ago

We already have a tax system that’s broadly proportional in its effects. The progressivity of the income tax scale is offset by the concessional treatment of dividends and capital gains (these more than outweigh company tax) and by the fact that all the taxes other than the income tax are regressive.

The best way to tackle the death taxes problem, IMO is to make inheritance income taxable in the hands of the recipient, rather than as a function of the size of the estate. I discussed a lot of this in my book Taxing Times

Graham Young
2022 years ago

The dangers of thinking aloud. Ken’s excerpt from my original post was a response to someone else on onlineopinions@yahoogroups.com, not a definitive position on the issue. For the record I have never advocated flat tax, or suggested that all taxes ought to be scrapped and replaced by just one, let alone an indirect one. Until the post (by someone called Valerie) to my list, I hadn’t even entertained the thought of doing away with income tax and relying entirely on indirect tax – afterall, didn’t the Commonwealth take over the income taxing powers of the states for the reason that indirect tax alone was not enough to fund its budget requirements?

But when someone puts a proposition to me I generally give it the time of day. On top of that the comment by John Quiggin that taking tax and benefits into account we essentially have a flat tax system has been running around in the back of my mind wearing a few circles in the grass and upsetting my view of the world.

So, the conjunction of the post and the conversation meant that I’m ready to think a bit more deeply about tax issues and give more radical suggestions a longer time of day. That doesn’t mean I’m a convert. BTW, the conversation with JQ came about as a result of this article http://slate.msn.com/?id=2077294 which says that the US tax system factoring all benefits in, is essentially flat.

David Morris
David Morris
2022 years ago

For research into the incidence of taxation (concluding that the system is progressive), see: http://www.natsem.canberra.edu.au/pubs/dps/dp39/dp39.pdf

trackback
2022 years ago

Some tax reform ideas

Ken Parish has posted a short piece on a post in the Online Opinions email list by Graham Young. The post to which he refers is available here – click past the ad….