Flat Taxes Fall Flat

Flat Taxes Fall Flat

Last Sunday, I presented my 36^th annual financial planning speech and one of the things I covered was the politics of taxes. Today, I will share some of my comments about the Flat Tax. Hopefully, this will shed some light on this complicated issue.

Taxes have always been with us – it is the way governments receive revenues to run the country. One proposal that gets much attention is the Flat Tax which is touted to be the cure all of all of the ills of government spending. I believe the claims about the Flat Tax are spurious and flat out wrong. Here are some of my reasons:

• In order for the Flat tax to be a viable alternative to the current income tax it should be revenue neutral. This means that it would have to provide the same revenue presently generated by the current tax. None of the proposals do this. They all fall short, thereby creating a massive tax cut.
• The support for the Flat Tax shortfall is that the Flat Tax would create such great incentives for growth that additional investments will be made by businesses and the Flat Tax will be a trigger for additional activity increasing tax revenues. I believe this is totally not true. For the past few years we have had record low interest rates and this has not done anything to spur borrowing, spending or growth. The proof of this is that the rates remain low. The Federal Reserve is issuing a lot of hocus pocus press releases that get a lot of play, but the reality is that interest rates are low because there is insufficient demand for long term money. If the demand was there, rates would be higher and the Fed would likely be tooting a different horn. Additionally energy costs declined to record lows, and this hasn’t provided much stimulus either. Businesses invest when they anticipate adequate returns on investment which they simply do not right now. Decreasing taxes would have no effect on stimulating the economy and spending.
• Proponents of the Flat Tax cuts point to the Ronald Reagan 1981 tax cuts which “started” the economy on a great upward trajectory. However, we had a recession from July 1981 to November 1982 and unemployment rose from between 7% and 8% when he was elected to a peak of 10.8% in December 1982 finally falling to 6% in September 1987. The tax cuts do not seem to have been much of a stimulus. Also under Reagan we had record Federal Budget Deficits rising from $74 Billion in 1980 to $208 billion in 1983 and $221 billion in 1986.
• The Flat Tax proposals do not offer a pure flat tax leaving deductions for home mortgages and charities. I am ok with this, but once some deductions are allowed, others will creep in as they always have.
• We have a Flat Tax now – actually many flat taxes. The Alternative Minimum Tax is a flat tax of which over 30% of those making over $200,000 are subject to. The Social Security tax is a 6.2% (with the employer matching that amount) flat tax on wages up to $118,500. The Medicare tax is 1.45% on all wages with no ceiling also with an employer match. Those that are self-employed pay both shares. There is also a net investment income tax with a 3.8% rate on such income over $250,000; and an additional .9% Medicare tax on earned income over $250,000.

Note: I am not against tax changes and reduction. This blog addresses the Flat Tax proposals (which I believe) will not be a suitable replacement for the current system, nor do I believe they will work in the forms proposed. Every proposal reduces the aggregate tax collections. If a tax cut is desired, then add a line on the return reducing the tax by a given percentage. If an increase is the goal, add a line increasing the tax calculated by a given percentage. Keep our convoluted system intact since it seems to be working and do not discard it with a flat tax claiming to “stimulate” growth to make up the shortfalls which it will not and cannot do. Our tax system should be changed, but not with unauthentic proposals.

I could go on, but I think I made my point – the Flat Tax proposals fall flat!