Reply to Scott Hicko on flat taxation | consa's Blog

Hicko's bottom line critique of flat taxation consists of a 25 question True-False quiz at the end of his chpt. 12, with tendentious model answers. I will now list the quiz questions, and comment on each.

1. The Flat Tax would greatly reduce the length and complexity of the Revenue Code. Answer. Hicko denies this, and I deny his denial. Getting rid of the present personal income tax, estate tax, and corporate income tax will result in a huge simplification. I do grant that many people with limited experience with business arithmetic will find some aspects of the Flat Tax hard to follow. I also grant that the some industries, such as financial services and the nonprofit sector, will require detailed regs. Nontrivial transition rules will be in effect for at least 50 years. The taxation of foreign income could retain a lot of its present-day complexity.

2. The Flat Tax would eliminate lobbying. Answer. Lobbyists would, as now, continue to push for amendments to the Revenue Code that would twist it to the advantage of clients. This is an unavoidable fact of life in any democracy. Moreover, the Flat Tax would in no way reduce the incentive to lobby for govt. expenditures.

3. The Revenue Code is chockers with various incentives. Answer. Of course. But the Flat Tax would greatly simplify those incentives, by reducing income taxation in the USA to two numbers: a flat rate, and a demogrant.

4. Complying with the Flat Tax would have a zero cost. Answer. The marginal cost of tax compliance, given any decent accounting system, would be trivial. Here Hicko says that the reduced compliance cost would have to be weighed against "the loss of economic freedom for the average American." I firmly deny that economic freedom is substantially under the current system than it would be under the Flat Tax.

5. Tax shelters supply real economic benefits. Answer. They may do so, but they come at a disguised cost in terms of lost revenue, and of perceived unfairness. Hicko claims that most abusive tax shelters were abolished in the 1980s. I wonder if present day tax professionals would concur.

6. Tax shelters are bad. Answer. Depends on what we call a shelter. Is the tax deferral built into retirement plans a bad thing?

7. Higher marginal brackets encourage risk taking. Answer. To a first approximation, this is correct. When the corporate income tax is 40% or higher, there is a sense in which the taxpayer is a sleeping partner with every nontrivial firm.

8. Rich people avoid paying income tax via loopholes. Answer. Hicko claims that most loopholes were closed in 1986. For him, the biggest loophole is the lower tax rates for realised capital gains, and these have been true with a vengeance since 2003. Hicko despises the Flat Tax because it does not tax capital gains. He cannot see that the Flat Tax will reduce capital gains on stocks by increasing the taxes take from corporations. The Flat Tax would not tax capital gains on real estate, and this could prove to be a problem.

9. Fair means taxing all persons at the same rate. Answer. Hicko does not appreciate that a flat marginal rate with a demogrant results in a progressive average tax rate. The flat marginal rate applicable to all value added has a signal advantage: it extinguishes all forms of tax arbitrage. Incidentally, I prefer to avoid talking of "fairness" when discussing the Flat Tax.

10. The concept of marginal tax rate is hard to understand. Answer. It is easy for accountants and economists to understand. It is an empirical question whether the median voter finds it, and the many ways the marginal rate influences behaviour, easy or hard to understand. We economists maintain that thinking average when marginal is the way to go is rife in everyday life, and I suspect that the same holds when contemplating taxation. Hicko says that calculations involving a schedule of marginal rates are not hard to undertake. He is correct, but that does not speak to whether small firms and households truly understand that optimal behaviour in the face of taxation is determined at the margin.

11. The Flat Tax would abolish special treatment. Answer. Hicko flatly disagrees, pointing to the large decline in the tax liabilities of the rich under the flat tax systems advocated by Hall, Rabushka and Steve Forbes. I have squelched that objection by recommending a flat rate of 35%, equal to the top marginal rate under current taxation. The flat tax would be much kinder to firms that regularly invest than to firms that do not. I predict that this will lead to accusations of partiality towards commercial real estate.

12. The Flat Tax will raise the total liabilities of many USA households. Answer. This is true of last century's flat taxes, that did not integrate FICA/Medicare, and that featured flat rates below 20%. I believe that my flat tax will collect more revenue from household earning over, say, 500K/year, and will collect little revenue from households whose taxable income is less than that of the median household.

13. Marginal tax rates are fair. Answer. Hicko's says Yes, then delivers a short and raising populist sermon to the Greatness of America, adding that income tax is modest price to pay for the privilege of living in the USA. I say that fairness has to be articulated mathematically, after which tax proposals can be ranked by fairness. I maintain that a demogrant of $350/month, food stamps and Medicaid would largely extinguish absolute deprivation in the USA. I think it would also materially reduce relative deprivation, defined as having an annual income, gross of benefits and net of taxes, less than 40% of the median per capita income.

14. The Flat Tax is regressive. Answer. The combined effect of 20th century flat taxes with FICA/Medicare taxes was regressive. The flat tax of this Note was carefully designed to counter this major criticism of 20th century flat taxes.

15. It is hard for most Americans to file their tax returns without professional assistance. Answer. Hicko disagree, but I demur. The success of H&RBlock attests to the truth of this. I would say that at least 25% of Americans are sufficiently functionally illiterate or innumerate as to be thoroughly intimidated by an income tax return. New Zealand tax forms and instructions are a lot easier to understand than their US counterparts. A major reason for this is that New Zealand tax is much simpler.

16. The Flat Tax would increase the revenue and power of the Federal govt. Answer. Hicko asserts that this is true. I believe that there is a serious risk that lowering the marginal cost of collecting a dollar of tax, could lead to a rise in the total tax take. If the flat tax leads to a spurt of economic growth, how much of that growth will the Federal govt seize?

17. The Flat tax will reduce the incomes of CPAs and tax attorneys. Answer. Hicko cynically denies this, pointing to American history. I believe that (17) would largely prove true.

18. The Flat Tax would advantage State & Local government. Answer. Hicko says that removing the exemption of state & local govt. bond interest would raise their borrowing costs and leave us all worse off. The exemption of muni bond interest is unique to the USA. Other First World nations get along fine without this feature. Under my flat tax, muni bonds would have the same yield as corporate bonds of the same risk. Hence no arbitrage opportunities. All taxes owed on bond interest would be paid by the borrower, not the investor.

19. A Flat Rate of 17-19% is too low to balance the budget. Answer. Agreed, which is why I advocate a rate of 30% or more.

20. The Flat Tax will end tax evasion. Answer. Wrong. Under the Flat Tax, there is ample incentive to understate sales, overstate costs, and to claim as a cost of goods sold, purchases whose only true purpose is to compensate employees in kind. All these activities would have to be vigorously monitored.

21. Under the Flat Tax, the IRS could be abolished. Answer, Wrong. Every business, every state & local govt. authority, every nonprofit entity would file an annual return that would have to be scrutinised and sometimes audited.

23. The estate tax is an arbitrary tax on the accumulation of wealth. Answer. No, it is an arbitrary tax on the intergenerational transmission of wealth.

24. The Flat Tax is not the driving force behind the flat tax movement. Answer. Few well heeled households would be better off under my flat tax than under the current income tax. Greed among households that would benefit from the demogrants, could have something to do with the political popularity of my flat tax.

25. The wealthy demand more public services than the poor. Answer. This is defensible. And the answer is that the tax system described in this Note does indeed exact more tax from the well heeled.flat

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