The Flat Tax Scam

            We’re all equal.  Shouldn’t that mean we should all pay taxes at the same rate?  Well, no, but that’s apparently the way Republican Senator and presidential candidate Rand Paul (R-KY) sees things.

            It’s campaign season (seems a little early, doesn’t it?), and so its time for Republicans to trumpet this old canard one more time as a way they’d like to see the tax code reformed.

            Under Paul’s proposal, the entire Internal Revenue code would be repealed—including the provisions that fund Social Security, Medicare and Obamacare—and replaced with a flat 14.5% tax on individuals and businesses.

            Paul’s website is unclear about whether this tax would apply to gross income or net income, but because he’s proposing to eliminate the “more than 70,000 pages of the tax code," it’s a fair bet that he’s getting rid of most deductions and exclusions.  Under any case, though, he’d keep the mortgage interest deduction and the deduction for charitable giving.   

            He claims that under his plan, a family of 4 would pay no income tax on the first $50,000 of income.  He also claims that his plan would cut taxes by over $2 trillion and create 1.4 million jobs, apparently over 10 years.

            Others have already pointed out why this proposal shouldn’t be taken seriously.  The main reason is that Paul’s proposal is merely a “starve the beast” plan covered over with arguments about fairness and simplicity.  A tax cut of $2 trillion over 10 years would require a huge cut in federal spending, which is likely to result in a larger federal deficit when those cuts in things like the military budget, Social Security and Medicare aren’t made.

            My project today is to show why most flat tax proposals premised on the idea that fairness dictates that all Americans pay tax at the same rate are scams.

            Consider a society with only 39 citizens.  Its budget is in balance. It has a progressive income tax system like ours where people with higher incomes pay tax a higher rate.  Table 1 shows how the tax burden is distributed among the citizens.

Table 1

Taxpayers	Taxable Income	Tax Rate	Tax Amount	Tax Collected
27	$50,000	13%	$6,500	$175,500
9	$100,000	22%	$22,000	$198,000
3	$150,000	28%	$42,000	$126,000
				$499,500

            Table 1 simplifies a complex system.  The tax rates shown are “effective” tax rates and not "marginal" tax rates.  Effective tax rates are total taxes collected from a taxpayer as a percentage of his or her total income.  Marginal rates are the rates that apply to each layer of tax in a progressive system.

            Now suppose that the three taxpayers who make the most money insist that it’s unfair that they have to pay a higher percentage of their income in taxes. They propose a flat tax where everyone pays the same rate.  Since this is a fiscally responsible society, the plan has to be revenue neutral to keep the budget in balance.

            Keeping the system revenue neutral means that it still has to collect $499,500 in taxes.  All taxpayers together have $2.7 million in taxable income (calculation not shown). To collect the same amount of money as under the progressive system, the flat tax rate has to be $499,500/$2,700,000 or 18.5%.  The impact of the change appears in Table 2:

Table 2

Taxpayers	Taxable Income	Tax Rate	Tax Amount	Tax Collected
27	$50,000	18.5%	$9,250	$249,750
9	$100,000	18.5%	$18,500	$166,500
3	$150,000	18.5%	$27,750	$83,250
				$499,500

           

            The people in the highest earning groups have gotten a tax cut out of the flat tax.  The poorest element of society had its taxes raised.  Table 3 shows how big a tax cut or increase each group got in nominal and percentage terms.

Table 3

Taxable Income	Flat Rate	Initial Rate	Nominal Change	Flat Tax	Initial Tax	Change	Percent Change
$50,000	18.5%	13%	5.50%	$9,250	$6,500	$2,750	42.31%
$100,000	18.5%	22%	-3.50%	$18,500	$22,000	-$3,500	-15.91%
$150,000	18.5%	28%	-9.50%	$27,750	$42,000	-$14,250	-33.93%

            In nominal terms, the poorest element of society got a 5.5% tax increase while the richest element got a 9.5% cut.  In percentage terms, taxes on the poor went up by over 42% while taxes on the rich went down by close to 34%.

            And this is the thing that most people don’t understand about flat taxes.  Though they sound simple and fair, the people who really benefit are the few at the top of the income distribution.  Most people would see their taxes go up rather dramatically.

            There is no way out of the Tragic Commons.  We either find a way to protect and share it, or we will destroy it.  There has never been any evidence that reducing the burden on the richest will benefit anyone but the richest.  The people who derive the most benefit from the Tragic Commons are in a better position to accept its burdens than everyone else.  Justice requires that they should pay more.