Flat Tax Equals Fat Tax

Flat Tax Means Fat Tax (An Alternative Opinion) Senator Tim Hutchinson notes that we should,” Toss out the tax code and start over.” As his reason he cites the usual Republican party’s argument that the tax code is too complicated and too unfair. There are a lot of things, however, that the tax reformers aren’t telling anyone. Certainly, simplifying our tax code should be a major concern for all of us. It is needlessly complicated and results in a huge industry for accountants. However, tax simplification and tax reduction doesn’t necessarily go hand-in -hand. For example, Congress can really make life easier for all Americans by utilizing a two line tax forms. Line one would say,” Report your income.” Line two would say, “ Send it in.” This is simple, but I doubt that anyone would like this new system. Similarly, most of the Flat Tax and Consumption Tax and national sales tax proposals have some ‘hidden’ problems. First, all Flat Tax and Consumption tax proposals will result in a greater amount of tax for most middle income people. Don’t believe me? Consider this: the top tax rate is 39.6% plus various phase outs for itemized deductions and exemptions. According to most studies, there are approximately two million people in this bracket. If we have a flat tax of 17%, who makes up the difference for these two million people who will pay a lot less? Answer: WE DO!! In fact, the Cato Institute and Money Magazine (January 1998 issue) estimates that the flat tax helps those who earn over $500,000 per year and hurts most of those people who earn less. In addition, not only will most taxpayers’ federal taxes increase, but state taxes will increase as well. Most states piggy back the federal deductions. If we eliminate interest on homes, property taxes, income taxes, charitable contributions, and the states keep the same rates, the state income rates will rise. This would result in a potential double whammy for most taxpayers. This is why many knowledgeable people refer to the Flat Tax as a Fat tax. Second, we had a flat tax in 1987. We went from thirteen brackets to four, with the top rate being 28%. Ten years later with most of the same deductions eliminated, the top rate is 39.6%. If history tends to repeat itself, this same result would occur with any proposed Flat tax. This means much higher taxes in the future!! My main problem with Flat Tax or Consumption Tax proposals is that our tax system is integrally part of our economic system. If we make significant tax changes, we see big ripples in the economy. For example, prior to 1987, you were able to deduct all cars in business over a three year period. Since Congress changed the law, automobile sales have died in comparison. Ford Motor published their yearly sales of cars after 1987 and noted that they did not sell as many cars in any one year after the tax law change(1987) as they did prior to the tax law change, costing over 200,000 jobs lost permanently. In addition, with the slight real estate changes, real estate died. Many economists estimate that most of the cause of the two hundred billion bank bailout by the Treasury (which means us) had resulted from the simple tax law change limiting real estate deductions to real estate income. If we suddenly make a major change in our tax system by eliminating our tax code and replacing it with another, it could , not only stop our period of unprecedented economic growth, but could actually put us in a major recession! As one of the Congressmen noted to me recently, “ no one really knows for sure what the economic implications would be!” Interestingly, Congress could change the Internal Revenue Code to be much more understandable and easier to use. Congress can simply eliminate phase outs, alternative minimum tax, and other complicated provisions. Unfortunately, it would take a lot of courage from our Congressional leaders to do this, and the more entrenched the representative, the less likely they are to make major courageous changes in our tax system. As to a national sales tax, this would even be a greater mistake than that of a consumption tax. In addition to having the same drawbacks that a flat tax has, it also has some additional problems. Firstly, it would be much too easy for Congress to raise the rates. Secondly, it would create a great deal of smuggling as occurs in Canada( who also has a national sales tax). Thirdly, it creates tremendous postal problems since the post office will scrutinize all packages for possible sales tax violations. This has caused major delays in delivery of packages throughout Canada. In fact, in Canada, where a national sales tax exists, the post office is extremely inefficient partly because of the sales tax problems. If you know any Canadians, ask them about their national sales tax. They, themselves, will tell you what a disaster it has become. Fourthly, small business has been the engine of our economy since our country’s inception. It already is very difficult to succeed in business as it is. A sales tax would result in increasing the cost of all goods and services incurred by small business by at least 20% before they make any money. This would greatly increase the cost of starting a business that , in turn, would result in fewer successful businesses. Fifthly, a national sales tax would be a tax disaster for low income and middle class taxpayers. In fact, they would have much more of their income subject to tax than that of the rich. For example, a person who earns one-million dollars a year will probably not spend everything he/she makes. Then may only spend $250,000 that would possibly be subject to the sales tax. However, a person earning $60,000 per year will probably spend everything they make and more. Thus, all of their income will be subject to the tax. Thus, middle class taxpayers will pay a proportionately greater share of the tax then the rich would pay. This is why many economists refer to the sales tax as regressive. Finally, If we have a whopping 30% sales tax on all goods and services( in addition to what the states charge), it is very possible that the public will do everything possible to reduce their purchases of goods and services. This could result in economic chaos such as a recession or even a depression. In short, we don’t need to replace the tax system, we need to replace all Congressmen and Senators with people who are courageous and have common sense. Thus, before you consider eliminating the current tax system and replacing it with one of the other proposals, always remember the words that Fagin used in the movie Oliver, “ I think I’ll think it out again.” Mr. Botkin is President of the Tax Reduction Institute of Germantown, Md. He is a former attorney with the IRS and was one of eight attorneys who trained the IRS attorneys nationwide in the IRS Corporate Tax Division. He is the author of the famous series, “ Tax Strategies For Business Professionals,” and “Tax Advantages for You Home Based Business”(US and Canadian versions).