Choosing the Flat Tax over the Fair Tax

After my recent post on "bashing the IRS," I got several emails and comments asking whether a national sales tax might be a better idea than the flat tax. I'm a big fan of proposals such as the Fair Tax. I've debated in favor of the national sales tax, done media interviews in favor of the national sales tax, written in favor of the national sales tax, and even defended the national sales tax in congressional testimony. As far as I'm concerned, we should junk the IRS for some type of single-rate, consumption-base (meaning no double taxation), loophole-free system. The flat tax is the most well-know approach for achieving these goals, but the national sales tax also would work. Indeed, the two plans are different sides of the same coin. A sales tax takes a piece of your income (but only one time and at one low rate) when it is spent, and a flat tax grabs a slice of your income (but only one time and at one low rate) when it is earned.

So why, then, do I devote most of my energies to a sales tax? The answer is that I don't trust politicians. I fear that they will pull a bait-and-switch, and implement something like a Fair Tax but never complete the deal by getting rid of the income tax. The European experience certainly serves as a warning. Nations across Europe began implementing their version of a national sales tax (the value-added tax) in the late 1960s. Voters often were told that other taxes would be eliminated or reduced. But all the evidence shows that VATs simply led to a much higher tax burden and a much bigger burden of government.

I don't want that to happen in America, as I explained 13 years ago for Reason and two years ago for the Media Research Center. But this video is probably the best summary of my argument.



By the way, some fans of the Fair Tax say the solution to this problem is an amendment to the Constitution. I fully agree, but then I point out that there are not even enough votes to approve a watered-down balanced budget amendment, so that seems an unlikely path to success. That being said, if we ever reach this point, and are able to repeal the 16th Amendment and replace it with something that unambiguously would stop the politicians from ever burdening America with an income tax, I will gladly offer my support and push a national sales tax

Time for some IRS Bashing

Being a lazy procrastinator, I filed an extension April 15 and then waited until this weekend to do my tax return. This experience has reinforced my hatred and disdain for our corrupt and punitive tax system. I don't even have a remotely complicated tax return, just a Cato salary and a few payments for articles and speeches on the income side, along with a standard set of itemized deductions for things like home mortgage interest.

But even dealing with a relatively simple tax return causes lots of angst and makes me long for a simple and fair flat tax. Actually, it makes me long for a limited government, as envisioned by our Founders, in which case we might not need any broad-based tax. And I suppose I shouldn't blame the IRS. The real villains are the politicians who have spent the past 97 years turning the tax code into a monstrosity.

Now that I'm done venting, I suppose I should include some educational content. In honor of tax day for procrastinators, here are three videos on the flat tax, the IRS, and the global flat tax revolution.

Good News from Romania

Redistributionists hate the flat tax, and this sentiment is widely shared by other statists. These proponents of big government want the tax system to to punish success and generate loot that can be used to buy votes (though they don't seem to understand that if they punish success too much, they won't actually get any additional money to spend, but that's a separate issue). This is why it's been amusing to watch nations in Eastern Europe adopt flat tax systems and compete with each other to have the lowest tax rate. The people who actually lived under communism are the ones most anxious to jettison the notion that a tax system should be based on "from each according to ability, to each according to need."

But this doesn't mean the flat tax is a permanent feature of the fiscal landscape in Eastern Europe. The high-tax nations of Western Europe don't like the flat tax. The bureaucrats at the OECD and European Commission don't like the flat tax. The IMF and World Bank don't like the flat tax. And, of course, there are always redistributionists in every nation who resent success and politicians who want more power. So it is remarkable that flat tax systems have been so durable. But I've seen several stories in recent weeks that the flat tax in Romania might be repealed and replaced with a class-warfare system. This would be bad news, and could be even worse news if it was the beginning of a trend. The good news, though, is that the Prime Minister just announced that there are no plans to change the system (notwithstanding the misguided views of the nation's Financed Minister). Tax-news.com reports.

During a recent gathering of small- and medium-sized enterprises in Bucharest, Romania’s Prime Minister Emil Boc announced government plans to maintain the flat tax of 16% imposed on income and profits, while also confirming plans to abolish the minimum tax from the autumn. Emphasizing that maintaining the flat tax was a fundamental objective of the government, Prime Minister Boc confirmed that the existing system would not be replaced by a progressive system of taxation, as it would not serve to generate additional income for the state budget. The government therefore has no reason to abolish the flat tax, Boc reasoned, which is also a symbol of stability and coherence of economic activity. Romanian Finance Minister Sebastian Vladescu had urged the government to move from the flat tax system of income tax, representing a bygone era, to a system of progressive rates, vital to supporting the state.

Great Moments in Government Stupidity

There really isn't much I can add to this story in USA Today about the IRS giving money to prisoners. Yes, it is a story about typical government incompetence. But it also shows the inevitable problems that occur when government engages in industrial policy and social engineering via the tax code. Let's call this argument 1,549,628 in favor of the flat tax.

Despite efforts by the IRS to combat scams, thousands of individuals — including nearly 1,300 prison inmates — have defrauded the government of millions of dollars in home buyer credits, Treasury's inspector general reported Wednesday. ...1,295 prisoners, including 241 serving life sentences, received $9.1 million in credits, even though they were incarcerated at the time they reported that they purchased their home. These prisoners didn't file joint returns, so their claims could not have been the result of purchases made with or by their spouses, the report said. 2,555 taxpayers received $17.6 million in credits for homes purchased before the dates allowed by law. 10,282 taxpayers received credits for homes that were also used by other taxpayers to claim the credit. In one case, 67 taxpayers used the same home to claim the credit.

Russia Getting Rid of Capital Gains Tax

The former communists running Russia apparently understand tax policy better than the buffoons in charge of U.S. tax policy. Not only does Russia have a 13 percent flat tax, but the government has just announced it will eliminate the capital gains tax (which shouldn't exist in a pure flat tax anyhow). Here's a passage from the BBC report:

Russia will scrap capital gains tax on long-term direct investment from 2011, President Dmitry Medvedev has said. ...Mr Medvedev told the St Petersburg International Economic Forum that long-term direct investment was "necessary for modernisation". ...Its oil revenues fund, which has been financing the deficit, is expected to end next year, and the government wants to attract more foreign investment to boost the economy.

Sounds like President Medvedev has watched the Center for Freedom and Prosperity's video explaining why there should be no capital gains tax. Now we just need to get American politicians to pay attention.

Dan Mitchell Gets Results

I gave a speech in Hungary about two weeks ago and now the government has announced a big step in the direction of better fiscal policy. According to Reuters, "Hungary's new government plans to introduce a flat personal income tax of 16 percent from 2011, as well as a 15 percent cut in public sector wages." Those are the headline initiatives, but the fiscal reform package includes other good policies. Here's a blurb from the economist.

After a three-day emergency cabinet meeting over the weekend, Viktor Orban, the prime minister, announced the government's new economic programme this afternoon. The battered forint quickly jumped almost 2% in response. ...The introduction of a 16% flat personal income tax is a daring move, and could have important repercussions beyond balancing the state's books. Unemployment, or at least that element of it which is declared, is nudging 12%, and one reason is Hungary's cumbersome bureacracy and heavy tax burden. Now Mr Orban has announced that corporation tax for companies with annual profits of less than 500m forints will be reduced from 19% to 10%. Ten more small and bothersome taxes are set to be abolished altogether.

A few years ago, when several nations each year were adopting the flat tax, I arbitrarily decided that this rock classic would be the theme song of the tax reform movement. Any better suggestions?

Is the FairTax Political Poison?

I have a question for my friends who support a national sales tax. First, some background. Beginning with the defeat of Woody Jenkins in his Louisiana Senate race back in the 1990s, various versions of the national sales tax have caused political headaches for GOP candidates. Even candidates from conservative states, such as Sen. DeMint in South Carolina, have been put on the defensive because they said good things about the FairTax. The latest example comes from the Pennsylvania special election for Rep. Murtha's seat. As this Wall Street Journal column points out, the winning Democratic candidate hammered the Republican because of his support for the FairTax. So even though I have said very nice things about a national sales tax, testified about the virtues of the national sales tax, and debated in favor of a national sales tax over the current system, I am increasingly convinced that the flat tax is the only plan that is sufficiently immune to demagoguery. Can anyone give me a persuasive argument about the political viability of the FairTax?

Democrats turned the table and ran against Mr. Burns on taxes. The GOP businessman had flirted in the past with supporting the FAIR tax, a version of a national sales tax that supporters want to replace the income tax. Mr. Critz's ads blasted Mr. Burns for supporting a 23% sales tax increase without mentioning the income tax elimination, and the GOP seems to have been caught flat-footed. Republicans can rightly complain that this is unfair and that Mr. Critz will vote to raise taxes when Mrs. Pelosi gives the order. But they need a real-time campaign answer to the tax-hike charge. Whatever the merits of the FAIR tax in theory, we've long thought it is a political loser because voters figure they'll get the sales tax without losing the income tax. At a minimum, FAIR tax supporters shouldn't have left Mr. Burns defenseless on the subject. By the way, this is also a political warning to Republicans inclined to fall for the Democratic trap of agreeing to a new value-added tax in return for lower income-tax rates.

A Flat Tax-Sales Tax Debate from the Archives

I only vaguely remember this debate that took place at Furman University, and I never saw this recording until it arrived in my inbox today. I invite fans of both the flat tax and FairTax to watch this debate and let me know your thoughts.

Many of my arguments, by the way, also apply to the debate on the value-added tax. Simply stated, I don't trust politicians when they claim a VAT won't be used to increase the overall burden of government.

Don't Give Up on the American People...at Least not Yet

Gloominess and despair are not uncommon traits among supporters of limited government - and with good reason. Government has grown rapidly in recent years and it is expected to get much bigger in the future. To make matters worse, it seems that the deck is stacked against reforms to restrain government. One problem is that 47 percent of Americans are exempt from paying income taxes, which presumably means they no longer have any incentive to resist big government. Mark Steyn recently wrote a very depressing column for National Review Online about this phenomenon, noting that, "By 2012, America could be holding the first federal election in which a majority of the population will be able to vote themselves more government lollipops paid for by the ever shrinking minority of the population still dumb enough to be net contributors to the federal treasury." Walter Williams, meanwhile, has a new column speculating on whether this cripple the battle for freedom:

According to the Tax Policy Center, a Washington, D.C., research organization, nearly half of U.S. households will pay no federal income taxes for 2009...because their incomes are too low or they have higher income but credits, deductions and exemptions that relieve them of tax liability. This lack of income tax liability stands in stark contrast to the top 10 percent of earners, those households earning an average of $366,400 in 2006, who paid about 73 percent of federal income taxes. ...Let's not dwell on the fairness of such an arrangement for financing the activities of the federal government. Instead, let's ask what kind of incentives and results such an arrangement produces and ask ourselves whether these results are good for our country. ...Having 121 million Americans completely outside the federal income tax system, it's like throwing chum to political sharks. These Americans become a natural spending constituency for big-spending politicians. After all, if you have no income tax liability, how much do you care about deficits, how much Congress spends and the level of taxation?

Steyn and Williams are right to worry, but the situation is not as grim as it seems for the simple reason that a good portion of the American people know the difference between right and wrong. Consider some of the recent polling data from Rasmussen, which found that "Sixty-six percent (66%) believe that America is overtaxed. Only 25% disagree. Lower income voters are more likely than others to believe the nation is overtaxed" and "75% of voters nationwide say the average American should pay no more than 20% of their income in taxes." These numbers contradict the hypothesis that 47 percent of Americans (those that don't pay income tax) are automatic supporters of class-warfare policy.

So why are the supposed free-riders not signing on to the Obama-Reid-Pelosi agenda? There are probably several reasons, including the fact that many Americans believe in upward mobility, so even if their incomes currently are too low to pay income tax, they aspire to earn more in the future and don't want higher tax rates on the rich to serve as a barrier. I'm not a polling expert, but I also suspect there's a moral component to these numbers. There's no way to prove this assertion, but I am quite sure that the vast majority of hard-working Americans with modest incomes would never even contemplate breaking into a rich neighbor's house and stealing the family jewelry. So it is perfectly logical that they wouldn't support using the IRS as a middleman to do the same thing.

A few final tax observations:

The hostility to taxation also represents opposition to big government (at least in theory). Rasumssen also recently found that, "Just 23% of U.S. voters say they prefer a more active government with more services and higher taxes over one with fewer services and lower taxes. ...Two-thirds (66%) of voters prefer a government with fewer services and lower taxes."

There is a giant divide between the political elite and ordinary Americans. Rasmussen's polling revealed that, "Eighty-one percent (81%) of Mainstream American voters believe the nation is overtaxed, while 74% of those in the Political Class disagree."

Voters do not want a value-added tax or any other form of national sales tax. They are not against the idea as a theoretical concept, but they wisely recognize the politicians are greedy and untrustworthy. Rasumussen found that "just 26% of all voters think that it is even somewhat likely the government would cut income taxes after implementing a sales tax. Sixty-six percent (66%) believe it’s unlikely to happen."

Fiscal restraint is a necessary precondition for any pro-growth tax reform. If given a choice between a flat tax, national sales tax, value-added tax, or the current system, many Americans want reform, but it is very difficult to have a good tax system if the burden of government spending is rising. Likewise, it would be very easy to have a good tax system if we had a federal government that was limited to the duties outlined in Article I, Section VIII, of the Constitution.

Republicans should never acquiesce to higher taxes. All these good numbers and optimistic findings are dependent on voters facing a clear choice between higher taxes and bigger government vs lower taxes and limited government. If Republicans inside the beltway get seduced into a "budget summit" where taxes are "on the table," that creates a very unhealthy dynamic where voters instinctively try to protect themselves by supporting taxes on somebody else - and the rich are the easiest target.

Last but not least, I can't resist pointing out that I am part of a debate for U.S. News & World Report on the flat tax vs. the current system. For those of you who have an opinion on this matter, don't hesitate to cast a vote.

Current System, Flat Tax, Fair Tax, or Value-Added Tax?

Here are four very short videos produced from an in-office interview I did at the Heartland Institute last week. Which tax system do you prefer?

I talk about the current internal revenue code…



...and the flat tax...



...and the national sales tax (Fair Tax)...



...and the value-added tax (VAT).

Debating the Flat Tax for U.S. News & World Report

Clemson University was a big rival when I was at the University of Georgia, so it seems natural that I am locking horns with someone from that school as we debate whether we should have a flat tax or the current system. You can see both arguments at this link, and there also is a chance to cast an online vote. At the time this was posted, the flat tax was winning with 65 percent of the vote.

The Flat Tax: Good for America, Bad for Washington

America's biggest fiscal challenge is excessive government spending. The public sector is far too large today and it is projected to get much bigger in coming decades. But the corrupt and punitive internal revenue code is second on the list of fiscal problems. This new video, narrated by yours truly and produced by the Center for Freedom and Prosperity, explains how a flat tax would work and why it would promote growth and fairness.

Merry Christmas from the IRS

Here are a few stories to bring holiday cheer for taxpayers. First, we have an Associated Press report that several hundred thousand federal bureaucrats have serious tax delinquencies. The Department of Housing and Urban Development always ranks high on the list of government entities that should be abolished, so it's interesting to see that HUD bureaucrats are most likely to be dodging their taxes:

More than 276,000 federal employees and retirees owed back income taxes as of Sept. 30, 2008, according to data from the Internal Revenue Service. The $3.04 billion owed was up from $2.7 billion owed by federal employees and retirees in 2007. Among cabinet agencies, the Department of Housing and Urban Development had the highest delinquency rate, at just over 4 percent.

This rampant nonpayment is especially outrageous since federal bureaucrats "earn" twice as much compensation, on average, as those of us laboring in the productive sector of the economy. One might think they would go out of their way to comply since their bloated salaries come from tax collections. Speaking of outrage, the internal watchdogs at the Treasury have just published a report showing that it is almost impossible to verify eligibility for the special interest tax breaks in the so-called stimulus. As Investor's Business Daily opines, this is an invitation to fraud:

A new report from the Treasury Department's Inspector General for Tax Administration counts 56 tax provisions in the bill having a potential cost of $325 billion. Of those, 20 are tax breaks for individuals and 36 are for businesses. The problem, the Inspector General says, is the IRS can't verify taxpayer eligibility "for the majority of Recovery Act tax benefits and credits." For individual taxpayers, 13 of the 20 benefits and credits can't be verified; for businesses, it's 26 of 36. ...To suggest, as Treasury does, that the biggest chunk of the $325 billion in stimulus package tax breaks can't be adequately followed violates the pledges of openness and fairness made when the stimulus was passed last February. As the government-stimulus-oversight Web site, recovery.gov, notes, last year's package "requires that taxpayer dollars spent under the Act be subject to unprecedented accountability." We wouldn't call being unable to verify upwards of two-thirds of the $325 billion handed out as "unprecedented accountability." Sounds more like an invitation to fraud, all at the expense of the taxpayers.

To be fair, even a competent government agency might have trouble making a bad law work, and the $787 boondoggle was rushed through the legislative process with very little - if any - attention paid to anything other than funneling other people's money to special interest groups. That being said, the IRS has trouble even with routine tasks. According to another IG report, the agency has a staggering 70 percent error rate in its processing of taxpayer identification numbers for individual taxpayers:

The Treasury Inspector General for Tax Administration (TIGTA) today publicly released its review of the IRS's processing of applications for Individual Taxpayer Identification Numbers (ITINs). TIGTA reviewed a sample of ITIN applications and found that almost 70% contained significant errors and/or raised concerns that should have prevented the issuance of an ITIN. The IRS estimates that it has issued more than 14 million ITINs as of December 2008. ITINs are intended to provide tax identification numbers to resident and nonresident alien individuals who may have U.S. tax reporting or filing obligations but do not qualify for Social Security Numbers, which generally are only issued to U.S. citizens and individuals legally admitted to the U.S. ..."The number of individual income tax returns filed using ITINs and reporting wage income has increased by 247 percent from 2001 to 2008," commented J. Russell George, the Treasury Inspector General for Tax Administration. "If the IRS continues to issue ITINs without proper verification, the risk of fraudulently filed returns – along with fraudulently claimed refunds – will continue to rise," added Inspector General George.

Just think how much fun it will be when the IRS is in charge of determining those of us who should get fined or jailed for noncompliance with government-run healthcare! No wonder so many taxpayers put a flat tax or national sales tax on their Christmas lists.

Tax-Free IMF Bureaucrats Urging Latvia to Repeal Flat Tax

The International Monetary Fund does not always give bad advice, but the bureaucrats (who get very generous tax-free salaries) are infamous for advising economically-troubled nations to raise tax rates. The latest example if from Latvia, which got itself in trouble by overspending during the boom years and taking on too much debt. The IMF, to its credit, has asked for long-overdue reductions in a bloated public sector, but Latvia's economy also needs investment to get back on the right path - and that will be less likely if the nation's politicians acquiesce to IMF demands to replace the flat tax with a system that discriminates against those that contribute more to growth. Bloomberg reports on how the IMF is using American tax dollars to push bad tax policy:

Latvia and the International Monetary Fund reached a preliminary agreement yesterday paving the way for the first loan payment from the Washington-based fund since December. ...The process of reaching an agreement has “been tumultuous,” Christensen said. The IMF and the Commission have made loan payments to the Baltic state conditional on budget standards being met, with the government pushing through pension, wage and other spending cuts to meet targets. The budget deficit may reach 10 percent of gross domestic product this year after the economy contracted 18 percent in the first quarter. ...The country has cut spending by lowering pensions, state pay and maternity benefits, and raised value added tax since signing the agreement. It plans to introduce taxes on real estate, capital gains and earned interest income in next year’s budget, and may close some schools and hospitals. ...“The idea of moving away from the flat tax to a progressive tax is very much one of the measures that we’re looking at,” Anne-Marie Gulde, senior advisor in the IMF’s European Department, said in a conference call. “It could help to increase revenues while putting more of the burden on higher- income groups.” The country’s parliament on June 16 passed 500 million lati ($1 billion) in spending cuts and revenue gains for this year, to unlock the loan from the European Commission.

President Obama's Dishonest Demagoguery

Politicians exaggerate as a routine matter and have well-deserved reputations for stretching the truth. But when they repeatedly make assertions that they (or their aides) know to be false, they surely deserve to be criticized. That is the purpose of my new video. Entitled "President Obama's Dishonest Demagoguery on So-Called Tax Havens," the four-minute presentation looks at the two sound bites that the President uses to demonize low-tax jurisdictions.

Defending Tax Havens on CNBC

Did I win?

American Companies Escaping for Lower Taxes...in Canada?!?

There has been considerable publicity in recent years about U.S. firms re-domilciling in the Cayman Islands and Bermuda to escape America's punitive corporate tax regime. The combination of a high tax rate and the self-destructive practice of worldwide taxation (imposing American tax on U.S. companies competing abroad, even though foreign governments already get to tax the income) has made America the least attractive place in the world to operate a multinational according to a former Chairman of the President's Council of Economic Advisers. Re-chartering abroad does not enable a company to escape taxes to the IRS on its U.S.-source income, but it does enable it to effectively compete in other nations without being saddled by the internal revenue code. Now the situation has become so bad in America that some companies are escaping to - I kid you not - Canada. Bloomberg reports:

Tim Hortons Inc, the largest fast- food chain in Canada, filed to reorganize as a Canadian company to lower its tax rate. Tim Hortons, which presently operates out of Oakville, Ontario, will become a unit of a Canadian-based parent with the same name, the company said today in a statement. Its current parent is based in Delaware. The coffee and doughnut seller began looking at moving its registration in the fourth quarter of 2008 as a way to cut its tax rate.

This may be the beginning of a trend. Reuters reports that Canadian lawamkers are advertising the fact that they have a more market-friendly system, and they hope to lure more firms north of the border:

Other companies are likely to follow Tim Hortons Inc in moving their corporate structures to Canada to take advantage of a falling corporate tax rate, Finance Minister Jim Flaherty said on Friday. The coffee shop chain said last month it applied with U.S. regulators to return to its Canadian corporate roots through a reorganization to benefit from lower taxes. Flaherty told reporters on a conference call from Chile, that he hoped the provinces would follow in the footsteps of the Conservative federal government and commit to reducing their tax rates to 10 percent by 2012. The federal government has pledged to reduce its corporate tax rate to 15 percent by that year, for a combined rate of 25 percent. "I'm optimistic that we're going to get to that 25 percent (corporate) tax rate, federal and provincial, by 2013 or so," he said. "That gives us an opportunity to brand Canada at a corporate tax rate of 25 percent globally. So that's the goal."

Arizona May Join Flat Tax Club

There are more than 25 countries with flat tax system. Several states also have flat tax regimes, including Massachusetts, Colorado, Illinois, and Pennsylvania. Arizona may soon join that club. That's the good news. The bad news is that the politicians also want to raise other taxes:

A flat income tax plan that is part of budget plans being crafted by the Arizona Legislature and Gov. Jan Brewer would take Arizona’s five personal income tax brackets down to one rate of between 2.6 percent and 3 percent and substantially cut corporate income tax rates. ...The state’s personal income tax rates range from 2.59 percent to 4.54 percent, depending on income. A flat personal income tax would take those to 3 percent or likely lower, said Tom Jenney, state director of Americans for Prosperity. ...Jenney like the idea of a flat tax but points out the budget deal would have come into play in later years, likely 2012, while Brewer wants voters to approve a 1-point increase to the state’s 5.6 percent sales tax. “That sounds like a bad deal,” said Jenney comparing the sales tax increase to the flat tax plan. ...“A flat tax would be a boon for the state’s economy,” said Steve Voeller, president of the Arizona Free Enterprise Club. “A single rate of no higher than 3 percent would make Arizona’s tax system one of the most competitive in the U.S.,” said Voeller.