Flat Tax (published – Warwick Economics Journal)
Economic Holy Grail or Potential Failure in Disguise?
The flat tax is, to most fiscal conservatives, the Holy Grail of public policy and the future. The simplicity of such a system is undeniable: one low income tax rate that would be paid by all but the poorest wage earners. In such an economic ‘nirvana’ there would be no loopholes for the rich to exploit and certainly no graduated rates of taxation that would take a higher percentage of income from those that work hard to earn more. Ultimately, the minimalism of such a system lies at the heart of its desirability and stands in stark contrasts to the complex and multifarious maze that is today’s tax regulations.
Under the current Labour Party, the government handbook on tax regulations has roughly doubled in volume since 1997. In France, the current taxation system offers a bewildering, yet humorous, 560 different types of tax breaks – ranging from a special exemption for journalists to a deduction for taxpayers who happen to employ household help. Clearly, in the face of such profound complexities and inefficiencies, is it not time for the western world to wake up to the golden opportunity of the flat tax?
In fact, the governments of the west should look eastwards for a clear example of the potentials of a single universal tax rate. In 2004, in an attempt to create an investor-friendly economic environment, Slovakia simply swept away its 21 categories of personal income taxes, five tax brackets, and scores of exemptions and deductions, replacing them instead with a flat 19% rate. In turn, the country has secured a $1.3 billion investment in 2005 by Hyundai Corp., the Korean automakers – which is now building a factory for its Kia brand cars in the Slovak city of Zilina. Even more impressive, the total foreign direct investment in Slovakia last year was $13.6 billion which constitutes a massive six-fold increase since 1998.
Yet, the beauty of the flat tax extends far beyond the mere ability to attract sizeable foreign investments, rather, it includes a whole foray of benefits that would advantage any country – developed or developing.
The US tax code is currently some 9 million words long and contains innumerable loopholes, deductions, and exemptions that create inefficiencies in tax collection. It is argued by proponents of the flat-tax that the system in its current form actually stifles economic growth by distorting economic incentives and allowing, indeed in some ways encouraging, tax evasion. However, if a flat tax was to be installed in the United States of America, then the transparency that would naturally ensue would guarantee a huge reduction in the incentives for the wealthy to create tax shelters.
Further, a flat tax system would actually result in higher revenues for the government involved. The simplification of the tax code would remove certain loopholes that are currently frequently used by corporations and the rich to pay fewer taxes. Again, western governments need only look over to the Russian Federation to see how this could take effect. Russia, after its introduction of a 13% flat tax rate, saw real tax revenues from ‘Personal Income Tax’ rise by 25.2% in the first year of its new system, followed by a 24.6% increase in the second year and a 15.2% increase in the third year.
It is also argued that the government’s cost of processing tax – a cost which is often unknown or ignored by the population at large – would become significantly smaller with a flat tax since the relevant tax bodies could be abolished or enormously downsized. Germany, for example, spends 3.7 billion euros or 0.14% of its GDP a year on tax collection and processing – a sum that could otherwise be used to build schools and hospital.
However, there is, understandably, no guarantee that flat taxes would work as well in Western Europe as they have in the countries to the east. In the former Soviet bloc, most of the countries that have enacted flat taxes gained an increase in revenue as people who had been previously working in the shadow economy began reporting their income and finally paying their taxes. The former tax dodgers simply figured that with rates so low, there was no longer any point in running the risk of breaking the law. However, unlike their compatriots behind the Iron Curtain, relatively few Western Europeans and Americans work in the shadow economy.
Critics of a single flat taxation rate have also claimed that making the income tax flat would actually make the overall tax structure regressive – in that lower-income people will pay a higher proportion of their income in total taxes compared with the affluent.
Still, in spite of such criticisms, a flat or streamlined tax code would go a long way towards restoring the public’s trust in the tax system – a trust that has long since been lost in the face of a multiplicity of loopholes and mounds of bureaucratic red-tape.
Ultimately, the simplicity of the flat tax may remain but a dream for some time, but, the realities of its incredible potential will continue to remain a force for its future implementation.