A Flat Tax?

I am currently enrolled in a Tax Research class. As we continue to work on case study-type research projects, our professor has been reviewing some articles with us that deal with U.S. tax policy. In the first couple of weeks we discussed the rationale behind the Thirteenth Amendment and a federal income tax. We next explored an alternative - a consumption tax (i.e. a national sales tax). This week we discussed the proposal of a pair of Stanford professors for a "flat tax".

As a tax attorney, our professor has often been asked (often snidely) what he thinks of a flat tax. Many people hope to trip him up because they assume that a "flat tax" would eliminate the need for tax lawyers and tax accountants. His usual response is to answer with the question: "What do you mean by a flat tax?"

It seems simple, right? A flat tax means that everyone is taxed at the same rate. That makes life easier and less complicated for everyone, right? Well, it really doesn't tax a Master's degree in accounting to realize that nothing is so neat and tidy.

At what point does this flat rate apply? If it simply replaces the current graduated rate scale, I would contend that a "flat tax" eliminates none of the complexity of the current Internal Revenue Code. The real challenge is arriving at taxable income, not simply multiplying numbers together.

Serious proponents of a "flat tax" argue that the point is to eliminate the confusion inherent in allowing all kinds of income exclusions and deductions. Even so, many argue that the poor need a break, so they would exclude a certain amount of income from taxation and tax the rest at one rate. Sounds good, right? Let's eliminate all those confusing and complicated "loopholes".

Wait! Doesn't Congress use the Code to shape public policy? What do I mean, you ask? What if you're a homeowner? Should you continue to be allowed to deduct your home mortgage interest from income? Or should the government eliminate that deduction and therefore almost discourage home ownership?

What if you have children? I'll bet most Americans with younger kids appreciate the child tax credit - it counts against tax owed, not income! We could make things a lot simpler if we did away with that.

How about if you're a charity? You probably count, in large part, on the fact that corporate or individual donations are tax-deductible (for individuals, only if they itemize). In fact, the charitable contribution deduction allows someone to "give unto God that which is God's" before giving "unto Caesar that which is Caesar's".

And here's another kicker. How about good old Joe the Plumber? Let's say Joe is self-employed and has annual gross revenue of $50,000. Joe's friend Dave is also a plumber, but Dave is employed by Ace Plumbing. Dave's salary is $50,000 per year. Under the current system, Joe can deduct his allowable business expenses. Some flat tax systems would treat these two exactly the same and tax both on $50,000 of income (though most flat tax systems allow businesses to deduct wages and salaries so income is taxed only once). Wouldn't it be easier to do away with all that law that defines what kind of expenses are deductible by businesses and when?

Why not, for the sake of simplicity, do away with all of these and the many other items to exclude from income?

As you can see, the issue is not that easy. Perhaps Congress shouldn't use taxation as a means to shape the behavior of its citizens, and that may be a fair argument. Still, people are always going to try to find ways to hide income to pay less tax, even if they don't have deductions to abuse. It's a tricky topic further complicated by the fact that many businesses make decisions now based on credits and deductions they expect to get over the next several years. Transitioning to a flat tax would likely be the hardest part of the process.