Arkady
President
In another thread, I pointed out that a 20% flat tax would be a crippling tax hike on 80% of Americans. Another poster responded that it wouldn't be if you exempted the first $30,000 of earned income. That's true, but it brings up other problems.
See here:
http://www.census.gov/hhes/www/cpstables/032011/hhinc/new06_000.htm
If you exempted the first $30k of household income, you'd collect no taxes on any household making less than $30k, which would decrease the tax base by $594,917,142,000. You'd further decrease it by $30k per household for each household making over $30k, for a total of $2,443,920,000,000. Between the two, the income tax base would decline by a little over $3 trillion. The current income tax base is a little over $8 trillion. Obviously, to collect what you'd get with a 20% tax on $8 trillion of income, you need a higher than 20% tax if you're only taxing $5 trillion of income. In fact, the math works out that you'd have to apply a 32.2% tax rate on everything over the first $30k.
There are a few problems with that. First, the conservatives would go nuts. Nearly 1/3 of all American households earn less than $30k, so they'd pay no federal tax under the new system. Note, I'm not saying no federal income tax. No federal tax, period. The conservatives hate the idea of so many Americans getting away with only payroll taxes, so how are they going to like almost a third also paying no Social Security or Medicare taxes?
Of course, there's no such thing as a free lunch. You can't lower taxes for a huge portion of the population and take in the same amount of money, unless you raise taxes on others. There's no good way to do the math to estimate what the tax hike would be on most people (since you can't just assume 100% efficiency at tax collecting, under the new scheme). But the overall impact would be to shift the tax burden upwards. The poor and much of the lower-middle class would pay less, and so the rich and upper-middle-class would pay more to make up for that.
That sounds like a good thing, from a liberal's perspective, but as a practical matter the proposed change would cause huge distortions in the economy. What you'd actually have isn't really a flat tax, but rather a two-tier graduated tax: 0% on the first $30k, 32.2% on everything else. The bigger the change in tax rate between one bracket and the next, the bigger the incentive to game it by shifting income -- either shifting it from one year to another, or from one person to another. With a huge 32.2 gap in rates between the brackets, the distortion would be gigantic.
Think of it this way. I'm not going to go to great lengths or take many legal risks to push off a tax event by a year in order to get some money taxed at a few percentage points lower (as might happen if I expected to fall from one bracket to another, under the current system). It's a relatively minor change, and simply isn't worth a lot of planning or risk. But if I thought I could get money taxed at 0% rather than 32.2%, that's a much bigger deal, and a much stronger incentive for me to engage in economically inefficient or criminal behavior. A two-band graduated tax, of the kind proposed, would almost certainly hurt the economy a lot more than a six-band graduated system like we currently have.
Such a structure is also a more plausible disincentive for work. Let's say you're paid hourly, and it's near the end of the year, and you're about to reach a point where your earnings put you in the next tax bracket, so that you go from taking home 85 cents of every additional dollar earned to taking home 75 cents of it. The chances of that making you decide to take the rest of the year off are fairly minimal. If you found the extra effort worth the effort at $8.50/hour, after tax, most likely it'll still be worth it at $7.50/hour, after tax. But what if, instead, you reached the threshold between taking home $1 of ever additional dollar earned, to taking home 67.8 cents of it? That would mean $8.50/hour suddenly became $5.76 per hour. It's a whole lot more likely to disincentivize additional work.
Because of those distortions, a graduated system will tend to be more efficient the more gradations you get, and a two-tier system like the one proposed would be the worst one possible, from the perspective of how much it would distort the economy.
See here:
http://www.census.gov/hhes/www/cpstables/032011/hhinc/new06_000.htm
If you exempted the first $30k of household income, you'd collect no taxes on any household making less than $30k, which would decrease the tax base by $594,917,142,000. You'd further decrease it by $30k per household for each household making over $30k, for a total of $2,443,920,000,000. Between the two, the income tax base would decline by a little over $3 trillion. The current income tax base is a little over $8 trillion. Obviously, to collect what you'd get with a 20% tax on $8 trillion of income, you need a higher than 20% tax if you're only taxing $5 trillion of income. In fact, the math works out that you'd have to apply a 32.2% tax rate on everything over the first $30k.
There are a few problems with that. First, the conservatives would go nuts. Nearly 1/3 of all American households earn less than $30k, so they'd pay no federal tax under the new system. Note, I'm not saying no federal income tax. No federal tax, period. The conservatives hate the idea of so many Americans getting away with only payroll taxes, so how are they going to like almost a third also paying no Social Security or Medicare taxes?
Of course, there's no such thing as a free lunch. You can't lower taxes for a huge portion of the population and take in the same amount of money, unless you raise taxes on others. There's no good way to do the math to estimate what the tax hike would be on most people (since you can't just assume 100% efficiency at tax collecting, under the new scheme). But the overall impact would be to shift the tax burden upwards. The poor and much of the lower-middle class would pay less, and so the rich and upper-middle-class would pay more to make up for that.
That sounds like a good thing, from a liberal's perspective, but as a practical matter the proposed change would cause huge distortions in the economy. What you'd actually have isn't really a flat tax, but rather a two-tier graduated tax: 0% on the first $30k, 32.2% on everything else. The bigger the change in tax rate between one bracket and the next, the bigger the incentive to game it by shifting income -- either shifting it from one year to another, or from one person to another. With a huge 32.2 gap in rates between the brackets, the distortion would be gigantic.
Think of it this way. I'm not going to go to great lengths or take many legal risks to push off a tax event by a year in order to get some money taxed at a few percentage points lower (as might happen if I expected to fall from one bracket to another, under the current system). It's a relatively minor change, and simply isn't worth a lot of planning or risk. But if I thought I could get money taxed at 0% rather than 32.2%, that's a much bigger deal, and a much stronger incentive for me to engage in economically inefficient or criminal behavior. A two-band graduated tax, of the kind proposed, would almost certainly hurt the economy a lot more than a six-band graduated system like we currently have.
Such a structure is also a more plausible disincentive for work. Let's say you're paid hourly, and it's near the end of the year, and you're about to reach a point where your earnings put you in the next tax bracket, so that you go from taking home 85 cents of every additional dollar earned to taking home 75 cents of it. The chances of that making you decide to take the rest of the year off are fairly minimal. If you found the extra effort worth the effort at $8.50/hour, after tax, most likely it'll still be worth it at $7.50/hour, after tax. But what if, instead, you reached the threshold between taking home $1 of ever additional dollar earned, to taking home 67.8 cents of it? That would mean $8.50/hour suddenly became $5.76 per hour. It's a whole lot more likely to disincentivize additional work.
Because of those distortions, a graduated system will tend to be more efficient the more gradations you get, and a two-tier system like the one proposed would be the worst one possible, from the perspective of how much it would distort the economy.
