Flat Tax

[a_majoor]

This applies to Canada as well (and even provinces in Canada). As a fact check, if a broad based tax cut generated an extra $10 billion in tax revenue due to increased growth (remember the "Common Sense Revolution tax cuts increased provincial tax revenues by $20 billion dollars, so this is a very conservative amount), then the extra revenues would eliminate the deficit and put $70 billion/year to paying down the national debt; a project that would be complete in roughly under 8 years.

http://www.hoover.org/publications/defining-ideas/article/99241

Three Cheers for Income Inequalityby Richard A. Epstein (Peter and Kirsten Bedford Senior Fellow and member of the Property Rights, Freedom, and Prosperity Task Force)
Taxing the top one percent even more means less wealth and fewer jobs for the rest of us.
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The 2008 election was supposed to bring to the United States a higher level of civil discourse. Fast-forward three years and exactly the opposite has happened. A stalled economy brings forth harsh recriminations. As recent polling data reveals, the American public is driven by two irreconcilable emotions. The first is a deep distrust of government, which has driven the approval rate for Congress below ten percent. The second is a strong egalitarian impulse that directs its fury to the top one percent of income earners. Thus the same people who want government to get out of their lives also want government to increase taxes on the rich and corporations.  They cannot have it both ways.

I voiced some of my objections to these two points in an interview on PBS, which sparked much controversy. The topic merits much more attention.

What are the origins of inequality? Start with a simple world in which all individuals own their labor. Acting in their self-interest (which includes that of family and friends), they seek to improve their lot in life. They cannot use force to advance their own position. Thus, they are left with two alternatives: individual labor and cooperative voluntary ventures.

Voluntary ventures will normally emerge only when all parties to them entertain expectations of gain from entering into these transactions. In some cases, to be sure, these expectations will be dashed. All risky ventures do not pan out. But on average and over time, the few failures cannot derail the many successes. People will make themselves better off.

The rub is that they need not do so at even rates. The legitimate origin of the inequality of wealth lies in the simple observation that successful actors outperform unsuccessful ones, without violating their rights. As was said long ago by Justice Pitney in Coppage v. Kansas, “it is from the nature of things impossible to uphold freedom of contract and the right of private property without at the same time recognizing as legitimate those inequalities of fortune that are the necessary result of the exercise of those rights.”

So why uphold this combination of property and contract rights? Not because of atavistic fascination for venerable legal institutions. Rather, it is because voluntary exchanges improve overall social welfare. This works in three stages.

First, these transactions, on average, will make all parties to them better off. The only way the rich succeed is by helping their trading partners along the way.

Second, the successes of the rich afford increased opportunities for gain to other people in the form of new technologies and businesses for others to exploit.

Voluntary exchanges improve overall social welfare.

Third, the initial success of the rich businessman paves the way for competitors to enter the marketplace. This, in turn, spurs the original businessman to make further improvements to his own goods and services.

In this system, the inequalities in wealth pay for themselves by the vast increases in wealth.

Any defense of wealth inequalities through voluntary means is, however, subject to a powerful caveat: The wealth must be acquired by legitimate means, which do not include aid in the form of state subsidies, state protection, or any other special gimmick. The rich who prosper from these policies do not deserve their wealth. Neither does anyone else who resorts to the same tactics.

As an empirical matter, large businesses, labor unions, and agricultural interests that have profited from government protections have drained huge amounts of wealth from the system. Undoing these protections may or may not change the various indices of inequality. But it will increase the overall size of the pie by improving the overall level of system efficiency.

The hard question that remains is this: To what extent will the United States, or any other nation, profit by a concerted effort to redress inequalities of wealth?

Again the answer depends on the choice of means. Voluntary forms of redistribution through major charitable foundations pose no threat to the accumulation of wealth. Indeed, they spur its creation by affording additional reasons to acquire levels of wealth that no rational agent could possibly consume.

Forced transfers of wealth through taxation will have the opposite effect. They will destroy the pools of wealth that are needed to generate new ventures, and they will dull the system-wide incentives to create wealth in the first place. There are many reasons for this system-wide failure.

First, the use of state coercion to remedy inequalities of wealth is not easily done. The most obvious method for doing so is by creating subsidies for people at the bottom, which are offset by high rates of taxation for people at the top. The hope is that high taxes will do little to blunt economic activity at the high end, while the payments will do little to dull initiative at the low end.

But this program is much more difficult to implement than is commonly supposed. The process of income redistribution opens up opportunities for powerful groups to secure transfers of wealth to themselves. This does nothing to redress inequalities of wealth. Even if these political players are constrained, there is still no costless way to transfer wealth up and down the income scale.

The administrative costs of running a progressive income tax system are legion. Unfortunately, that point was missed in a recent op-ed. Writing in the New York Times, Cornell economist Robert H. Frank plumped hard for steeper progressive income tax rates as a way to amend income inequality.

There is no costless way to transfer wealth up and down the income scale.

Yet matters are not nearly as simple as he supposes. In his view, the source of complexity in the current income tax code lies in the plethora of special interest provisions that make it difficult to calculate income by recognized standard economic measures. Thus, he thinks that it is “flatly wrong” to think that the flat tax will result in tax simplification. After all, it is just as easy to read a tax schedule that has progressive rates as one that has a uniform flat rate.

But more than reading tax schedules is at stake. First, one reason why the internal revenue code contains such complexity is its desire to combat the private strategies that people, especially those in the top one percent, use to avoid high levels of taxation. Anyone who has spent time in dealing with family trusts and partnerships, with income averaging, with the use of real estate shelters, and with foreign investments, knows just how hard it is to protect the progressive rate schedule against manipulation.

Second, the creation of these large tax loopholes is not some act of nature. Frank, like so many defenders of progressive taxation, fails to realize that progressive rates generate huge pressures to create new tax shelters. Lower the overall tax rates and the pressure to create tax gimmicks with real economic costs diminishes. Overall social output is higher with a flat tax than it is with a progressive one.

Third, the dangers posed by the use of progressive taxation are not confined to these serious administrative issues. There are also larger questions of political economy at stake. The initial question is just how steep the progressive tax ought to be.

Keep it too shallow, and it does little to generate additional public revenues to justify the added cost of administration. Make it too steep, and it will reduce the incentives to create wealth that are always unambiguously stronger under a flat tax system. But since no one knows the optimal level of progressivity, vast quantities of wealth are dissipated in fighting over these levels. The flat tax removes that dimension of political intrigue.

Fourth, sooner or later—and probably sooner—high tax rates will kill growth. Progressives like Frank operate on the assumption that high taxation rates have little effect on investment by asking whether anyone would quit a cushy job just to save a few tax dollars. But the situation is in reality far more complex. One key to success in the United States lies in its ability to attract foreign labor and foreign capital to our shores. In this we are in competition with other nations whose tax policies are far more favorable to new investment than ours. The loss of foreign people and foreign capital is not easy to observe because we cannot identify with certainty most of the individuals who decide to go elsewhere. But we should at the very least note that there is the risk of a brain drain as the best and brightest foreign workers who came to the United States in search of economic opportunity ultimately may return home. They will likely not want to brave the hostile business climate that they see in the United States.

Fifth, sophisticated forms of tax avoidance are not limited to foreign laborers. Rich people have a choice of tax-free and taxable investments. They can increase transfers to family members in order to reduce the incidence of high progressive taxation. They can retire a year sooner, or go part-time to reduce their tax burdens. And of course, they can fight the incidence of higher taxation by using their not inconsiderable influence in the tax arenas.

The incentives to create wealth are stronger under a flat tax system.

Sixth, the inefficiencies created by a wide range of tax and business initiatives reduces the wealth earned by people in that top one percent, and thus the tax base on which the entire redistributive state depends. Defenders of progressive taxation, like Frank, cite the recent report of the Congressional Budget Office, which shows huge increases of wealth in the top one percent from 1979 to 2007. The top one percent increased its wealth by 275 percent in those years. The rest of the income distribution lagged far behind.

Unfortunately, the CBO report was out of date the day it was published. We now have tax data available that runs through 2009, which shows the folly of seeking to rely on heavier rates of taxation on the top one percent. The Tax Foundation’s October 24, 2011 report, contains this solemn reminder of the risks of soaking the rich in bad times:

In 2009, the top 1 percent of tax returns paid 36.7 percent of all federal individual income taxes and earned 16.9 percent of adjusted gross income (AGI), compared to 2008 when those figures were 38.0 percent and 20.0 percent, respectively. Both of those figures—share of income and share of taxes paid—were their lowest since 2003 when the top 1 percent earned 16.7 percent of adjusted gross income and paid 34.3 percent of federal individual income taxes.

It is worth adding that the income of the top one percent also dropped 20 percent between 2007 and 2008, with a concomitant loss in tax revenues.

There are several disturbing implications that flow from this report. The first is that these figures explain the vulnerability in bad times of our strong dependence on high-income people to fund the transfer system. The current contraction in wealth at the top took place with only few new taxes. The decline in taxable income at the top will only shrink further if tax rates are raised.  A mistake, therefore, in setting tax rate increases could easily wreck the entire system. Indeed, the worst possible outcome would be for high taxation to lower top incomes drastically. Right now, for better or worse, the entire transfer system of the United States is dependent on the continued success of high-income earners whom the egalitarians would like to punish.

Put otherwise, if a person at the middle of the income distribution loses a dollar in income, the federal government loses nothing in income tax revenues. Let a rich person suffer that decline and the revenue loss at the federal level is close to 40 percent, with more losses at the state level. The slow growth policies of the last three years have cost far more in revenue from the top one percent than any increase in progressive taxation could possibly hope to achieve. The more we move toward an equal income policy, the more we shall need tax increases on the middle class to offset the huge revenue losses at the top. Our current political economy makes the bottom 99 percent hostage to the continued success of the rich.

The dangers of the current obsession with income inequality should be clear. The rhetorical excesses of people like Robert Frank make it ever easier to champion a combination of high taxation schemes coupled with ever more stringent regulations of labor and capital markets. Together, these schemes spell the end of the huge paydays of the top one percent. Those earners depend heavily on a growth in asset value, which is just not happening today.

But what about the flat tax? Frank and others are right to note that a return to the flat tax will result in an enormous redistribution of income to the top one percent from everyone else. But why assume that the current level of progressivity sets the legitimate baseline, especially in light of the current anemic levels of economic growth? What theory justifies progressive taxation in the first place? The current system presupposes that this nation can continue to fund the aspirations of 99 percent out of the wealth of the one percent. That will prove to be unsustainable. A return to a flatter tax (ideally a flat) tax will have just the short-term consequences that Frank fears.  It will undo today’s massively redistributivist policies. But it will also go a long way toward unleashing growth in our heavily regulated and taxed economy. 

The United States is now in the midst of killing the goose that lays the golden eggs. That current strategy is failing in the face of economic stagnation, even with no increase in tax rates. It will quickly crumble if tax increases are used to feed the current coalition of unions and farmers who will receive much of the revenue, while the employment prospects of ordinary people languish for want of the major capital investments that often depend on the wealth of the privileged one percent of the population.

The clarion call for more income equality puts short-term transfers ahead of long-term growth. Notwithstanding the temper of the times, that siren call should be stoutly resisted. Enterprise and growth, not envy and stagnation, are the keys to economic revival.

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Richard A. Epstein, the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution, is the Laurence A. Tisch Professor of Law, New York University Law School, and a senior lecturer at the University of Chicago. His areas of expertise include constitutional law, intellectual property, and property rights. His most recent books are The Case against the Employee Free Choice Act (Hoover Press, 2009) and Supreme Neglect: How to Revive the Constitutional Protection for Private Property (Oxford Press, 2008).

 

[a_majoor]

Another examination of the Flat tax, in this case the political argument that it will deliver long term market stability since it is less capable of being "gamed" by clever people. Remember the 1937-38 "Capital Strike" was the worst year of the Depression, and was caused by business simply refusing to take any more investment risks due to the continuing changes caused by the implimentation of the "New Deal". America's current economic crisis is exacerbated by uncertainty due to the approaching Fiscal Cliff (when many tax changes expire) and the uncertainty caused byh the introduction of Obamacare. There are several examples in the article of real life examples of responses to negative incentives, and of course one can consider the drop in revenues caused byt the increase in tax rates in the UK and various US States that instituted "millionaire taxes":

http://www.hoover.org/publications/defining-ideas/article/134921

The Flat Tax Solution
by Richard A. Epstein (Peter and Kirsten Bedford Senior Fellow and member of the Property Rights, Freedom, and Prosperity Task Force)
To step back from the fiscal cliff, we need to simplify our tax policy.
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This past Friday, I gave the “Presidential Address” at the Southern Economic Association (SEA) in New Orleans, on the topic of what President Obama’s reelection means for the future of liberty in the United States. As a classical liberal, my outlook is best captured in one simple proposition: a system of sound governance needs to promote a mixture of individual liberty and private property in order to allow individuals to maximize the gains from individual effort and social cooperation.

A strong government that can protect these rights must, of course, backstop the market system by collecting tax revenues that are spent on the public goods that markets cannot easily or efficiently supply, such as defense and social infrastructure. The use of state power always opens up the path for general abuse because large doses of government discretion allow all political forces to secure factional gains that result in overall social losses. The central challenge for government is to incur minimum political distortions while allowing taxes to raise the revenues needed to discharge essential government functions.

There are two key methods by which to constrain the political risks of faction. The first is to adopt only a single instrument of taxation—most likely an income or consumption tax—in order to reduce the risk of political intrigue. There is, for example, no place under a sound system of taxation for special excise taxes like the 2.3 percent tax imposed on medical devices to help fund ObamaCare. The second is to make the system of taxes durable over time, so that the form and incidence of the tax is not subject to constant maneuvering. Our fiscal cliff has arisen because tax policy is revised every two years, provoking political crises.

Without question, the form of taxation that best meets these dual requirements is a flat tax on consumption—a position which enjoys virtually no visible political support today. My speech to the SEA was not optimistic in large measure because virtually every key tax policy initiative today lurches in the opposite direction. The constant calls for higher levels of progressivity; the short-shelf life for key tax rates that must be renegotiated every year or two; and the constant playoff between interested parties jockeying to shift wealth among income, death, and excise taxes, which only magnifies the amount of political mischief. Unless something is done to alter the direction of political discourse in the United States, the next four years will be a replay of the last four years. We will witness a slow decline in the standard of living across all groups within the United States. Tax policy is a key piece in that overall mosaic.

The Perils of Static Tax Policy

The President is obsessing about the increases in income inequality, which for him clinches the case for higher tax rates for privileged individuals that earn over $200,000 per year, or privileged couples that earn over $250,000. The President thinks that revenue growth from taxes can be reduced to a simple task of addition and multiplication. Start with the current tax base, and multiply it by the increased tax rates in order to determine the added tax revenues. That static thinking was also embraced in a New York Times editorial:

The special low tax rates for investment income are among the largest tax breaks in the code. They allowed investors to pocket some $100 billion in 2012 alone compared with what those investors would have paid if investment income were taxed the same as regular income.

What this editorial never asks is whether we would have had the same amount of capital gains revenue if capital gains rates were higher. The answer to that question is likely to be no. The lower rate of return will make it more likely that individual investors will hold on to their stocks for longer periods of time, which could reduce the total amount of gains in ways that more than offset the tax increase.

The slow down in the rate of capital turnover spells bad news to the economy because it reduces the efficiency of capital markets by making it more costly for investors to reallocate capital from weaker to stronger ventures. Both the President and the New York Times support a whopping tax increase in dividend income—from the current 15 percent to 39.6 percent—which will surely retard the mobility of capital.

The Virtues of a Flat Consumption Tax

A sound tax system has as few moving parts as possible. We should scrap the current system in favor of a flat tax on consumption.

Radically simplifying the tax system to a flat tax on consumption would facilitate two desirable economic changes. First, it reduces taxes to zero when capital is redeployed from one venture to another, which in turn would induce better investor monitoring of current firms. The ability of investors to sell out without adverse tax consequences thus provides an added incentive for efficient market behavior. Second, it eliminates the need to draw any distinction between ordinary income and capital gains, which is one of the weak points of the current system.

It is, of course, difficult to work an immediate transition from an income tax to a consumption tax. But it is possible to exempt all capital gains from taxation to the extent that it is reinvested in other capital assets. Right now, that approach is in fact tax policy with respect to an exchange of capital assets as part of a business reorganization, such as a recapitalization or merger. It takes little ingenuity to use the same system for any sale and reinvestment. Any short term loss in revenue is likely to be made up by the combination of higher wages, higher dividends (at least if the tax is kept low), and higher capital asset values, which would generate additional revenues when liquidated for other uses.

One advantage of introducing the flat tax on consumption is that its variation leaves the government the only degree of freedom that it needs to make necessary budget adjustments. It is commonly thought that during economic slowdowns, the government should engage in deficit spending, just as ordinary individuals try to even their consumption patterns by borrowing, while making up the gap by saving in good times. Any aggregate target can be achieved by just manipulating a single rate to achieve the desired revenue goals. At this point, the deliberations in question will become simpler, in sharp contrast to today’s bitter, protracted, and expensive negotiations.

Rate stabilization will also lead to more reliable and rational decisions in both capital and labor markets, by removing one gratuitous degree of uncertainty from business risk. These indirect benefits are typically ignored because they are so hard to measure directly. But they are ubiquitous, and should prove substantial because they operate quietly and reliably in both the long and the short run. The stability of social institutions was a great theme of such classical writers as David Hume and Adam Smith. It should not be forgotten today.

Private Responses to Public Mischief

Current tax policy puts items like income and deductions into political play, generating deleterious short-term consequences. Evidence of this can be seen in the rapid response of investors, who are anticipating the future tax hikes and scaling back on their investments. The adverse responses are not confined to large firms but also extend to wealthy individuals who will bear the brunt of any tax increase.

The proposed increase in the estate and gift taxes, targeted exclusively at high-income taxpayers, has set off an immediate flurry of tax planning efforts by well-to-do individuals to minimize the bite of these unknown and unwelcome tax changes. Typical of the common hijinks are the estate planning tactics recently reported in the Wall Street Journal by Annamaria Andriotis, which should belie the naïve belief that high-income taxpayers don’t respond to incentives.

It is not just that people go to extra lengths to alter their patterns of giving in order to take full advantage of the life-time exemption from the gift and estate taxes and annual exclusions (now $13,000 per each donor/donee pair); it is that they engage in the conscious destruction of wealth in order to minimize the impact of taxes. Thus one common scheme involves the transfer of a valuable asset—a family vacation home, for example—to a limited liability company (LLC) where it is then owned by several family members. This decision to complicate the state of the title reduces the marketability of the asset, and thus reduces the amount of tax that it will attract at the death of the senior generation. The cold-blooded calculation is that the tax savings for the family unit more than justifies the losses in market value.

Yet what possible social reason is there to spend tax deductible dollars in order to reduce social wealth? Moving to a system of taxation that looks to consumption only treats the transfer of wealth from one person to another as a non-taxable event. The result is the better mobility of capital, lower tax drag, and fewer wasteful tax planning expenses. It will also generate more income (or consumption) tax from more productive firms.

Choosing the Right Path

This sensible push for tax simplification and tax reduction does not look through the world with rose-colored glasses. Since the advent of the income tax in 1913, tax rates have gyrated from high to low and back again. As Stephen Moore has once again demonstrated in the Wall Street Journal, the typical response to these tax reductions is a spur in economic activity that results in the collection of larger amounts of capital gains taxes from wealthy individuals, who also prosper under the regime by their higher after-tax earnings. As Moore points out, strong revenue surges followed the tax cuts under John F. Kennedy, Ronald Reagan, and George W. Bush, as investors responded with higher levels of economic activities and more rapid turnover of investments.

What makes the situation more impressive is that these overall gains were achieved in a less than ideal tax environment. Tax rates were still progressive; multiple instruments of taxation were still in use; tax horizons were short; and special gimmicks were the order of the day.

There is a desperate need to get this nation’s fiscal house in order. The last way in which to achieve that goal is to double-down on the structural defects of the current tax structure in the hopes that it will generate some much needed relief to the middle class. If we sock it to the rich, we run the risk of impoverishing the nation.

Too many people agree with the implicit supposition of the President that taxation is a zero-sum game, whereby the rest of the population can gain amounts that are taken from the rich through taxation. Not so. The explicit tax increases on the rich will be passed on in a variety of ways to the population as a whole so that everyone is made worse off in the name of income equality. John F. Kennedy famously said that a rising tide raises all ships. A falling tide will leave many of these same ships grounded.

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Richard A. Epstein, the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution, is the Laurence A. Tisch Professor of Law, New York University Law School, and a senior lecturer at the University of Chicago. His areas of expertise include constitutional law, intellectual property, and property rights. His most recent books are Design for Liberty: Private Property, Public Administration, and the Rule of Law (2011), The Case against the Employee Free Choice Act (Hoover Press, 2009) and Supreme Neglect: How to Revive the Constitutional Protection for Private Property (Oxford Press, 2008).
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[ModlrMike]

Remember the 1937-38 "Capital Strike" was the worst year of the Depression, and was caused by business simply refusing to take any more investment risks due to the continuing changes caused by the implementation of the "New Deal"

Are there not companies like Apple that are currently contributing to the mess in a similar method by holding billions off shore? AFIK Apple has something on the order of $35+ billion in cash that would be subject to tax if it were repatriated. I'm sure they're not the only culprit, but they're certainly indicative of the climate of fear that some corporations have vis-a-vis taxation.

 

[a_majoor]

That is exactly right. While Apple's dragon's horde is probably the most impressive example, other companies do much the same thing, regardless if they are Obama supporting Crony Capitalists (GE comes to mind) or not. For small and medium companies which do not have the ability to move their cash offshore, they are simply sitting on it rather than investing in goods and services or hiring new people.

A flat or single tax environment, by eliminating much of the gameing and political uncertainty, will start to attract money. Even without a flat tax, just look at the difference in the economies of various Canadian Provinces. The ones with high tax and regulatory environments are generally poorer or even "Have Not" provinces. A flat tax might still be high, but falls into the low regulatory environment, so a flat tax set at a low rate will have a much larger impact.

 

[a_majoor]

Arguing for a flat tax from a different direction. High tax rates and tax and regulatory uncertainty changes people's economic behaviour (to maximize their wealth, not increase the Government's take). Real life examples include all those US States that tried to impliment a "millionaire tax", the UK which saw tax receipts drop as higher tax rates were introduced and now France:

http://reason.com/archives/2012/12/23/taxpayers-arent-stationary-targets/print

Taxpayers Aren't Stationary Targets
Sheldon Richman|Dec. 23, 2012 8:00 am

Actor Gérard Depardieu's decision to flee France for Belgium to avoid a 75 percent marginal tax rate on incomes above $1.3 million sends a message we here in America should heed: Those who are singled out for tax increases are not stationary targets. The means of avoiding and evading the taxman are legion.

U.S. government agencies routinely issue estimates of how changes in the tax code will affect the flow of revenues to the treasury. President Obama says the tax changes he has been seeking will bring in $1.6 trillion over a decade. But such estimates assume taxpayers are something other than human beings who engage in purposive action. People like to keep the money they make—why shouldn't they?—and they typically avail themselves of every legal (and not-so-legal) strategy to do so. Change the tax environment by raising rates or adversely modifying the rules, and taxpayers, especially those in the upper echelons of earners, can be counted on to modify their conduct accordingly; there's no reason to think their wish to hold on to their money has diminished just because the tax code has changed.

Economists as far back at J. B. Say and Gustave de Molinari in the 19th century understood this. As Molinari wrote in his 1899 book, The Society of To-morrow, "The laws of fiscal equilibrium set a strict limit to the degree within which it is possible to impose new taxes, or to increase the rates of those already in force. The relative productivity of taxes soon shows when this point has been overstepped, for then returns not only cease to rise, but immediately begin to fall."

Things can work in the other direction too. Other things being equal, cutting tax rates can prompt revenues to rise. This is not to say rising revenue is a good thing. As Milton Friedman once said, if a tax-rate cut brings in more revenue, the rates weren't cut enough. Hear, hear!

Nevertheless, revenues can increase after a rate cut. Case in point: the rate cuts of 2001 and 2003, the so-called Bush tax cuts, which President Obama (until yesterday) had been hoping would expire for the top 2 percent of earners. According to the Congressional Budget Office, revenues increased from $1.9 billion in 2003—when all the cuts kicked in—to $2.3 billion in 2008 (in constant 2005 dollars). At that point the Great Recession hit and of course revenues then fell. Tax revenues always fall in a recession because when people lose their jobs they stop paying the income tax. Companies also pay less as economic activity slows down. When would-be tax raisers today complain that revenues are a smaller percentage of GDP than in previous years, that is the reason. It's not that the tax rates are too low.

Leaving recessions out of the account, for the past 60 years federal tax revenues have been rather steady at just under 19 percent GDP regardless of the tax rates. The top income-tax rate has ranged from a low of 28 percent in 1988-90 to a high of 92 percent in 1952-53, yet the flow of money has been a fairly constant proportion of the economy. This would seem to confirm the apparently controversial hypothesis that taxpayers are purposive human beings who can be counted to modify their behavior according to the incentives and disincentives that government places in their paths.

Yet most politicians don't get it. In The Wall Street Journal a few years ago, W. Kurt Hauser, formerly of the Hoover Institution, wrote:

    Even amoebas learn by trial and error, but some economists and politicians do not. The Obama administration's budget projections claim that raising taxes on the top 2% of taxpayers, those individuals earning more than $200,000 and couples earning $250,000 or more, will increase revenues to the U.S. Treasury. The empirical evidence suggests otherwise. None of the personal income tax or capital gains tax increases enacted in the post-World War II period has raised the projected tax revenues.

"Hauser's Law" seems quite robust. Over 60 years, "there have been more than 30 major changes in the tax code including personal income tax rates, corporate tax rates, capital gains taxes, dividend taxes, investment tax credits, depreciation schedules, Social Security taxes, and the number of tax brackets among others. Yet during this period, federal government tax collections as a share of GDP have moved within a narrow band of just under 19% of GDP."

The explanation is simple enough for a child to understand, though politicians have difficulty with it:

    When tax rates are raised, taxpayers are encouraged to shift, hide and underreport income. Taxpayers divert their effort from pro-growth productive investments to seeking tax shelters, tax havens and tax exempt investments. This behavior tends to dampen economic growth and job creation. Lower taxes increase the incentives to work, produce, save and invest, thereby encouraging capital formation and jobs. Taxpayers have less incentive to shelter and shift income.

Hauser shows that GDP grows faster when taxes are lower. "In the six quarters prior to the May 2003 Bush tax cuts, GDP grew at an average annual quarterly rate of 1.8%. In the six quarters following the tax cuts, GDP grew at an average annual quarterly rate of 3.8%. Yet taxes as a share of GDP have remained within a relatively narrow range as a percent of GDP in the entire post-World War II period."

So where does that leave us as we head for the "fiscal cliff"? Obama has backed away from his intention to raise the top 33 and 35 percent tax rates to 36 and 39.6, respectively, on people making over $200,000. Now he says he is willing to have only the top rate raised to 39.6 percent on people making more than $400,000. This, he adds, would raise $1.2 trillion over a decade—again assuming those people are stationary targets. 

Republican House Speaker John Boehner has also been seized with the spirit of compromise. From his earlier no-tax-increase position, he is now willing to see the top rate raised on people making over a million dollars. He expects $1 trillion to be raised.

But in light of the information above, this all appears to be Washington's standard ritual dance. When—or if—the economy recovers from the recession, revenues will rise to their historic level whether or not Congress tampers with the rates. One need not leave the country, à la Depardieu, to escape taxes. But raising the rates in a struggling economy will help assure that the economy keeps struggling. 

The tax raisers like to point out that the economy boomed during the Clinton years even though top tax rates went up. But this is a simplistic claim. Many other things were going on at the same time—such as the productivity boom ignited by the desktop computer and information revolution—that offset the higher rates. Economic growth likely would have been even greater had the burden of government been lighter.

Alas, the new bipartisan climate in Washington is turning uniformly pro-tax hike. This is sad news, indeed. If taxes can't be cut, at least they shouldn't be raised. First, do no harm! Meanwhile, spending of all kinds must be slashed deeply.

This article originally appeared at The Project to Restore America.

And Instapundit suggests the real reason for the continuing manipulations of tax codes rather than the adoption of an efficient one:

Two things. First, most politicians aren’t good at math. That’s one reason they went into politics in the first place. Second, it’s not so much about revenue as it is about control. Particularly in Obama’s case, it’s about punishing high-earners — or as he puts it, “fairness.”

Also, while revenue may be roughly the same at different tax rates, higher tax rates produce more distortions in the economy, and inflict deadweight losses from conduct that is driven by taxes rather than economics. That’s why research shows that GDP grows faster when tax rates are lower. But if you derive your own sense of importance from slicing up the pie, you don’t care as much whether the pie grows or not.

 

[a_majoor]

Sadly, the idea of the Flat Tax seems to have been stifled in Alberta (yes, it is only by a tiny amount, but there is a saying about a camel putting it's nose under the tent...) Hopefully, some more disciplined spending control will be applied to future budgets and the Flat tax re instituted:

http://business.financialpost.com/fp-comment/william-watson-requiem-for-the-flat-tax

William Watson: Requiem for the flat tax
William Watson | April 1, 2015 | Last Updated: Apr 1 4:22 PM ET
More from William Watson

By ending its flat tax rate Alberta is snuffing out an important policy beacon for all Canadians

To conservatives everywhere, a sad part of the latest Alberta budget was the extinguishing of the province’s flat tax, which Ralph Klein introduced in 2001. Albertans with taxable income have been paying 10% on any and all additions to their income. But in the future those making $100,000 or more will pay 11.5%, while the 44,000 tax filers with taxable income over $250,000 — they’re the province’s top 1.5% — will pay 12%.

It’s not exactly soaking “the 1.5%.” More like a light rinse, though when you add a new “Health Care Contribution Levy” that starts at 5% for people with $50,000 of income and maxes out by dinging people making $132,800 or more a full grand (ka-ching!) the rinse becomes more of a drenching.

Five years out these two measures bring in $1.4 billion — though estimating future tax yields is always dicey: Are we completely sure we’ve incorporated the full disincentive effects on economic activity? That $1.4 billion is on projected total revenue of $54.4 billion and it assumes of course that the top rate doesn’t rise again, which may not be so sure a political bet now that the margin has been breached.

Maybe an extra 1.5 or two per cent at the margin really isn’t worth worrying about. The budget argues that even with this and other new taxes the “Alberta Advantage” remains. For a four-person family with employment income of $200,000 — a most desirable immigrant package, presumably — it will still be $18,698 a year with respect to Quebec, though only $7,301 a year vis-a-vis Ontario and just $1,470 compared to BC.

But money isn’t everything. An additional cost, especially to those of us outside Alberta, is the snuffing out of an important policy beacon.

Everyone’s assumption is that flat-rate taxes can’t be progressive. That presumably bothers Alberta’s Conservatives, who, unlike Ottawa’s, are still at least nominally Progressive. But the assumption isn’t true, at least not in terms of average taxes. If some minimum amount of income is exempt from taxation — and in Alberta it can be over $18,000 — then the average rate of tax rises with income. For example, at a 10% rate the first $10 of income above $18,000 generates a $1 tax liability, which produces an average tax rate of $1/$18,010 or just 0.006%, a rate that rises — progressively — with every extra dollar of income and approaches, even if it never quite reaches 10%.

Some studies done by perfectly reputable economists, i.e., not “far-right” nutbars, suggest the best rate structure, even taking the interests of poor people into account, may by an umbrella, in which rates rise for a while but then, for the super-mobile highest earners, actually decline—though try selling that in the current inequality-obsessed political environment!

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Fairness aside, there are all the terrific efficiency effects of a flat-rate tax.

If the marginal rate is low to begin with and doesn’t rise as you earn more income, why bother trying to evade it, either legally or illegally? If you’re being taxed at 50 cents on the dollar, it almost certainly pays you to hire smart tax lawyers to try to erode your taxable income. Every dollar they can make non-taxable or less taxable saves you up to 50 cents — though their fees will bite into that. They could be doctors or scientists or economists or entrepreneurs but your high marginal tax rates create a big profit opportunity for them in figuring ways for you to game the system. Most of the people involved are perfectly honourable, and we have a tax court to make sure they behave even if they aren’t, but at bottom it’s a social waste to devote so much high-quality brain power to searching for avenues for re-definition and arbitrage.

With a low, constant marginal rate, there’s also less payoff to government efforts to get people to alter, not just their accounting, but their actual economic behaviour. If the tax saving from engaging in government-preferred activity is 50 cents on the dollar, that grabs people’s attention much more than if it’s only ten cents. In fact, you sometimes here politicians argue, in unguarded or unusually lucid moments, that they can’t lower marginal tax rates because that would be bad for their ability to manipulate the economy, which they of course would characterize as “encourage socially beneficial activities.” But as most of this manipulation is of dubious value at best and economically costly to boot, it’s hard to believe we’d miss it.

Finally, with a 10% marginal rate, take-home pay is a juicy 90 cents on the dollar, unlike in more “progressive” jurisdictions, where it’s 50 cents or less. If you think government shouldn’t stand in the way of people working or investing more, whether because you believe people should decide their effort levels for themselves or because you actually prefer they work and invest as much as possible so the community can reap the benefits of having lots of worker-bees and investor-bees around, low marginal rates are what you need.

It’s true that ten U.S. states still have single-rate income taxes, as do several dozen countries around the world. But having a shining beacon of tax clarity in our very own country, lit by people whose cultural and political assumptions we could understand if not, in the case of Toronto intellectuals, empathize with, at least gave hope the idea might catch on in other Canadian jurisdictions.

After last week’s budget, however, we eastern … well, just say we easterners, are freezing in the tax-policy dark again.