#2: What the Flat Tax Taxes

The Myth & Misconception: A flat tax would apply a single, flat tax rate to all forms of income.

Half wrong! The flat tax proposals do use a single, flat tax rate rather than progressive rates. But the original Hall-Rabushka flat tax, the Steve Forbes flat tax, the Armey-Shelby flat tax, and most other flat tax proposals would not tax individuals on their unearned income—such as dividends, interest, and capital gains. Only earned income—wages, salaries, commissions, and the like—would be taxed. In other words, it is a tax on income from labor, not income from capital.

If one of these proposals were enacted, people who receive only unearned income would escape tax altogether. As Patrick Buchanan said about the Forbes flat tax proposal when Buchanan and Forbes were seeking the Republican nomination for president in 1996, “Under the Forbes flat tax, should Bill Gates…decide to retire early [and live on his investments], he would never again pay a dime in income taxes for the defense of his country. But the men and women who continued to work at Microsoft would have to pay.”

 A Related Question. Incidentally, many, and perhaps most, Americans believe that a single, flat tax rate would be fairer than our system of progressive rates. So, you might ask, who would pay more income taxes, and who would pay less, if the only change to our income tax system were the adoption of a single, flat tax rate today that would generate as much revenue as is generated by our progressive rates? The single tax rate would have to be about 19% in a typical year.

Answer: Middle-income taxpayers would, on average, pay considerably more, and high-income taxpayers would pay considerably less.  For people with taxable income in the $50,000 -$75,000, the tax rate on that income is, on average, about 13%. For people with between $2 million and $10 million of taxable income, the tax rate on that income is, on average, about 26%, nothwithstanding favorable tax rates on dividends and capital gains. So if you’re in the solid middle class, your tax rate would be about 6 percentage points higher with a flat tax rate, while very high income households would enjoy a tax rate about 6 to 7 percentage points lower. Now what do you think?

The figures are for 2007, before the economic recession. See SOI Bulletin, Statistics of Income, 2009, Fall, Volume 29, No. 2, 36 – 37.]

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