Should the US adopt the Flat Tax Amendment?

No

6 of 12

by Michael Greaney

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First, I am in favor of everyone paying the same tax rate on income above what is necessary to meet common domestic needs adequately. That being said, however, simply to impose a flat rate tax over the abominable tax structure that today afflicts the United States and virtually every other country on the face of the earth would be a disaster.

Every discussion of a flat rate tax takes as a given that only the progressive portion of the income tax would be changed to a single rate. The heavily regressive Social Security and Medicare tax would remain in place, a gross injustice by means of which the poor are taxed on the very first dollar they earn for redistribution among themselves. At the same time, individuals whose income is derived from non-wage sources not only escape the Social Security tax, but often pay a lower income tax on dividends and capital gains.

True, dividends and capital gains are taxed at the corporate level, being charges against post-tax corporate income, and this is unjust. Two injustices do not, however, cancel each other out; two wrongs do not make a right. A serious and fundamental reform is in order, but first we have to examine the justification for taxing non-wage income (dividends and capital gains) at more favorable rates than wage income.

The reason for taxing non-wage income at favorable rates is to encourage reinvestment of income derived from ownership. This is believed to be the source of job creation, which is the principle means by which most people gain their income. Without favorable treatment of such investment income, so the theory goes, there would be little or no new investment, no job creation, and thus most people would have no jobs and thus have no source of income.

The problem is that this belief is entirely false, even extraordinarily damaging to the process of capital formation and the general health of the economy! As Dr. Harold Moulton explained in his 1935 classic, "The Formation of Capital," it is much better to finance capital formation by extending bank credit rather than relying on existing accumulations of wealth - most of which is in the form of corporate retained earnings. The wealthy should not be reinvesting their income, but spending it, thereby increasing effective demand and spurring economic growth.

Using savings - essentially non-consumed income - to finance capital formation puts the cart before the horse. Moulton discovered that when consumption increases, investment in new capital follows. When consumption decreases, however, investments fail. Thus saving - which cuts consumption - causes the very capital being financed to be non-viable, and the economy is forced into a never-ending cycle of "boom and bust."

Proper use of the commercial banking system and the central bank (e.g., the Federal Reserve System) can supply sufficient financial capital to the economy without first having to save. There is saving going on, of course - Keynes was absolutely correct that savings must equal investment, and vice versa. He was wrong, however, in asserting (completely without proof!) that the savings had to take place before investment. It can take place after investment, a process called "future" or "forced" savings, which relies on the capacity of the very thing being financed to generate sufficient income to pay for itself, a concept accountants and finance professionals call "financial feasibility."

Using bank credit removes the need for the rich to save their income instead of spending it; as Adam Smith observed, the rich confer greater benefits on society by spending than they do by saving through the increase in effective demand. Removing the need for the savings of the rich from the economy thus removes the justification for giving favorable tax treatment to the rich in order to encourage them to save, e.g., a lower tax rate on dividends and capital gains.

That being the case, a properly structured single tax rate would be of great benefit to society - after some major reforms:

Since the justification for the labyrinthine tax structure in the United States is to effect capital formation through savings and redistribution when wage income proves inadequate, all capital formation should be financed with bank credit. To raise income levels without tampering with a market-determined wage rate, ownership of all new capital should be spread out by giving everyone democratic access to bank credit with which to purchase sound, financially feasible capital, usually in the form of corporate equity. Thus, the U.S. currency would change from being backed by government debt, to being backed by the hard assets of the economy. This would be better than gold, because gold by itself does not produce anything.

Merge Social Security and Medicare into the general tax rate so that the exemption applies.

So that the capital can pay for itself (and repay the bank loan used to purchase the capital), dividends should be tax deductible at the corporate level, and (to increase the tax base) taxed as ordinary income at the personal level. Without the need to retain earnings to finance capital, in fact, it would be counterproductive to retain earnings instead of paying them out; the corporate tax should be raised very high to encourage payout of tax deductible dividends and inflation-indexed capital gains.

All personal tax deductions for any purpose should be eliminated, as well as all individual tax credits. To make up for this, the personal exemption should be raised to a realistic level, sufficient to cover reasonable living expenses, including housing, health care, education, and so on. Currently, a realistic amount for an exemption for a non-dependent adult appears to be approximately $40,000, and for a dependent, $20,000. Anyone below this amount should be paid a version of Milton Friedman's "negative income tax" to bring them up to an adequate and secure income, and all entitlements - two-thirds of the $3 trillion federal budget! - eliminated.

One personal tax deferral must be permitted, up to, say, $1 million worth of income-generating assets that can be accumulated tax-free. Financed with bank credit extended democratically, with individual accounts professionally managed, this would allow the United States (and any other country adopting similar measures) to become a true "nation of owners." Taking the increased exemptions into account, the current level of government expenditure, and forbidding the socialist measure of the federal government borrowing any more money (the current deficit is, according to the "national debt clock" just under $10 trillion), a single rate tax would be in the neighborhood of 62.5%.

While this might sound shocking, people earning under the median income would pay no taxes of any kind. Nor would there be a tradeoff for those over the median until a non-dependent's personal income hit around $100,000. At that point, given the current tax structure, a self-employed individual with no dependents would pay approximately the same tax as under a $40,000 exemption and a 62.5% single rate tax on all income above $40,000. A "typical" family of mother, father, and two children would pay nothing until aggregate family income exceeded $120,000.

This is the basic reasoning underlying a proposal called, "Capital Homesteading for Every Citizen," from the book of the same title. The current crop of candidates for public office would do well to investigate this concept.

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