Income tax reform

Why a flat tax is often a bad idea

Published: September 8, 2004

As part of his reelection campaign, President Bush is pushing for a simpler federal income tax. He says that tax laws are "a complicated mess," filled with "special-interest loopholes." And he's absolutely right.

The big question is: What is the best way to overhaul a tax system that, according to the president, requires 6 billion hours of paperwork every year?

Mr. Bush says that if reelected he will lead a bipartisan effort to simplify the federal tax code and to make it fair. The president's aides say he is considering making a so-called flat tax a priority. That's quite a challenge, since almost every flat-tax proposal that has come down the pike has been anything but fair.

The idea behind the flat tax is to tax all Americans at the same rate, and eliminate - or greatly reduce - the number of deductions and credits. That may make filling out the federal income tax forms a lot less burdensome, but it would also inevitably provide a windfall for the rich at the expense of middle-income or moderate-income Americans. The income tax has traditionally been progressive, with the wealthy paying a higher percentage tax.

What's more, flat-tax proposals in the past would not have taxed such investment income as dividends, interest, and capital gains, so the rich would benefit even more. A wealthy person living exclusively on a trust fund, for example, would pay no income tax. People who work would be penalized to the benefit of those who don't. Where's the fairness in that?

House Speaker Dennis Hastert, a Republican ally of the president, has been calling for a variation of the flat tax - the "fair tax" - which would replace the federal income tax with a national sales tax. No one would get taxed on income, and everyone would pay the same sales-tax rate.

A national sales tax would encourage people to save their money and discourage short-term spending. What's more, to make sure the economically disadvantaged aren't hit hard, the poor would receive some sort of annual rebate, based on family size and income.

But once again the rich would benefit the most, since they would be paying taxes at the same rate as the middle class, and would be spending a far smaller amount of their overall incomes. And, according to William Gale of the Brookings Institution, a Washington think tank, it would take a national sales tax rate of more than 26 percent to make up for the federal revenue generated by the income tax. That's a lot more than most Americans currently pay in federal income taxes.

The president is right when he says that the federal income tax is far too complicated, and that a bipartisan approach is the best way toward reform. It's when his aides or congressional cronies start talking about flat-tax plans - especially ones that exclude unearned income - that people should get nervous.