Under a Flat Tax, everyone's income is taxed at the same rate. (Forbes says 17 percent; Hall and Rabushka say 19 percent). And not only are there no tax brackets, there are generally no tax deductions other than personal and dependent allowances. Social Security and Medicare taxes would remain as they are now. The appeal of the Flat Tax is simplicity. You can do your taxes on a postcard-sized form says Forbes. Goodbye compliance costs.
The problem with the Flat Tax is a simple one: the Flat Tax is not flat. And furthermore, no one actually pays 17 or 19 percent. In fact, taxpayers don't even pay the same percentage. The Flat Tax is actually a highly progressive tax. It is more progressive than our current system, and effectively has more tax brackets. Who said progressivity requires graduated tax rates? Under the Forbes plan, a family of four would pay no federal income tax on its first $46,165 of income; a family of six would owe nothing until its income exceeded $65,930. And those figures are sure to have increased since they were first proposed back in 2005. But not only would many families pay no income tax, they still might get a refund anyway because the Forbes plan includes a refundable child credit and earned-income credit.
If you want an example of a real flat tax, look no further than the 2.9 percent Medicare tax. Everyone pays 2.9 percent (split between employer and employee), on every dollar earned, no matter one's marital status, number of dependents, or income level. I am in favor of neither the tax nor Medicare, but if you are looking for a genuine flat tax, then the Medicare tax is your tax.
The FairTax is a consumption tax. It is the most radical tax reform plan, bar none. It also has the most vocal and intolerant proponents. The FairTax is the brainchild of three businessmen concerned about the crippling effects on the economy of the current federal tax code... [Representative John] Linder (R-GA) first sponsored the "Fair Tax Act" in the House in July of 1999, and has reintroduced a FairTax bill at the beginning of every term of Congress since then, including the current one.
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The FairTax is a national retail sales tax of 30 percent on the final sale of all new goods and services. All new goods – from cars and houses to prescription drugs and food; and all services – from operations and funerals to rent and haircuts. Because it would replace the personal income tax, there would also no longer be withholding tax, capital-gains tax, the alternative-minimum tax, or taxes on interest and dividends. Even your gambling winnings would no longer be taxed. Of course, there would be no tax deductions either. The FairTax would likewise eliminate corporate income tax, estate tax, gift tax, unemployment tax, Social Security tax, and Medicare tax. The appeal is obvious: no more complex tax code, no more taxes withheld from paychecks, no more 1040 forms, no more record keeping, no more compliance costs, no more IRS audits. And if that weren't enough, the FairTax also includes a monthly rebate to offset the taxes paid on basic necessities.
But for a plan that promises such a utopia, the problems with the FairTax are legion. The stated rate of the FairTax is too low to achieve the promised revenue neutrality. The amount by which it is claimed that prices would fall under a FairTax system has been grossly exaggerated. There is nothing to prevent an income tax from being reinstituted, giving us a two-headed hydra of an income tax and a consumption tax. And not only would state and local governments have to pay a national sales tax to the federal government, the federal government would have to pay sales taxes to itself on all its new purchases. Since I have already written extensively about the problems with the FairTax, I will stop with its problems here and focus on why the FairTax, like the Flat Tax, is not true to its name.
