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Senator Ted Cruz said
I think we ought to abolish the IRS and instead move to a simple flat tax where the average American can fill out taxes on postcard.
What are the benefits the supporters of this plan ascribe to it and what are the drawbacks of the plan in the eyes of its opponents?
The "real" pros and cons are extremely complex, but the popular understanding of the plan is roughly as follows:
Pros:
It's fair for everyone because we all pay the same tax rate. No one gets disproportionately burdened or singled out.
It's impossible for anyone to game the system or exploit loopholes because it's so simple.
It eliminates the cost for the government of maintaining the IRS, saving taxpayers money.
Eliminating the progressive tax system lowers taxes for the rich, allowing them to reinvest that money into the economy instead of sending it to the government to be wasted.
Cons:
It removes tax incentives that are economically useful, e.g. encouraging people to start small businesses by giving them tax breaks.
Removing tax breaks may also increase the relative tax burden for the middle class, people with families, etc. who are already financially struggling in this economy.
Rich people pay less taxes than they do now, and thus don't contribute their fair share to society, despite benefiting immensely from public spending.
Before I get into the implications of the flat tax, let's define progressive tax and regressive tax.
Progressive taxes are imposed in an attempt to reduce the tax incidence of people with a lower ability to pay, as such taxes shift the incidence increasingly to those with a higher ability-to-pay. The opposite of a progressive tax is a regressive tax, where the relative tax rate or burden decreases as an individual's ability to pay increases.
The term is frequently applied in reference to personal income taxes, in which people with lower income pay a lower percentage of that income in tax than do those with higher income. It can also apply to adjustments of the tax base by using tax exemptions, tax credits, or selective taxation that creates progressive distribution effects.
Implications of progressive taxation include...
Progressive taxation has also been positively associated with happiness, the subjective well-being of nations and citizen satisfaction with public goods, such as education and transportation.
Progressive taxation has a direct effect on reducing income inequality. This is especially true if taxation is used to fund progressive government spending such as transfer payments and social safety nets.
High levels of income inequality can have negative effects on long-term economic growth, employment, and class conflict.
The economists Thomas Piketty and Emmanuel Saez wrote that decreased progressiveness in US tax policy in the post World War II era has increased income inequality by enabling the wealthy greater access to capital.
Some citations that follow come from https://www.investopedia.com/terms/f/flattax.asp
Cons of a flat tax include the fact that it is a more regressive tax than our current tax code.
While a flat tax imposes the same tax percentage on all individuals regardless of income, many see it as a regressive tax. A regressive tax is on which taxes high-income earners at a lower percentage of their income and low-wage earners at a higher rate of their income. The tax is seen as regressive due to a more significant portion of the total funds available to the low-income earner going to the tax expenditure.
Note also that Cruz's proposal is a flat tax PLUS deductions.
Typically, a flat tax applies the same tax rate to all taxpayers, with no deductions or exemptions allowed, but some politicians such as Ted Cruz and Rand Paul have proposed flat tax systems that keep certain deductions in place.
A flat tax with deductions can be even more regressive than a flat tax with no deductions, since large deductions get utilized more often by wealthier taxpayers.
Another feature of flat taxes...
Most flat tax systems or proposals do not tax income from dividends, distributions, capital gains, and other investments.
This means that flat taxes only apply to some or none of the income of wealthy citizens who make their income from investment. However, the flat tax applies to ALL of the income of working class citizens who do not have any investments. So the effective tax rate on ALL income is actually lower on wealthy citizens and higher for poorer citizens. This is yet another way that a flat tax is even more regressive than it appears at face value.
Since regressive taxes put a greater tax burden on the lower and middle class, they are more likely to hurt consumer spending, which can cause recession, reduced wages, job loss, and falling GDP. Since progressive taxes place a greater burden on the upper class, they are more likely to create ladders of upward social mobility, reduce investment from the wealthy, reduce the growth of large corporations, increase the expansion of small business, and reduce the overall value of the stock market.
Senator Ted Cruz said "I think we ought to abolish the IRS and instead move to a simple flat tax where the average American can fill out taxes on postcard." What are the benefits the supporters of this plan ascribe to it and what are the drawbacks of the plan in the eyes of its opponents?
Ted Cruz is being intentionally obtuse when he offers up this slogan. It is a pipe dream that can't meaningfully provide the benefits claimed.
First, somebody has to still prepare, receive and process the postcards, which would take a comparable amount of time to processing efiled tax returns. The "postcard tax return" plan, even in its ideal sense, saves money only on the taxpayer side, not on the government side.
Second, the single biggest job of the IRS is forcing people to turn over money to them in cases where people don't pay (even if all taxes are withheld by employers and financial institutions, they have to spend time and money to do the withholding and some government agency has to make sure that they turn over the money they withhold). This job doesn't go away.
Third, another very big job of the IRS is to pursue people who provide inaccurate information or untimely information to the IRS that causes their income to be incorrectly reported. Even if they are relying on "postcard returns" prepared based upon information returns of employers and banks and the like, there will still be mistakes and fraud in information return preparation. If your employer files a tax return saying you make $30,000 a year as Vice President of a 10,000 employee corporation, yet you have an expensive yacht and live in a mansion in NYC, somebody needs to audit the employer's information returns to catch this fraud, or widespread fraud will develop.
Fourth, someone has to make rules regarding what does and doesn't count as income, whether that is the IRS or some replacement agency. Taxable income is an inherently arbitrary concept. It currently takes two thick books of statutes and six thick books of regulations to define it. Tax regulations are like speeches which as Abraham Lincoln, take more effort to make draft in a short version than to draft in a longer version.
So, any effort to abolish the IRS would simply lead to a new agency with precisely the same job with a new name in the same cabinet level department of the United States government (i.e the Treasury Department).
About 97%+ of the work of preparing a tax return involves figuring out what someone's taxable income is and what tax credits they are entitled to, and only 3% or less of the work involves figuring out how much tax is owed based upon that taxable income. The more income someone earns, the smaller a proportion of the tax preparation time and tax return processing time goes into applying the tax rate to the person's taxable income. Most people just take taxable income and look it up in a table that comes with the form without doing any math at all.
Also, calculating the tax due is already optional; you can already elect to let the IRS do that final step for you, if you want.
A flat rate primarily leads to redistribution of wealth from low income earners to high income earners, by making the tax system less progressive, but since the progressive marginal tax rate structure is not the source of complexity in preparing income tax returns, eliminating progressive marginal tax rates won't make the tax system any simpler.
Taxing all kinds of income at the same rate, rather than providing favorable tax rates for some kinds of income (e.g. corporate profits, long term capital gains, and qualified dividends), can sometimes make the tax system as a whole simpler by eliminating artificial tax incentives to turn income that would be taxed at an unfavorable tax rate into income that is taxed at a favorable tax rate through planning the way that businesses and business transactions are set up for tax purposes.
But, the proposal of Ted Cruz and similar U.S. flat tax reformers isn't truly a flat rate system, he actually proposes taxing lots of kinds of investment income at a zero percent rate and earned wage and salary income at a flat rate. So, the need to police arbitrage between different tax rates continues to exist in his plan.
In contrast, limiting progressive marginal tax rates on some kinds of income doesn't meaningfully add to the tax planning problem or make taxation more complex.
The taxation of wage and salary earners could be made somewhat simpler by having the IRS send out a presumptive tax return to people (based upon employer prepared W-2s send to the IRS and 1099s from financial institutions sent to the IRS) with few if any deductions or credits. But, for people who take the Standard Deduction (most working class and most middle class families who rent their homes), preparing a tax return is already quite simple, and the credits that make their taxes simpler mostly benefit them and involve only a little more information. A reform of this kind has a strong likelihood of increasing the total tax burden on the low income taxpayers with the least discretionary income.
On the other hand, most of the time and complexity of preparing tax returns for business owners and other self-employed people comes from gathering up lots of information on revenue received and expenses paid to determine profits which are the starting point for determining taxable income. But, it is basically impossible to have an income tax on self-employed people and businesses that doesn't require people to collect, summarize and report this information to a tax collection agency which in turn has the power to audit returns to see if they have omitted income or included expenses that aren't legitimate expenses.
Similarly, you need rules to tell you went to count particular items of revenue towards income and when to count particular expenses, and someone has to write those rules and enforce them.
This isn't to say that there is anything wrong, in principle, with finding ways to actually simplify income taxation, or to find ways to reduce tax preparation burdens on taxpayers.
The U.S. certainly doesn't have the simplest or least burdensome of all possible income tax systems, and simplification can often also reduce opportunities for tax evasion. For example, even within the U.S., the FICA tax system of the United States has much lower collection costs per dollar of revenue raised than the ordinary federal income tax system.
But, no amount of tax simplification can eliminate the need for the IRS or an equivalent agency with a new name, and the kind of steps needed to simplify the tax code involve thousands of little complexities that need to be unraveled one by one in detail, not steps that can be taken in one fell swoop without bankrupting the federal government by eliminating almost all of its income tax revenues (something that even Ted Cruz does not support). It might be possible to make the IRS and the Tax Code a little smaller, but it can't simply be eliminated.
Furthermore, the vast majority of true tax simplifications involve reducing barriers to getting tax breaks for the poor and middle class (like simplifying the earned income tax credit and Obamacare Premium Tax Credit) while removing loopholes and credits for businesses and affluent individuals (e.g. removing the complex R&D tax credit and the new passthrough taxation credit which are wildly complex). This is something that Ted Cruz and his supporters would almost certainly oppose in practice.
If you read the entire statement, he's not talking about eliminating the IRS itself, but going to a flat tax... eliminating the various tiers of taxation on income.
The idea comes up every so often... but has one fundamental flaw.
The US government, like most democratic governments, uses taxes to encourage or discourage actions. They may offer a tax break for a corporation to locate a factory in the US, as opposed to locating it elsewhere. There are tiers of taxation to encourage investment - capital gains tax tends to be lower than tax on wages earned... to encourage investment. Contributions to an IRA defer income tax to when someone isn't earning as much, as in retirement, and will pay less... unless a flat tax is instituted, in which case there is no advantage to contributing to an IRA.
A flat tax also negates the concept that people who make more, should pay a higher percentage. The idea is that the country provides the circumstances where they can make more money, so they should give up a higher percentage if they do well. Given that the US remains a leader in innovation and invention, especially in the technical field, the idea that the country provides unique opportunities to make a lot of money is a valid concept.
Given that the top five percent of citizens pay nearly half the current income tax revenues, a flat tax would hit the nation's budget balance particularly hard, when it's already well into the red, and has been for decades. For that reason alone, a flat tax would probably never pass congress.
A flat tax eliminates a very powerful tool to encourage business and personal behavior, by making that behavior either very inexpensive, or very expensive, as the case may be. Even if a flat tax were passed, it would quickly be picked apart with tax breaks or tax penalties, as the need arises. And the cycle would start all over again.
In the end, a flat tax is an election day red herring, that sounds good to a portion of the electorate, but ends up being impractical.
Very much like Trump's wall or the free college education of Sanders, or increased immigration of Clinton. Sounds great, until you look into the details of what the actual cost and results would be... but that's another thread.
The usually overlooked advantage is that the cost of collecting the tax is significantly reduced by such a system. Guesstimates currently place the cost of collecting one spendable tax dollar at over $5. Reducing that cost by even 20% means that there is an additional dollar in the economy for every single tax dollar that can be spent.
The IRS budget is currently over $11 billion dollars, and many times that amount is spent on tax lawyers. The costs to individuals and companies involved in calculating, collecting, auditing and paying taxes are all significant and are often more then the actual tax bill. This is just draining resources out of the economy to nobodies advantage. The simplest and fairest system that I have heard of is called the fixed base flat rate. The government already publishes the Federal poverty level income. Every taxable entity gets to deduct twice that amount from their gross taxable income and they a flat rate of the remaining income as tax.
So what should the rate be? The 2017 US GDP was just under $20 trillion and the federal budget was ~$4trillion (20%). The tax take was $3.3trillion (the difference adds to the national debt), so I suggest start at a flat 20% and let the cost savings reduce the national debt.
Box 1, gross taxable income,
Box 2 poverty level * 2,
Box 3, taxable income (box1 - box2)
Box 4, tax (Box3 times 0.20)
Example1 - Income $65,000
Box 1 Gross income $65000
Box 2 poverty level $12,486 * 2 $25000
Box 3 taxable income $40000
Box 4 tax $ 8000
Example2 - Income $650,000
Box 1 Gross income $650000
Box 2 poverty level $12,486 * 2 $ 25000
Box 3 taxable income $625000
Box 4 tax $125000
Example3 - Income $6,500,000
Box 1 Gross income $6500000
Box 2 poverty level $12,486 * 2 $ 25000
Box 3 taxable income $6475000
Box 4 tax $1295000
Example4 - Income $35,000
Box 1 Gross income $35000
Box 2 poverty level $12,486 * 2 $25000
Box 3 taxable income $10000
Box 4 tax $ 2000
