Flat Tax, Fair Tax

The “Flat Tax” is a variant of an Income Tax that taxes every dollar of income at the same rate. For example, after determining your taxable income, that amount would be taxed at, say, 25%. Rich or poor, every dollar of taxable income is taxed the same. In some cases (I have never seen an exception), the Flat Tax begins with an exemption of the first $20,000 or $30,000, to soften the blow on low wage earners.

The “Fair Tax” is another variant of an Income Tax that is really a fixed-rate Sales Tax or Consumption Tax. For example, you do some shopping at your local Big Box store and end up with a big wagon of stuff; in addition to local and state sales taxes on individual items, there would be a fixed rate federal Sales Tax on the total checkout that would be the same in every locality in the nation, and this would replace the old Income Tax. And like the Flat Tax, the Fair Tax begins with what they call a “prebate,” a monthly check, to soften the blow on low-wage earners (and everyone else).

To give them their due, Flat Tax proponents and Fair Tax proponents see “equality” as the key to “fairness.” “It is fair to tax everyone equally, at the same tax rate.” This feels right, because “fair” and “equal” are very often nearly synonymous, but it betrays an impatience with thoughtfulness as both taxes are eminently UNfair – upon examination.

For example, in order to collect the same tax revenues that we collect now (which are themselves inadequate to keep from adding a trillion dollars annually to the National Debt), a Flat Tax would have to be seriously upwards of 30%. Imagine a minimum wage income, say $20,000. Taxed at 30%, we leave this poor fellow with $14,000. Do you know anyone who can get by on $20,000 / year? Do you know anyone who can get by on $14,000 / year (after taxes)? Even without a spouse or children to house and feed? Imagine a CEO who “earns” $5,000,000 / year. Take 30% from him – $1,500,000 of federal Income Tax! What a huge contribution he is making to the Treasury, God bless him! But, do you know anyone who cannot get by on $3,500,000 / year? Feeding three spouses and ten kids. An expensive house in a good neighborhood, great schools for the kids, fancy automobiles, the best suits, frequent 5-star dining. That $1,500,000 of federal taxes doesn’t make a dent in our hero’s standard of living. Pity the poor millionaire. Taxing everyone at the same rate sounds fair, but on examination it will cripple low-end wage earners and have little impact on high-end earners.

Which, of course, is why every Flat Tax proponent exempts some income from being taxable. But the exact same logic that compels Flat Tax advocates to exclude the first $20,000 or $30,000 from taxation, that same logic would suggest lower tax rates on low wage brackets and higher tax rates on high wage brackets.

The Fair Tax is even more unfair than the Flat Tax as it only taxes what we spend and leaves untaxed what is left over for saving and investment. Poor people spend all their income on taxable necessities, and most must add credit card debt to survive, while our mythical CEO will save and invest a cool chunk of his income, protecting it from any federal taxation whatever. So, the effective tax rate on a poor person will always be much higher than the effective rate (total tax assessment / total wages) on a successful person. Not too fair!

Lower tax rates on lower wages, higher tax rates on higher wages. This is called a progressive tax (or graduated tax); it is what we have now, and it is what we have always had; Congress has always thought it the only way to have an income tax that is truly “fair.” Indeed, the progressive tax does tax everyone the same, equally. Every tax payer pays the same tax on their first $50,000 of taxable income, or their third $50,000 of taxable income; higher tax brackets do have higher tax rates, but everyone pays his taxes based on the same tax rate schedule.

A tax is called regressive when it hurts the poor more than the rich (the Flat Tax) or when the poor pay a greater “effective” rate of taxes than the rich (the Fair Tax). In determining how fair – really fair – a tax is, the only question is how “progressive” that tax is. The more progressive it is – the bigger the difference between low tax rates on low wages and higher tax rates on high wages – the more really “fair” that tax rate is. Up to a point of course!

In addition, such really unfair tax schemes would run the biggest deficits you have (n)ever seen.

If you are not comfortable with numbers, please avoid the tables below. They do not say anything that I have not already said. But they do make my argument concrete for those who are comfortable with numbers.

Table of Tax Consequences² (in Dollars)

Taxable Income	Current Tax Rates3	Flat Tax4	Fair Tax5
$15,000 (poverty)	$1,835	$323	$487.60
$50,000	$8,688	$6,273	$7,388/ $8,538
$500,000	$152,644	$82,773	$54,538 / $112,038
$5,000,000	$1,727,644	$847,773	$227,038 / $1,147,038
$50,000,000	$17,477,644	$8,497,773	$572,038 / $11,497,038

Table of Tax Consequences² (in Percentages)

Taxable Income	Current Tax Rates3	Flat Tax4	Fair Tax5
$15,000 (poverty)	12.23%	2.15%	3.25%
$50,000	17.38%	12.55%	14.78% / 17.08%
$500,000	30.53%	16.55%	10.91% / 22.41%
$5,000,000	34.55%	16.96%	4.54% / 22.94%
$50,000,000	34.96%	17.00%	1.14% / 22.99%

1. effective tax rate = total tax / total taxable income (as a %)
2. single adult rates used
3. 2010 tax tables
4. There are several proposals by this name: this assumes a tax rate of 17% and an exemption of $13,100
5. There are several rates associated with the Fair Tax, 23% is the most common I have heard. The “prebate” is the product of an “Annual Consumption Allowance” (aka poverty level expenditures) times the FairTax rate (23%), or $2962.40 for a single adult in 2021. I have assumed (the 1st number in the last column before the " / ") that more successful persons will save more and spend less.  I have assumed %age rates of consumption (spending) for each Taxable Income level as 100%, 90%, 50%, 20% and 5% (feel free to assume different rates, you will see that the core of my argument has no need of alteration).  The $'s and %'s after the " / " assumes that the wage earners will spend 100% of their gross taxable income.  I used the Fair Tax Calculator to derive my original estimates (this may be a mistake).

As you can see by examining the tables,

1. The Flat Tax collects half the revenue that the current progressive income tax does. While being generous to everybody, it is particularly generous to the rich and the very poor. The deficits under this level of Flat Tax would be worse than any we have ever seen. In order to collect as much revenue as the current tax rates, the Flat Tax would have to be set at 34%, a pretty high tax rate for someone with low- or middle-class wages.
2. The Flat Tax is apparently fairer to the poor than current tax rates (but only because of the exemption). This may seem like an argument for the Flat Tax, but it equally argues for lower tax rates on low incomes within the current progressive tax system.
3. The Fair Tax taxes consumption (spending).  However, in the real world, the more you earn the smaller %age of your gross income you will spend, and the more you will save or invest.  At a certain point your effective tax rate will keep dropping.  So, the middle class will ultimately pay a higher effective tax rate than a super earner.

If our objective is to minimize taxes on everyone (we all want to pay less tax, don't we?), we should just stop taxing everyone and just not pay for a government either (as governments and taxes go together, under tyranny or democracy).  But my objective in this piece is to answer the question, “What taxation scheme will bring in enough tax receipts to pay for what our duly-elected representatives in government choose to spend (with the people’s blessings, of course), without incurring an unsustainably huge deficit, at the same time as doing it fairly, with the least harm to the most vulnerable people.” What we have discovered together is that everyone "benefits" (pays less tax) from the Flat Tax and the Fair Tax. But we have ignored the ugly reality that both the Flat Tax and the Fair Tax do a woeful job of collecting enough taxes to avoid a $1-3 trillion annual deficit; we do need to collect more tax revenues, but how do we do it with the least damage to our citizens? The progressive tax accomplishes both objectives at the same time. We collect less taxes from those with the least money and more taxes from those with lots of money. We are not soaking the rich (no more so than we did until 1981 under President Reagan)! We are collecting our taxes from those who have the money, a paraphrase of a famous Warren Buffett quote!  (Indeed, we are NOT collecting much if any income taxes from our wealthiest citizens, as they often declare little or no taxable income, quite legally!)

Americans love the idea of paying less income tax, the devil be damned.  The Flat Tax and the Fair Tax deliver in spades on that account: most of us will pay much less income taxes under these schemes than we pay currently.  The other side of the coin, however, is that we will pay for that benefit with an explosion of our annual deficits and our National Debt.  If government spending were our personal monthly credit card, our instincts would be to pay off the entire balance, paying for what we buy.  What a concept!  But the federal budget isn't OURS, is it?

A final irony is that Jeff Bezos and friends will pay much more in income taxes under the Fair Tax than they do now.  But it will be a pittance as they will rarely spend as much as 1/10 of 1% of their wealth in a year.  Yeah, the system is rigged!