Like clockwork every four years, Republican presidential candidates propose to “simplify” the income tax by replacing it with a “flat” tax — an income tax where all income is taxed at the same rate.
As I’ll explain below, a flat tax doesn’t simplify anything, but progressives could respond with a proposal that would: Eliminate the work penalty. Don’t tax dividends and capital gains separately from wages or at a lower maximum rate. Treat all income the same.
Fake simplification. Here’s what’s wrong with the idea that a flat tax is simple. An income tax has two parts:
- defining what income is
- saying how much tax a person at each income level pays.
If you’ve ever filled out your own tax return, you know that the complicated part is (1). Once you know your taxable income, you just look up your tax on a table.
But a flat tax only changes (2), so it doesn’t make your life simpler at all, and it doesn’t shrink the “three million words of the current tax code” that Rick Perry rails about. It slightly simplifies the formula the IRS uses to compute the tax tables, but that’s about it.
The only purpose a flat tax serves is to cut taxes for rich people and raise them for everyone else. “Simplification” is a just ruse to sell the change to people who aren’t rich.
Deductions. Now, sometimes a flat-tax proposal is coupled with eliminating a bunch of deductions. Depending on how it’s implemented, that could simplify both your tax return and the tax code. And it might or might not be a good idea, depending on which deductions get eliminated and whether or not the corresponding tax expenditures are replaced with subsidies.
But that part has nothing to do with flattening the tax. If getting rid of a bunch of deductions is a good idea, we could do that while continuing to tax the rich at a higher rate than the poor or the middle class. The two ideas are unrelated.
The Work Penalty. However, there is a way progressives can steal the tax-simplification issue, and simultaneously put the plutocrats on defense: We could propose eliminating what Andrew Tobias has aptly called “the work penalty”.
Currently, if your money makes any sizable amount of money for you through dividends and capital gains, you fill out a way-too-complicated worksheet in the instructions for Schedule D. (Check out page D-10.) That’s because we don’t really have one income tax system, we have two: One for people who make money by working, and a different one for people who make money by having money.
Guess which system has the lower rates?
For the last several years, tax rates on wages have started at 10%, jumped to 15% when a single wage-earner’s taxable income got over $8,500, gone up to 25% at $34,500, and kept rising from there to max out at 35%.
Meanwhile, the tax rate on qualifying dividends and capital gains is capped at 15%. So (because of how tax-brackets work) a wage-earner whose taxable income tops $38,750 ends up paying a higher tax rate than an idle billionaire whose income is all dividends and capital gains.
That’s a work penalty. If you work, you pay more than if you had acquired the same amount of money by being idly rich.
Herman Cain’s 9-9-9 plan would make the work penalty bigger by not taxing capital gains at all. Cain would tax dividends at the same rate as wages, but this is mostly a ruse, because corporations would stop paying dividends. Instead, they’d use their excess cash to buy back stock, which raises their stock price and so converts taxable dividends into tax-free capital gains.
Making tax simplification a liberal issue. The work penalty is the reason that Warren Buffett pays a lower tax rate than his secretary. President Obama has proposed to fix this by adding a new Buffett Rule to the tax code: a higher minimum tax rate for people whose income is higher than $1 million a year, however they acquire it.
But rather than tack on an extra rule, why not go for the heart of the beast? Eliminate the work penalty. Treat all income the same.
If we made this proposal revenue neutral, tax rates on wages could go down. (Whether we need more revenue in general should be debated separately.) The tax booklet would get slimmer. The income tax would get conceptually simpler, and the Schedule D worksheet would go away. Plus, it would eliminate all the games that make astronomical CEO and hedge-fund manager wages look like capital gains. It’s a win all around, unless you make a lot of money off your money and pay somebody else to do your taxes.
And the framing is tremendous. The work penalty captures the part of the Occupy Wall Street message that most resonates with the general public: the feeling that the rich have special privileges. (Robert Reich’s tax proposals address the work penalty, but he buries it at the end of his article, not realizing the power of the idea.)
It also follows the pattern of the marriage penalty, a concept the Right has put a lot of effort into publicizing. (Marriage and work are both traditional American values that don’t deserve to be treated badly by the tax code.) It associates liberals with working people and conservatives with the idle rich. It steals the tax simplification and tax reform memes from conservatives.
And finally, it’s just the right thing to do. Income is income. There’s no moral justification for favoring the idle rich over people with jobs.