Flat Tax Folly

by Laurence M. Vance

In his new book, Flat Tax Revolution (Regnery, 2005), which is subtitled Using a Postcard to Abolish the IRS, Steve Forbes pulls no punches when describing the federal income tax code:

• A monster of a system.
• Abominably, appallingly confusing.
• A multi-headed hydra of countless brackets, deductions, and exemptions.
• Our horrifically heavy, appallingly complex, corruption-inducing tax code.

Forbes, of course, is the overseer of the Forbes publishing empire. He also sits on the board of the National Taxpayers Union. As a Republican presidential candidate in 1996 and 2000, he campaigned on a platform of medical savings accounts, a new Social Security system, school choice, term limits, a strong national defense, and a flat tax — the subject of his new book.

In addition to his accurate description of the horrific US tax code, Forbes also correctly points out the huge costs of complying with the tax code. Compliance costs in terms of time have skyrocketed from an average of 17 hours and 7 minutes fifteen years ago to 28 hours and 30 minutes today. Lost productivity is in the billions of hours. The cost in dollars is now about $200 billion.

The US tax code — with its "nine million word mountain of verbiage" — is so complex and "littered with impenetrable passages" that a fictional tax return given by Money magazine to forty-five tax preparers resulted in forty-five different calculations of the correct amount of tax due. This is not surprising since IRS employees (Forbes says that there are 97,440 of them) don't even give the same answers to tax questions. Forbes mentions a 2003 Treasury Department study which found that callers to the IRS toll-free help lines "gave the wrong answers to tax-related questions more than 25 percent of the time."

Forbes also reminds us that our tax code kills jobs by penalizing people for "productive activities," "punishes savings by taxing dividends," and breeds corruption by "encouraging the crassest, crudest political conduct." The estate tax "destroys capital." Tax increases exacerbated the Great Depression. High tax rates discourage investment, hamper economic growth, and "make it extremely difficult for most Americans to amass vital savings for college, retirement, or the starting of a business." Forbes also shows that the distortion of the health care system is due to the tax code creating "a disconnect between health care providers and consumers."

Forbes did not become the overseer of a publishing empire by just pointing out problems and not recommending solutions. In exchange for the current system, he calls for "a new tax system that is simple, honest, and fair" — a flat tax of 17 percent "with generous exemptions for adults and children" that can be filed on a twelve-line, postcard-sized form. Corporations too would have a similar plan, and have their profits taxed at the same rate.

The flat tax idea is not new to Steve Forbes. He mentions how the first proposal for a flat tax was made in Milton Friedman's Capitalism and Freedom in 1962. This should come as no surprise to those familiar with Friedman's statist proposals as outlined by Murray Rothbard in his classic 1971 essay, "Milton Friedman Unraveled." The "prime movers" behind the flat tax are acknowledged by Forbes to have been Hoover Institution economists Robert Hall and Alvin Rabushka, who authored The Flat Tax back in 1985 (2nd ed. 1995).

The Book

Flax Tax Revolution, with a foreword by that great champion of limited government, Newt Gingrich, contains glowing endorsements from a diverse lot: Donald Trump, Sean Hannity, Neil Cavuto, Lawrence Kudlow, and former congressmen Joe Scarborough and Jack Kemp. But is the Forbes plan a solution to the horrendous, convoluted, wealth-destroying federal income tax code?

There is no question that many people will have a lower tax bill and a shorter and simpler tax form to fill out under the Forbes flat tax plan. In this respect we can say that the Forbes plan is a solution if the problem is how we can shorten and simplify the tax code and at the same time allow people to keep more of their money so they will feel better about paying their taxes.

But as we shall presently see, there is another winner under the flat tax: the US federal government — a bloated, corrupt, monstrosity that now spends almost $3 trillion a year while redistributing the wealth of its citizens, enriching federal contractors and other special interests, and maintaining an empire around the globe. Is shortening and simplifying the federal tax code the solution or does it mask the problem? Will it perpetuate the federal leviathan or result in more liberty and less government?

Unlike other recent books that recommend a replacement for our current federal income tax system, like The FairTax Book, by Neil Boortz and John Linder, Flat Tax Revolution is well-written, and is not condescending to the reader. After a brief introduction, Forbes begins with the "nightmare on main street" that is the federal income tax code. Chapter two chronicles the "birth of the tax beast" — the attempts by the US government to establish an income tax, which finally came to pass permanently in 1913, and a brief account of how it has increased since then.

The next chapter shows how the "complexity and confusion of the current code corrupts our behavior and values and is ruining the quality of life for us as individuals and as a society." Chapter four presents the details of the Forbes flat tax plan. Because he believes that "the flat tax is the only way to bring back sanity and put an end to the clutter, confusion, and distortions of the current system,"

Forbes then spends a whole chapter on why he believes a flat tax is better than a national retail sales tax. He grasps what advocates of a national sales tax have never been able to understand: "Before a sales tax is put in place, we must first repeal the Sixteenth Amendment to the Constitution, which allows Washington to impose the income tax. Otherwise we will end up with the situation that exists in most states — and indeed in most other countries — and that is both an income tax and a sales tax."

Chapter six examines the "success" that other nations are having with a flat tax. The seventh chapter is an attempt to answer objections to a flat tax. Here Forbes discusses the effects of the flat tax on charitable giving, job creation, the poor, tax-free bonds, employee benefits, and deductions for interest and taxes. The last chapter and the six appendixes contain some useful information. So much for the book, what about the plan?

The Plan

Under our current income tax system, there are six tax brackets ranging from 10 to 35 percent and, as Forbes rightly says, "an avalanche of different personal exemptions and deductions." Under Forbes's proposed flat tax scheme, there would be "a single-rate federal income tax and corporate tax of 17 percent." There would no longer be any taxes on capital gains, Social Security benefits, interest earned, or dividends received.

Additionally, the estate tax and the Alternative Minimum tax would be done away with. Individuals would have "generous exemptions for adults and children" such as deductions of $13,200 for adults and $4,000 for dependents. Single mothers fare even better. They receive an exemption of $17,160 instead of the normal $13,200. Corporations could expense all investments — no more depreciation schedules (at least for tax purposes, accounting is another matter) — and would only be taxed on what they made in the United States.

As expected, Forbes believes that the adoption of his flat tax will

• Make us more prosperous.
• Invigorate the economy.
• Make us more competitive overseas.
• Give rise to a strong, innovative, and dynamic economy.

"The flat tax will free America," he says, "It will liberate us, as individuals and as a society, from the tyranny of the federal tax code." That may be true, but it should be noted that because it is only a replacement for the federal income tax, the flat tax will not eliminate Social Security taxes, Medicare taxes, or federal excise taxes. And neither will it have any effect on state and local taxes. But to his credit, Forbes does not make any grandiose claims for the flat tax like we read about a national sales tax in publications like The FairTax Book.

The Problems

If many people will have a lower tax bill and a shorter and simpler tax form to fill out under the Forbes flat tax plan then what problems could there possibly be the plan?

Problem #1: the flat tax is not a flat tax. It is a highly progressive tax that shifts the tax burden to the "rich" — the middle class and upper middle class that earn wages and salaries. Forbes obviously has no problem with a progressive tax; indeed, he proudly proclaims the progressive nature of his flat tax: "Those who complain that the flat tax isn't progressive are mistaken. Just look at the effective tax rates in the Flat Tax Rate Table."

Forbes says that under his plan "there would be one rate — 17 percent — after generous exemptions for adults and children." In another place he says that a key feature of the flat tax is "generous and refundable exemptions for adults and children." The significant words here are "after" and "refundable." The 17 percent tax is not applied until the "generous exemptions" are deducted from the taxpayers' income. This means not only that no one will actually pay 17 percent (everyone will in fact pay less than 17 percent unless he makes over about $5 million), but that people will pay different rates (just the opposite of what a flat tax is supposed to be).

Furthermore, the Forbes flat tax would enable "a family of four to pay no federal income tax on its first $46,165 of income." A family of six "would owe no income tax until its earnings exceeded $65,930." This is because not only does the Forbes plan include deductions for each adult and child in a family, it also includes a tax credit of $1,000 per child "as under the current system." This credit is refundable: "If the child tax credit exceeds federal taxes owed, the family can receive a refund." A refund of what? Why, a refund of other taxpayers' money. This is a welfare scheme, pure and simple. It is incredible that Forbes retains what he admits is a "complex relic of today's code."

In actuality, the flat tax has tax brackets just like the current system. There is the single bracket, the single mother bracket, and a series of married with children brackets. If you want an example of a real flat tax then look at the Medicare tax. The rate is 2.9 percent for everyone no matter how much or how little they make. What Forbes calls the flat tax may be a lower tax and a simpler tax than the system we have now, but it is not a flat tax.

Problem #2: the flat tax eliminates some key and longstanding tax deductions. If there is one theme that resonates throughout the book it is how unfair deductions, credits, shelters, and loopholes are. Most every one of these would be eliminated under the Forbes flat tax plan, as well as "the possibility of setting up complicated tax-avoidance schemes." Because when you mess with a man's home and his church you are asking for trouble, the mortgage interest deduction and the charitable giving deduction are two deductions that are of particular concern to some taxpayers. Both of these would be eliminated under the flat tax.

Naturally, Forbes assures us that any loss of benefit would be offset by additional benefits gained under the flat tax. And besides, the mortgage interest deduction "results in a disproportional benefit for taxpayers earning more than $100,000." On the corporate level, there will no longer be deductions for fringe benefits or interest payments.

Forbes says to "think of it this way: Washington politicians take one dollar from your pocket — and then return fifty cents in various tax deductions. Wouldn't it be better if they taxed you only that fifty cents in the first place?" No, it would be better if they taxed you only forty cents, thirty cents, twenty cents, or ten cents in the first place.

Not mentioned by Forbes is an important deduction for small business owners that would disappear under the flat tax: the deduction for one-half of self-employment tax paid. All small business owners, including those who own the smallest of home-based businesses, are currently entitled to this deduction because it helps to offset the self-employment tax paid on their profits. Currently, employers and employees each pay half of the 15.3 percent that is taken by the feds for Social Security and Medicare taxes. Self-employed individuals have to pay the full amount, hence the deduction for one-half of self-employment taxes paid.

Deductions, exemptions, credits, shelters, and loopholes all accomplish the same thing; albeit in different ways: they allow people to keep more of their money. But instead of arguing that people gain when they get to keep more of their money, Forbes maintains that the government loses: "Since 1993, the government has lost $85 billion in tax payments because of abusive tax shelters — money that could have been returned to you, the people." This statement also shows what Forbes believes should happen to the money that the government loses — it should be transferred to "the people." But what is wrong with letting the rightful owner of the money keep it in the first place?

But is Forbes really against tax deductions and credits? Well, first of all, we have already seen that his flat tax includes "generous exemptions for adults and children." Secondly, he criticizes the current system for phasing out some deductions and exemptions beyond a certain level of income. And third, the Forbes plan includes — are you ready — that fraudulent welfare tax credit scheme known as the Earned Income Tax Credit. Forbes even acknowledges that "there are people who receive the EITC but should not. An estimated $6.5 billion to $10 billion in EITC payments each year may be improper. That's about one-fourth of the dollars spent on the program." He claims that the EITC is "a back-door way of effectively refunding" the Social Security and Medicare taxes paid by "low-income families with children." Why is Forbes so concerned about "low-income families" paying half of their Social Security and Medicare taxes but not at all concerned about the self-employed small business owner who struggles with the whole amount?

Problem #3: the flat tax retains the withholding tax. Forbes modestly claims that his flat tax proposal "is a first, major step towards a total overhaul of the entire American tax system." But the Forbes plan is no "first, major step"; short of doing away with a tax on income altogether, it is the most drastic overhaul of the income tax system that has ever been devised. Yet, the flat tax contains no provision for the elimination of the withholding tax. Forbes recognizes that "most Americans don't realize how far the politicians reach into our pockets." He believes that "the politicians have anesthetized us to the scale of their tax larceny."

And he even specifically informs his readers what is wrong with the withholding tax:

The problem with withholding is that it reduces the discomfort of paying income tax by spreading payments out over the course of a year. Americans end up feeling a sting instead of a painful bite. Withholding made collection easier: But it also made Americans less acutely aware of the impact of taxes on their financial well-being — allowing the system to grow more easily and become less accountable. And, like income taxes themselves, withholding was supposed to be a temporary wartime measure!

So why is there no mention of the withholding tax in the chapter that outlines "how the Forbes flat tax will free America"? True, it doesn't state that the withholding tax will be retained. But since all the bad things in the current system that will be eliminated are mentioned in this chapter, I take Forbes's silence on the matter as consent. But what about "The Steve Forbes Flax Tax Form" found on page 73 of the book — there is no line for "income tax withheld" like we see on our current tax forms? The form in question is obviously just an example of how simple a form we would need under a flat tax plan that eliminated most credits and deductions. Since there is no space on this form for a taxpayer's name and address it obviously cannot be taken as an example of a "real-world" flat tax form. The "real-world" tax form that a smiling Steve Forbes holds in his hand in the picture on the book's cover reads differently than the form on page 73.

The withholding tax makes it possible for the government to silently steal the wealth from its citizens with little or no outrage about the loss. A flat tax that reduces the taxpayer's discomfort by masking how much tax is being paid while at the same time simplifying the filing process will eliminate both the sting and the bite of paying taxes.

Problem #4: the flat tax is still an income tax. As mentioned previously, Forbes calls for "a new tax system that is simple, honest, and fair." But what is so fair about a tax on income? And what is so fair about the government confiscating 17 percent of our income, even after "generous exemptions for adults and children." Ignoring for the sake of argument the fact that all taxation is theft, the least harmful and "fairest tax" would be a head tax (an equal tax) low enough for "low-income families" to pay. What is fair about requiring the "rich" to pay more just because they can afford to do so?

In his chapter on the history of the income tax, Forbes criticizes the income tax the whole way through: "In 1909, President William Howard Taft's successful enactment of a corporate income tax laid the groundwork for acceptance of the idea of a personal income tax — allowing the beast to rise again." But if an income tax is so bad then why advocate one — like the flat tax? Yes, the tax rates would be lower under a flat tax than they are under the current system, but the rates were much lower back then without a flat tax.

The reason we "need" an income tax is because of the federal government's insatiable desire for money. Such was not always the case, as Forbes himself says: "Between 1817 and the start of the Civil War in 1861, the federal government operated successfully without having to levy any new internal taxes." Before the advent of the income tax, as Forbes again says, "The biggest source of tax revenue was tariffs on imported goods. There were also levies on a variety of items, including whiskey." The problem is clearly the size of the federal government.

The "best" tax system from the standpoint of liberty, and not from the standpoint of what the government says it needs, would be one that interferes the least with the free market. The ideal amount of taxes collected would then, of course, be zero. Therefore, the best type of tax reform is one that has for its goal the lowering of the amount of taxes collected. "The flat-tax movement, as explained by Murray Rothbard, "is part of a process by which the government and its allies have been able to split and deflect the tax protest movement from trying to lower the taxes of everyone, into trying to force everyone into paying some arbitrarily defined "fair share."

Problem #5: the flat tax increases government revenue. Proponents of other plans to change the US tax system usually talk about how their tax will be revenue-neutral. Forbes does them one better:

The flat tax is a reform of our federal income tax system. It does not affect, for example, state and local taxes. But, contrary to what some may fear, it will generate increased government revenue.

A flat tax enacted in 2005 would, four years from now, produce $11 billion more for the government than the current system.

The flat tax will create some $6 trillion in new assets and $892 billion in additional payroll tax receipts.

From 2005 to 2015 the flat tax would generate $56 billion more in net government income tax revenue than the current tax code.

But how will cutting everyone's taxes increase government tax revenue? Although he doesn't mention it, Forbes is relying on the old Laffer Curve argument that there exists an optimum point on a curve that corresponds to a tax rate percentage that maximizes government revenue so we can in some cases lower the tax rates and still "get more tax money from the rich." Forbes has a paragraph heading on page 71 that reads: "The Numbers Show: The Flat Tax Will Create Wealth and Government Revenue." But what could possibly destroy wealth more than government revenue? Where does Forbes think government revenue comes from? Why would we want to maximize the government's tax revenue? And even if it were true that the flat tax would raise more revenue, what makes this government worthy of almost $3 trillion dollars a year for its spending orgy? Spending cuts and deficit reduction be damned — the flat tax allows members of Congress to maintain their obscene spending orgy and cut taxes at the same time. The masses get to enjoy their tax cut and their government subsidies — for a while. But after taxes inch back up and more deductions and credits are added, Congress can reform the tax system again by lowering rates and closing loopholes.

Forbes wants the government to have its revenue and spend it too. And what will the government do with all this extra revenue it receives under a flat tax? Forbes tells us that his flat tax plan will result in "more government revenue and dollars to fund programs like Social Security and Medicare" and will "give rise to a strong, innovative, and dynamic economy that will help us wage a successful war against Islamic terrorism." In other words: the flat tax will help perpetuate the welfare/warfare state.

Real tax reform

Forbes is a typical Republican. Reagan is praised as a great tax cutter, but no mention is made of the Social Security tax rate increasing from 10.16 percent when he took office to 12.12 percent when he left, or the Medicare tax rate increasing from 2.1 percent when he took office to 2.9 percent when he left. And what about Reagan's record spending and deficits?[1] Forbes also praises Reagan for "a massive military buildup" while he criticizes Carter for "gutting the military." The most laughable statements in the book are about President Bush. He is said to be "a genuine tax-cutter" who "is fully committed to a major overhaul of the tax code." The truth, however, is that Bush has presided over an increase in spending that Lyndon Johnson and his Democratic congresses only dreamed about.

The Solution

Let it not be said that I am too quick to criticize a proposed solution to a problem without offering a solution of my own. For starters, why not cut federal spending in half and at the same time cut federal income tax rates by an appropriate amount? Too drastic? How about an incremental approach: Cut spending by 10 percent each year and cut taxes each year to match it. It doesn't matter what kind of tax system we have, if the rates are lowered enough then it will result in economic growth, but not necessarily increased revenue for the government.

You want a flat tax? Okay, but if we are going to have a flat tax then why make it 17 percent? In discussing the results of the flat tax in Russia (which also has a VAT of 20 percent), Forbes tells us that although his "proposal has a rate of 17 percent," Russian president Putin "instituted a 13 percent rate." Then he remarks: "I never thought the day would come when a former communist and KGB agent such as Vladimir Putin would be more radical on taxes than I."

Given Forbes's free market and limited government rhetoric, I never thought so either. How about a rate of 10 percent? In his introduction, when trying to show how the flat tax idea has been around for decades, Forbes says that some view the flat tax "as a descendant of the 'tithe' which exacted 10 percent off the fruits of men's labor in biblical times." This is nonsense, of course, since the tithe went to the Lord's work and the flat tax goes to the government's work.[2] But why not make the flat tax 10 percent? Should government get more than God?

The invectives hurled at the federal tax code and the tax collection system are misplaced. The real problem is the very existence of the federal leviathan that feeds off tax dollars. A tax plan that perpetuates the welfare state and pays for the warfare state is not the solution. I would appeal to Forbes to consider not only something he said about taxes early in the first chapter of his book — "first and foremost, we pay too much" — but also that the reason we pay too much is that the federal leviathan devours too much. As Congressman Ron Paul (R-TX) so succinctly says: "The real issue is total spending by government, not tax reform."

Laurence M. Vance is a freelance writer and an adjunct instructor in accounting and economics at Pensacola Junior College in Pensacola, FL. See his Mises.org archive. Send him mail. Comment on the blog.

[1] Must reading on the Reagan record is Robert P. Murphy, "Bread, Circuses, Tax Cuts, and Debt"; and Murray N. Rothbard, "Ronald Reagan: An Autopsy."

[2] The perceptive religious reader of Forbes's book will also note that his remark that "The Holy Bible has 773,000 words" is likewise nonsense — it has 788,258 words.