Tax season will soon be upon us. Wouldn’t it be nice if filing taxes was not such a long, drawn-out process?
Two weeks ago I mentioned the flat tax when talking about the effects of marginal tax rates. A related tax plan is known as the negative income tax. This gives taxpayers a refundable tax credit and couples this with a constant marginal tax rate or “flat tax.” One of the benefits of such a system is the ease with which taxes can be filed.
As an undergraduate student in the 1980s, I heard a fascinating lecture by Robert Hall of Stanford University on his tax proposal with Alvin Rabushka. I remember he passed around sample tax forms printed on 3-by-5 index cards. They looked something like this:
Line 1 – Enter your total income for the year.
Line 2 – Multiply line 1 by 0.2.
Line 3 – Subtract $10,000 from line 2. This is your total tax.
The negative income tax has a lot of nice things going for it. First, it is very simple. There is no itemizing of deductions and the math is simple enough to do with a pencil and paper. There is no need for tax professionals or tax software. No one is likely to make a Tim Geithner Turbo Tax mistake, and if they do, well, it’s pretty easy to check.
Secondly, the system maintains a constant incentive to earn and does not penalize high-wage earners with higher proportions of additional dollars being taxed as income rises. In the example above, all taxpayers keep 8 cents of every dollar earned.
The disincentive to earn income is, ironically, most pronounced for low-income earners who lose welfare and other benefits when they earn wages. In many cases, the effective tax on income and benefits exceeds 80 percent. For this reason, a negative income tax must be coupled with welfare reform. All forms of welfare payments must be accounted for in the lump-sum tax credit.
Third, the system is still progressive. That is, the burden of taxation is lighter on people with lower incomes. This is due to the tax credit, which allows citizens to receive a refund even if they owe no tax. Unlike the earned income credit, which is also refundable, the negative income tax credit does not phase out at higher incomes. In the example above, anyone with an income below $50,000 would receive a refund. People with higher incomes would pay net taxes and the proportion rises as income rises.
A negative income tax is highly unlikely to be passed anytime soon, but that is not because the system is untenable. To illustrate this, I went to the Bureau of the Census and got publicly available data on the distribution of household income in 2012. Assuming that incomes remained unchanged under this flat tax system (unlikely, since it would not penalize earning income as much), I was able to get an estimate of how much revenue the system would collect.
With a 20 percent tax rate and $10,000 tax credit per household, the total federal tax revenue that would have been generated in 2012 is $1.47 trillion. The federal government collected approximately $1.40 trillion in 2012, so this is close to revenue neutral.
How do the poor fare under this system? The total of all federal tax refunds to lower income households would have been $302 billion. By contrast, government at all levels spent around $700 billion on welfare programs in 2012 (excluding Social Security and Medicare, which are not welfare programs, though they are transfers). On the other hand, there is very little overhead in the flat tax system, at least compared to current welfare programs.
If we want to replicate the amount of tax revenue collected and also match total payments to the poor, a flat tax system with a rate of 26.33 percent and a tax credit of $17,500 would have accomplished this.
So the flat tax is not incapable of funding the government and the poor at the same levels as our current system. We are unlikely to impose a flat tax system in the foreseeable future, but if we did we would certainly have a more efficient tax and transfer system.
Now ask yourself why we don’t have a more efficient tax system and why we’re unlikely to get one.
Kerk Phillips is an associate professor of economics at Brigham Young University. His views do not necessarily represent those of BYU.