In 2007, according to Census Bureau data collected from IRS-aggregated Form 1040 filings, we Americans earned $17.8 trillion dollars from all sources: wages and salaries, interest payments, dividends and capital gains, gambling earnings, pass-throughs from their small businesses, and so on. In 2007, according to Government Accounting Office data, we paid an aggregate of $1.15 trillion dollars in taxes on that income. That’s an aggregate rate of around 6.5%, with the top 10% of taxpayers paying 70% of that bill (compare that with the roughly 20% paid by Republican Presidential Candidate Mitt Romney over the last 20 years, and the roughly 20% paid by Democratic Presidential Candidate Barack Obama last year).
That’s a ton of money for the government, paid by those who actually pay taxes (50% of Americans pay taxes in the range of 0%-3%).
What would happen, though, to revenues if we moved to a flat tax of 10% with no deductions, credits, or other loopholes, and everybody pays? One immediate result is that the government would collect $1.78 trillion in income tax revenue—a one-third increase. Think about what that would mean toward paying down our $16 trillion debt.
Such a static analysis is interesting but unsatisfying since it doesn’t consider the dynamics of an economy. Let’s look at the impact on a hypothetical family of four, making (to keep the arithmetic sort of simple—we’re dealing with the tax system, after all) $100,000 per year, and taking a currently normal set of deductions: married filing jointly, exemptions for dependents (four, in this case), and they donate $5,000 to charity (this is a bit high for a conservative family, and quite a bit high for a liberal family, but we’re keeping the numbers round). Let’s also say they own a $200,000 house and they’re four years into a 30 year mortgage at 3.5% (a roughly current market rate in the middle of the range of rates Bankrate.com says can be found for the Dallas area in a quick search last Sunday). We’ll also say they’re healthy, and their other deductions don’t meet the 7% or 2% thresholds.
Their deducitons, then add up this way. Their annual mortgage interest deduction is in the neighborhood of $6600 dollars. Four dependents at $3,700 per gives them a total exemption of $14,800. Add their charity giving, and all of these together reduce the family’s income to a taxable amount of $73,600. The 2011 IRS tax tables put this family’s tax bite at $10,656.
Now take away all those deductions, and bill the family on the top-line (now bottom line, also) $100k at 10%, and they see a drop in their taxes of $656. That’s a fair amount of beer and pizza. Or a mortgage payment.
Some might argue that such a no-frills tax system hurts the poor (now they’re payers of taxes, instead of receivers). Accordingly, what happens when we allow a single exemption: half the then-year Federal Poverty Guideline. For our family of four, this would be half of $22,350 for 2011, or $11,175. Now the 10% tax bite is reduced to $8,882—a reduction relative to our proposed system of $1,118 and of $1,774 relative to the current tax system. Add pretzels to the beer and pizza. Or another mortgage payment—every year. Or car payments—every year.
How does this scale to the national level? Again, only looking at the back of our envelope, and saying that our 2011 non-retired population consists entirely of families of four, that makes 68,000,000 filings taking that $11,175 exemption: a $760 billion reduction in the government’s tax collection relative to the simple flat tax collection, and a $120 billion reduction compared to last year’s collections and a $544 billion reduction compared to 2007’s actual collections.
Looks like a disaster. But we’re still in the static analysis stage. Think about the stimulative effect of those additional $1,774 available for private use, instead of government “investment.” For those 68,000,000 families of four, that’s those $120 billion left in private hands.
All that money represents additional spending and saving and paying down personal debt (faster, we already are to a certain degree) represents an active, dynamic economy, with all the revenue that will generate in increasing employment (more folks earning income, and so paying taxes), increasing business activity—which feeds investment and hiring—and so on.
The government likes to say that each $1 in its “investment” returns a $1.5 to the economy as that spent dollar circulates and gets spent again and again, multiple times, before it’s fully absorbed. That compares with each $1 of spending in the private economy returning $1.7, but let’s use the government’s own figure. Those $120 billion left in private hands through the lower tax rate will return $180 billion, just in the first year. And it will grow in subsequent years as economic activity continues to increase from this freeing of us from our present, heavier tax burden. The revenue “deficit” disappears in very short order.
Nor will I get into the premise that tax reform needs to be revenue neutral at all; nor will I get into the fallacious premise that the government is somehow entitled to our money; nor will I get into the need for government to cut spending—this is a tax reform proposal.
The higher total tax revenue I mentioned at the outset? That results from the far broader base of folks who actually pay taxes under this proposal and so who now have positive reason to be active participants in our political process.
I will ask a question, though, since the idea of losing all those deductions and credits will itself be questioned. What’s the value of those deductions and credits when their sole purpose is to reduce the tax bite from tax rates that are artificially elevated to begin with in order, in part, to recover the “cost” of those deductions?
There’s another aspect to this, also, and that’s the idea of business taxes. American businesses “pay” taxes, nominally, at a rates as high as 35%, the highest rate in the known world. Leaving aside examples like GE, which paid no net taxes on revenue of around $148 billion in 2010 (a result of our corporate tax system being as Byzantine as our personal income tax system), our businesses paid in the aggregate some $370 billion in Federal income taxes in 2007 (to keep the year of interest consistent).
I used quotes on “pay” taxes on purpose, though. Even though the business’ officer signs the tax check, the business isn’t paying a penny of those taxes. From the business’ perspective, the tax bill is just another cost of doing business, and that cost is passed on to its customers in the form of prices that are elevated to cover that cost, just as the price is set to cover all the other costs that a business encounters. The customers—you and me at the end of a chain of intermediaries and stores—are the ones who are paying that tax through that elevated price.
My tax reform proposal, then, includes this: eliminate the business income tax altogether. Reduce our tax bite even further, in the form of reduced prices.
What’s the outcome of this loss of $370 billion in revenue to the government? First, see the multiplier discussion above. Then, consider our neighbor to the north; Canada’s example offers an answer. The chart just below, from the Cato Institute’s “Corporate Tax Competitiveness Rankings for 2012,” shows the effect on the Canadian GDP over the years since 2000 that the Canadians have been drastically reducing their corporate tax burden.
The effect has been nil: corporate revenues as a per cent of GDP have been stable over the entire period of steady reductions.
The chart below shows Canada’s GDP growth in real terms since 1999; I constructed it from these data.
Plainly, drastically reducing (eliminating in my case) the corporate tax bill has no material effect on GDP. Not only did the rapidly falling tax bite not impact the Canadian government’s corporate tax revenues as a per cent of Canadian GDP, that reduction had no negative effect on the GDP itself.
It’ll be the same in the US, with the single difference that Federal tax revenue as a per cent of US GDP will drop, some, from the elimination of Federal business income taxes. The per cent of GDP won’t go to zero, though, because I’m only talking about the Federal tax burden; states will remain free to tax—in competition with their fellow states—their domiciled businesses.