Previous posts have mentioned the so-called "FairTax", a national retail sales tax plan advocated by former Arkansas Governor Mike Huckabee.  As I detailed, advocates of the "FairTax" have made extraordinary claims about the benefits of replacing the income tax system with a single-rate sales tax, and they regularly accuse critics of the system of advocating the status quo.

Our current system is impossibly complicated, complex, inefficient, and punitive.  Politicians use the tax code to attempt to incentivize people to adhere to their wishes and act in ways meant to decrease their tax liability rather than choosing the actions most advantageous for individuals and families.  The current tax code even promotes higher state and local taxes, forcing people in low-tax states to subsidize taxes in high tax states (state taxes are deductible from the federal taxable income).

There is another way.  In 1996 and 2000, Steve Forbes ran campaigns for the presidency largely centered around one main idea:  replacing the current income tax system with a "flat tax" system.  The flat tax involved having one income tax rate of 17%, replacing all itemization with a standard deduction and a standard exemption.  Everyone would be able to fill out his or her respective tax return on basically a postcard, everyone would get the same exemption and deduction (so no itemization would be required), and everyone would be paying the same rate of taxation.  Likewise, businesses would pay the same rate as well, with no depreciation schedules or other complexities; rather, businesses would take income and deduct expenses, paying 17% on the difference.  Because investments are made with income that has already been taxed, investment and interest income would not be taxed — thus, no taxes on dividends, interest, or capital gains from the sale of stocks, bonds, or homes.

The flat tax would be fair, in that a person making ten times the income of another would pay basically ten times the income tax (actually, more than that because of the exemptions and deductions).  The deductions and exemptions would be generous, meaning that the "first fruits" of a person's labor belong to him, not the government, and thus taking away any charges of cutting taxes for "the rich" on the "backs" of "the poor"; under Forbes's flat tax plan, a family of four would have gotten something like $45,000 of exemptions before the 17% tax kicked in.  Because of the simplicity of calculating a tax bill, families would no longer need to pay someone to assist them; nor would families need to keep boxes of receipts and live in fear of an audit.

Under a flat tax plan, businesses would have more incentive to make capital improvements, as capital would no longer be depreciated over several years, but rather would be on the books as soon as it was spent as a business expense.  This would also reduce the need for accountants to calculate the depreciations and to ensure tax compliance.

Several nations have implemented flat tax plans in the past few years, led by Estonia in 1994.  Hong Kong implemented a flat tax system in the 1940s.  The results have been an overwhelming success, ironically occurring mostly in formerly Communist countries.  Because the rate is low, there is little incentive to cheat the system; because compliance is simple, less money is spent filling out forms and calculating rates; because savings and investment aren't double- and triple-taxed, economic growth is robust.  A dollar of consumption is taxed once and only once (and yes, the flat tax, while levied on income, is actually a consumption tax; it takes a bit of algebra to understand it, but if you balance the equation on what is taxed on the business and personal level, noting that savings and investment aren't taxed, it is consumption that is ultimately taxed), so the system is efficient and fair.

I had the opportunity this summer to speak with a cabinet minister from Hungary, which has implemented a flat tax.  The result in his country was not only robust economic growth but a huge increase in tax revenues.  Paradoxically, cutting tax rates often causes tax revenues to rise rather than fall; the reason is two-fold.  First of all, lower tax rates spur economic growth, and greater economic growth results in greater tax revenue.  Secondly, a lower tax rate means there's less incentive to take a risk on cheating, as mentioned above.  In an economy growing at a faster rate, consumption is increasing; a consumption tax captures that.

One other seemingly paradoxical result comes from cutting marginal tax rates:  even though the tax rate they pay goes down, the overall share of total taxation paid by the very rich tends to increase rather than decrease.  This was seen, for example, following the tax rate reductions implemented by President Kennedy (the top rate was lowered from 90% to 70%), by President Reagan (the top rate was lowered from 70% to 50%, and later from 50% to 28% by the bipartisan Tax Reform Act of 1986), and by President Bush (the top rate was lowered from 39.6% to 35%).  The same phenomenon has been observed in flat tax nations, dispelling fears of benefiting "the rich" at the expense of the middle class or the poor.

For decades, dissidents in the Soviet bloc nations of eastern Europe looked to the United States as a shining example of economic freedom and individual liberty.  Today, America should look towards nations like Romania and Slovakia for an example of how to unshackle our economy and institute a fairer, more efficient, less intrusive tax system.  The flat tax is the way to go.