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It then goes into the flat tax solution and explains what the flat tax is and how it would treat Americans equally according to its creators (Armey and Shelby) and its advocates. How the flat tax would affect both individuals and businesses is addressed and how the tax payments would be distributed among different income levels. After explaining about the flat tax and how it will treat everyone equally, the flaws of the flat tax are exposed and the truth about the flat tax is told. The current income tax system is very complex. It is so complex; that the IRS publishes 480 tax forms then they publish another 280 forms that explains the 480 forms. “The IRS sends out eight billion pages of forms and instructions each year, which, if laid end to end, would circle the earth 28 times. Nearly 300,000 trees are cut down each year to produce the paper on which IRS forms and instructions are printed” (Armey, Shelby). The main reason the tax code is so complex is the proliferation of deductions, credits and other special preferences in the tax law. Taxpayers with similar incomes can pay vastly different amounts in taxes because of these loopholes. This uneven treatment of taxpayers is fundamentally unfair to those who do not know the loopholes and is at odds with the American value of equality under the law. “According to a study by an economist with the Congressional Research Service, the corporate income tax costs the economy more in lost production than it raises in revenue for the Treasury. Dale Jorgenson, the chairman of the Economics Department at Harvard University, found that each extra dollar the government raises through the current system costs the economy $1.39” (Armey, Shelby). A typical American family pays more in taxes then they spend on shelter, clothing, food and transportation combined. Taxes now represent a larger share of the U.S. economy than ever before. “The American people are beleaguered by the highest tax burden in American history” (Armey, Shelby). During the last few decades, the tax burden has risen dramatically on families with children. High taxes have implemented unparalleled growth in government. With the exception of Japan and the United States, the U.S. public sector now is larger than the entire economy of any country in the world. The Armey-Shelby flat tax (H.R. 1040) rejects the entire income tax code and replaces it with a flat-rate income tax that treats all Americans equally. The flat rate would not be in full effect until its third year, with a 20 percent rate for the first two years and a 17 percent rate for following years. According to the advocates, this plan would break down the tax code, promote economic opportunity, and reinstate fairness and integrity to the tax system. Individuals and businesses would pay the same rate. The only income not subject to tax would be a generous personal exemption that every American would receive. This plan eliminates all deductions and credits and there are no loopholes. It is just a simple tax system that would supposedly treat everyone equally. “The Armey-Shelby flat tax plan, the Freedom and Fairness Restoration Act, scraps the entire tax code and replaces it with a flat-rate income tax that treats every taxpayer equally. The plan would clarify the tax code, promote job and income growth, and restore fairness and integrity to the tax system” (The Doctor). The new system would be based on three principals. “1. Tax all income with no deductions except a generous allowance based on family size. Today's complex system could be replaced by two simple, postcard-size forms, one for business and one for individuals. 2. Tax all income at one rate, applying the law equally to all taxpayers. Everyone faces the same 17 percent rate, and the government would not punish or subsidize taxpayers on the basis of how they earn or spend income. 3. Tax all income just once, ending the bias against savings and investment. Capital income would be taxed on the business form to ensure compliance, and labor income would be taxed on the individual form” (Beach, Mitchell). The Armey-Shelby flat tax proposition follows each of these principles. For individuals, only the income from wages, salaries, and pensions are taxed, then generous personal and dependent exemptions are deducted. What is left after these deductions is taxed at 17 percent (after being taxed 20 percent for the first two years). For businesses, taxes are paid on income from the sale of goods or services. The business first adds up all of its income and then subtracts all of their expenses. The income that is left after these subtractions is taxed at 17 percent. “After seven decades of amendments, revisions, exceptions, loopholes, extenders, and the occasional overhaul, the current U.S. tax code is a monument to complexity. Working Americans currently spend 5.4 billion man hours learning the tax laws, finding the right forms, gathering their receipts and canceled checks, completing their returns, and dealing with IRS problems. That's more time than is spent producing every car, truck, and van manufactured in the United States. By one estimate, the needless time and paperwork costs our economy a staggering $200 billion a year”(Armey). “The current tax code isn't just confusing to the average American, it's even confusing to professional tax preparers. Last November, Money magazine asked 45 tax professionals to prepare a return for a fictional family. The results: no two came up with the same tax total and not one preparer calculated what Money magazine believed to be the correct federal income tax. Fewer than one in four came within $1,000 of that figure. What's worse is that even the people at the IRS whose job it is to provide answers to taxpayer questions don't always understand the tax code. In 1993, for example, the IRS provided confused taxpayers with 8.5 million incorrect or incomplete answers” (Armey). The flat tax replaces the current income tax code, with its maze of exemptions, loopholes, and targeted breaks, with a system so simple Americans could file their taxes on a postcard-size form. The Tax Foundation estimates that a flat tax would reduce compliance costs by 94 percent, saving taxpayers more than $100 billion in compliance costs each year. No longer will families have to maintain shoeboxes filled with receipts and canceled checks. So, the clearness of the flat tax will end for individual Americans the anguish over a system that treats them like second-class citizens. According to the advocates, the flat tax will restore fairness to the tax law by treating everyone the same. No matter how much money you earn and what kind of business you are in, you would be taxed at the same 17 percent rate as every other American. The flat tax replaces today's complicated maze of politically motivated tax breaks with a simple, honest system. There would be no tax breaks or special loopholes. “According to one study by a former chief economist for Congress' Joint Committee on Taxation, under the flat tax the economy would be 5.7 percent larger after five years than under the current system. That translates into $522 billion in higher output, or $3,000 in higher income for the typical family of four. Michael Boskin, a former chairman of the Council of Economic Advisors, estimates that the flat tax would increase the size of the economy by ten percent” (Armey, Shelby). Because of the high tax overpayment, there is room to provide tax relief. The flat tax would provide significant tax relief. When the rate is reduced to 17 percent in the third year, there would be significant further tax reduction. The bill was carefully designed to safeguard taxpayers against a return to budget deficits; however, rigid spending caps are included in the plan. Coupled with the additional economic growth the flat tax will spur, the tight spending controls will ensure that the budget reaches balance by 2002. The flat tax eliminates the marriage penalty and almost doubles the deduction for dependent children. By ending the multiple taxation of saving, the flat tax provides all Americans with the tax equivalent of an unlimited IRA. This will make it easier for families to save for more important things in their life like a home, vacation, college education for themselves or for their children or retirement. The flat tax is also pro-growth. Today, business earnings are double tax through the corporate income tax and then the tax dividends, which are after-tax payments. This double taxation of the same direction of income makes saving and investing much less attractive relative to consumption. As any businessman or economist knows, savings provide the dollars for investment in the technologies that make workers more efficient. Without investment, workers cannot enhance their productivity and their wages stagnate. Today's double taxation of income discourages saving, reduces the pool of investment dollars available to entrepreneurs and workers, slows productivity and wage growth, and lowers living standards. Because the flat tax removes the bias against work, saving, and investment, it would lead to an investment boom and higher wages. By lowering the top marginal income-tax rate from 40 percent to 17 percent, the flat tax would encourage more work, entrepreneurial effort, and risk taking. And by ending the destructive policy of double taxing savings, and by sweeping away all double taxation the estate tax, the capital gains tax, and the tax on dividends saving would increase and the capital funds would surge. “Lower Interest Rates. According to a study by an economist at the Federal Reserve Bank of Kansas City, published in the Kansas City Federal Reserve's Economic Review, the flat tax would reduce interest rates by 25 percent, or about two percentage points. Interest rates under the flat tax will not only reduce the costs of student, car and credit card loans; they will also offset the loss of the home mortgage interest deduction. According to reports by the Congressional Research Service and the Tax Foundation, the flat tax will have no meaningful effect on home values” (Armey, Shelby). “Individuals pay 17 percent of all wages, salaries, and pensions, after subtracting allowances. In 2001, when fully phased in, the family allowances will be $12,200 for a single person, $24,400 for a married couple filing jointly and $5,500 for each dependent child. These allowances are indexed to inflation. The flat tax replaces the current income tax system, but does not affect the Social Security and Medicare payroll taxes. Social Security benefits would not be taxed” (Armey, Shelby). All business income, whatever the source may be corporate, partnership, sole proprietor, professional, farm, rental profits and royalties, is taxed at one low rate. If there is a positive difference between revenues and expenses businesses pay 17 percent of the difference. Collecting business income earned by individuals at the business allows for a simple, airtight system that ensures all income in the economy is taxed. “According to Joseph Stiglitz, President Clinton's former chairman of the Council of Economic Advisors, it is more efficient to collect business income at its source. He writes, "The uniformity of [flat] marginal rates...means that income can be taxed at its source; taxing income at its source will reduce compliance costs and increase compliance rates"” (Armey, Shelby). Taxing business income at the business level does not mean that investment income escapes taxation. As a New York Times editorial points out, "Corporations would pay tax on capital income--dividends and interest--eliminating the need for individuals to keep track of these payments" (Armey). The most impressive feature of this flat tax distribution table (shown below) is how much taxes are reduced for extremely low and extremely high incomes. At the low end, millions of households see their tax payments disappear as a result of the philanthropic family deduction. Precisely, about 24 million families who pay federal income taxes now will pay no federal income taxes under the adequately implemented Armey-Shelby flat tax. Taxpayers at the high end of the income scale also see an abundant reduction in income taxes. These tax cuts result from two factors one being the lower tax rate, which is a drop from an average effective rate of 33 percent to about 17 percent and the other is an end to the practice of double taxation of passive income. At first glance, the flat tax, may appear to possess an attractive simplicity, that of a single rate and the elimination of all deductions. Less discussed is that it also eliminates from taxation unconsumed capital income-dividends, interest and capital gains. “The notion of a flat tax does have a certain simplistic, egalitarian appeal. But it has three main flaws: 1) It seeks to improve something that is already completely equal; 2) It forces middle-class taxpayers to subsidize the wealthy (especially those incarnations such as Forbes' that exempt "unearned" income such as the interest on his invested inheritance, so that people who actually worked for what little they got would support rich people who simply inherited great wealth); and, 3) It confuses much-needed tax reform and tax simplification in defining taxable income with the unrelated issue of whether the rate applied to that income is flat or graduated. Anyone who wants to support a flat tax better run the numbers first and see how much more they're going to pay” (Dunn). With moderate exemptions for low income persons, the rate would have to be raised for middle income taxpayers to make up for the drastic reductions in rates on high incomes and the elimination from the tax base of capital income that is largely received by affluent taxpayers. It is difficult to argue that a flat tax would be fair or that it would contribute significantly to savings or growth. The notion that a flat tax would achieve complete simplicity by eliminating deductions is also questionable. “First of all many items now excluded from income would have to be valued and taxed-health insurance provided by employers and other fringe benefits for example. And in fact any discussion of a flat tax rapidly begins to include exceptions by way of deductions-such as home mortgage interest and gifts to charity-and the single rate necessarily rises, contributing both to complexity and shift of tax burden to the middle class. As Deputy Secretary Summers often says, by the time you figure in all these exceptions, you would need an electron microscope to read the postcard that it is claimed would suffice for a tax return” (Lubick). The flat tax initially would raise taxes on the middle class by 20 percent. On average, a family with between $40,000 and $50,000 in adjusted gross income would see their taxes rise about $700 to about $7,500. The flat tax also appears to have a major fairness problem. For example consider two families. The Jones have a combined salary of $50,000 in wages. Under the flat tax, a 20 percent rate would cost this family $3,700. Now consider the Smiths, who in retirement consume every dollar of their $1 million in dividend income. Under the flat tax, the Smiths owe no tax at all because capital income is excluded from the tax base. Their dividend income was taxed already at the business level before they received it, so they owe no taxes on it. But the perception would persist that a high-income family would pay no tax. Will tax fairness be defined so that individuals consuming significant amounts of capital income would pay little or no tax? The historical evidence is conclusive; when taxes were cut in the 1980s, the effects hoped for by proponents did not materialize. Instead, deficits soared. Now, when the budget is finally balanced, is not the time to jeopardize the progress that has been made. At first glance the flat tax proposal looks very intriguing. The proposal talks about how every income level would be treated the same by setting a standard 17 percent income tax. However, the flat tax does not treat everyone equally. This tax clearly favors the wealthy, since most of their earnings are not working wages, which would be taxed but they are inheritances or dividends. The flat tax also helps out the low-income families by making them pay very little in taxes because of the personal exemptions. Then there is the middle-class that suffers from this tax. Their taxes would not be lowered if anything they would be raised. A tax reform is very much needed to replace the complexity of the current tax system, but it should be one that does treat everyone equal and built on the aspects of our current tax system that are fair and reform the areas that need change. There is no tax system that is perfect and no tax reform proposal that is without flaws. The flat tax may work if the flaws were worked out and the tax did treat everyone equal, but until then the current tax system seems to be a better choice. Bibliography: Works Cited Armey, Dick. “Flat Tax – Not Just a Distant Dream.” WWW.Flattax.gov. Http://Flattax.house.gov/armey/article/insight.asp Armey, Dick and Shelby, Richard. “A Comprehensive Plan to Shrink the Government and Grow the Economy.” The Freedom and Fairness Restoration Act. March 9, 1999. Http://flattax.house.gov/proposal/flat-sum.asp Beach, William W. and Mitchell, Daniel J. “How the Armey-Shelby Flat Tax Would Affect the Middle Class.” The Heritage Foundation. F.Y.I. No. 90. March 12, 1996. http://flattax.house.gov/others/heritage/fyi90.asp The Doctor Is In – Flat Tax. http://freedom.house.gov/survival/flattax.asp Dunn, Douglas. “Flat Tax Fiasco.” Word Wizards communications. 2001. http://www.wordwiz72.com/flattax.html Lubick, Donald. Treasury News From the office of public affairs. February 5, 1998. http://www.ustreas.gov/press/releases/pr2201.htm Schaefer, Rebecca S. “ Straight Talk about the Flat Tax.” WWW.Flattax.gov. Http://Flattax.house.gov/others/cse/stratlk.asp Word Count: 2902
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