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Only two things are sure in life

By Dashiell Mace
web posted September 27, 2010

Taxes, everyone pays them.  When you buy a consumer good, you pay sales tax.  If you own property, you will find that property is subject to a tax, but of all the taxes, there is one that is feared over the rest, income tax.  This tax is a pain, financially and mentally.  We have all seen our parents work over these mind bending and hopelessly complicated forms, or they pay an accountant to fill out the forms for them.  Of course, then you are paying someone to tell you how much you have to pay the government.  There is also the ever-present fear of an I.R.S. audit if the forms are filled out incorrectly or if you forget where the decimal point goes.  Wouldn't it be great if there was a better system, a system that could replace the frustration and the complication with a tax that does just what it says it will do, tax income?   Back in 1962 the great economist Milton Friedman wrote the book Capitalism and Freedom.  This book was filled with innovative and revolutionary ideas that changed the way we view economics.  One of the ideas he posed was the idea of a flat income tax.  A flat income tax is an income tax that removes all the jargon, complicated forms, and guess work out of calculating taxes.  It simply taxes your yearly income, multiplies it by a decimal percentage, and then that's how much the government takes.  While this system is obviously much simpler, does that mean it's more effective?

In order to make things easier to understand, we will refer to the current system of income taxation as graduated taxation.  The greatest problem with graduated income tax isn't its complexity, but how it is used by the government to redistribute wealth.  In the words of Milton Friedman, "I find it hard…to see any justification for graduated taxation solely to redistribute income (he stated earlier in the chapter that the graduated income tax is solely used to redistribute income).  This seems a clear case of using coercion to take from some in order to give to others and thus to conflict head-on with individual freedom."  The reason he says this is because the money that the government taxes is primarily used to fund such economic redistribution efforts as social security or welfare.  The other problem with a graduated income tax is that there are a number of ways to trick the government.  We have all heard of politicians who have been arrested because of tax evasion.  There are loop holes, tricks, and different ways to get around this needlessly complex, and ineffective graduated income tax.  A graduated income tax taxes people in their attempt to become wealthy.  Those who are extremely wealthy (and thus subject to the largest tax) are usually the ones who use their wealth to find ways to evade the tax.  This means that those who are poor are not taxed, and the rich have found ways to avoid the tax, so most of the tax is paid by the middle class, those who are trying to become wealthy.  Therefore, the graduated income tax is a tax which takes money away from those who are seeking to acquire wealth and then gives that money to the poor, in a clear case of redistributing income and the government trampling on individual rights, just like Milton Friedman said.

Okay, we now see that a graduated income tax is not the best idea, but is a flat tax any better?  Well, let's see what Milton Friedman has to say:

"A flat (tax) rate of 23.5 per cent on taxable income… would yield a higher revenue because a larger amount of taxable income would be reported for three reasons: There would be less incentive than now to adopt legal but costly schemes that reduce the amount of taxable reported income, so called tax avoidance; there would be less incentive than now to fail to report income that legally should be reported, tax evasion; the removal of the disincentive effects of the present structure of rates (referring to a graduated income tax that would increase how much you had to pay if you moved up to a higher income bracket, which gives you a disincentive to rise to a higher income bracket) would produce a more efficient use of resources and a higher income." 

Therefore, a flat income tax would increase revenue, remove the disincentive to gain wealth created by a graduated tax, create less of an incentive to break the law through tax evasion, and reduces the severity of the redistribution of wealth (which would help preserve individual rights).  Because of all these reasons, a flat income tax, as proposed by Milton Friedman is a better choice than the graduated income tax.

When dealing with a flat income tax there is one final question that must be hurdled, what about the poor?  What about the people who can't afford to pay 23.5 per cent of their pay check?  In a graduated income tax there are also tax rebates for the poor.  If we remove the graduated income tax, how will the poor be able to survive?  Many of them need this rebate to survive, and with a flat income tax we won't be able to offer a tax rebate.  In his book Milton Friedman was able to kill three birds with one stone.  He presented the idea for a flat income tax, he devised a way to help the poor through the flat income tax, and he created a system that would remove all welfare and social security through the income tax.  This innovative income tax is called the negative income tax.  The government would set a minimum income for a family of four, let's say 15,000 dollars.  If you make 40,000 dollars in a year you would receive a tax of 23.5 percent (or whatever percent is decided on by the government) on the amount of money you are over the minimum income, so in this case, 25,000 dollars.  What if you only made 10,000 dollars that year?  This is where the negative tax comes in to play.  The family of four would receive 15,000 dollars minus 10,000 dollars divided by two.  Therefore, the government would give the family 2,500 dollars.  The fact that the money is divided by two gives the family an incentive to work instead of simply receiving money from the government, but the money would also help those who are out of work or elderly.

Therefore, this negative income tax would not remove incentives to get a job, would help poor families, and would actually be able to replace the current system of welfare and social security.  This means government spending would actually go down.  Milton Friedman said this about the negative income tax in the book Capitalism and Freedom, "The advantages of this arrangement are clear.  It is directed specifically at the problem of poverty.  It gives help in the form most useful to the individual, namely, cash…  Like any other measures to alleviate poverty, it reduces the incentives of those helped to help themselves, but it does not eliminate that incentive entirely, as (a system where the government makes sure everyone has at least a minimum income) would.  An extra dollar earned always means more money available for expenditure…  A few brief calculations suggest also that this proposal could be far less costly in money (then our current system), let alone in the degree of government intervention involved."  Therefore, the system of negative income tax is helpful because it would allow the institution of a flat income tax, help the poor, save money (by replacing social security and welfare), lower the government intervention in the economy, target the cause of poverty (a lack of money), and it wouldn't lower the incentive for people to work and earn a living.

You would think that a flat income tax would have been implemented by now, but sadly it hasn't been.  However, that doesn't mean that a flat income tax, a negative income tax, and Friedman's idea of putting them together, hasn't had any impact.  Steve Forbes (president, publisher, and editor-in-chief of Forbes magazine) attempted to run for president twice under the Republican nomination.  He ran his campaign under one main idea, the institution of a flat income tax.  He even included the idea that only income over a certain level would be taxed, but he didn't include the idea of a negative tax.  While he didn't receive the nomination, he won the Delaware and Arizona primaries in 1996 and won a large amount of votes in other states.  This shows that the American public is accepting of the idea of a flat income tax. 

Another idea that is quite similar to the flat tax is the fair tax.  However, the fair tax is unlike the flat tax in that it is a tax on consumption, not on income.  It would be like an advanced kind of sales tax, where the government removes income tax, but raises the sales tax to approximately 25 percent.  This idea would be coupled with monthly tax rebates that cover purchases up to the poverty line.  While this tax might have some downsides (such as how it could lower consumption because people don't want to be taxed) it would increase the tax base to all purchasers, and would use the tax receipts from the previous fiscal year to calculate the tax rates for the next year, effectively making the system self correcting.  That means if the tax rate needs to be changed (and it definitely should be depending on what situations arise) Congress doesn't have to pass legislation and mathematicians don't have to spend months figuring out what the new tax rate will be, a computer program will effortlessly figure out what tax will be the most useful, and it can be put into effect.   While there is still much to learn about fair tax, it seems, at least at first glance, to be much more effective than our current system.  The monthly rebates (which would replace social security and welfare, just like the negative income tax), the ease of changing the rate of taxation, and the fact it can be collected easily make it a very effective tax.  While normal flat income tax is still superior (with a flat income tax you don't risk lowering consumer spending, which would slow down an already weakened economy) the fair tax seems to be one of the better systems of taxation that has been presented in the last few years, and it seems to have some close connections to the ideas presented by Milton Friedman 40 years earlier.  Tea party protesters and Mike Huckabee have both supported fair tax, which seems to indicate a large amount of public support for the fair tax.

Many of the economic problems that we face today are very similar to the problems we have been facing for over 250 years.  There has always been a large amount of controversy about taxes in our society.  We have had wars fought over them, presidents have been elected (or not) because of them, and every time we make a purchase we are confronted with the grim face of these taxes.  Income tax has always been controversial.  The complicated taxes have never been popular, but Milton Friedman showed way back in 1962 that a flat income tax would be a more efficient use of government intervention.  Many times this tax policy has been considered and debated by congress.  These taxes would raise the same amount of money, be less complicated, not remove the incentive to earn as much money as possible, and, with the institution of a negative income tax, replace welfare and social security with a more effective system of incentives and support.  With all these advantages it is easy to see how this would be a great economic policy.  Milton Friedman, in his formation of this theory, cemented his place as a great economist.  I whole heartedly agree with Milton Friedman's economic policy of a flat income tax supplemented with a negative income tax.  This is a theory that has, and continues to, shape tax policy to this day.  Imagine a world without graduated income tax where, instead of having to do a million calculations to find your tax bill, you can find out how much you owe by pushing 10 buttons on a calculator.  Will this theory ever become the American tax policy?  Only time will tell. ESR

Dashiell Mace is an AP high school student. This is his first contribution to Enter Stage Right. (C) 2010 Dashiell Mace.

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