Rand Paul has proposed a flat 14.5 percent tax on personal and business income (somewhat sadly for Democracy, he chose to publish his proposal in a subscription-only article in the Wall Street Journal). Except that it isn’t truly a flat tax because he is preserving subsidies to realtors and home builders:
I devised a 21st-century tax code that would establish a 14.5% flat-rate tax applied equally to all personal income, including wages, salaries, dividends, capital gains, rents and interest. All deductions except for a mortgage and charities would be eliminated. The first $50,000 of income for a family of four would not be taxed. For low-income working families, the plan would retain the earned-income tax credit.
He adopts one of my pet ideas (see 2008 economic recovery plan): “All capital purchases would be immediately expensed, ending complicated depreciation schedules.” (I actually proposed more flexibility than this.)
Rand Paul’s idea would seem to fit Singapore very nicely. This page says “Government expenditures are equivalent to 14.4 percent of the domestic economy.” But how could it possibly work in the U.S., especially considering that Paul proposes to eliminate payroll taxes (currently themselves close to 14 percent)? Government spending is roughly 40 percent of GDP (chart). Only about half of the total is spent by the federal government, however, so in theory Rand Paul’s idea isn’t as crazy as comparing 40 percent and 14.5 percent. But comparing 20 percent and 14.5 percent still leaves a deficit of roughly 5.5 percent of GDP, no? Or even larger if you consider that Paul is preserving subsidies for housing and exempting lower-income Americans. This chart shows that the federal deficit is not typically as high as 5.5 percent.
Currently the federal government collects about $3 trillion per year in revenue (Treasury) and spends $3.5 trillion (Wikipedia), resulting in a deficit that is 3 percent of GDP ($16.77 trillion). If all of GDP were taxed at 14.5 percent there would be only $2.43 trillion in revenue. It would take a flat tax of at least 18 percent, with no housing subsidies built in and no exclusions for people earning less than $50,000 per year, to yield the current level of revenue. A tax of 21 percent would be required to collect as much in taxes as the federal government currently spends (and spending is forecast to rise from Social Security and Medicare for the elderly plus various kinds of welfare for Americans whose labor is not worth the new, higher minimum wages (see The Redistribution Recession)).
[The Feds do get some revenue from excise taxes, e.g., on alcohol, tobacco, aviation fuel, etc., (pie chart) but I don’t think these are large enough to change the analysis. These boosts have to be balanced by reductions due to fraud. Here’s an LA Times article on how Americans created 7 million fictitious children for tax purposes. Also see “History of Divorce” in which Americans in the aggregate claim to be paying more alimony than they admit to receiving.]
How could Rand Paul’s idea possibly work?
Related:
- Steve Forbes’s 2014 proposal for a 17 percent flat tax (closer to the 18 percent number that would be revenue-neutral)
- Wikipedia on the flat tax (Hong Kong has an interesting “alternative maximum tax” of 16 percent of gross income)
I believe the way it is intended to work (emphasis on intended) is that by dramatically revamping and simplifying the tax code, we would stimulate the economy and re-accelerate growth, thereby growing tax revenue.
Obviously if government spending is fixed at c. 20% of GDP, the gap wouldn’t close. But if the economy grows faster than federal government spending, and taxes are a fixed percentage of GDP, the gap can be narrowed and eventually eliminated.
Personally, I believe that a simplified flat tax would stimulate economic growth, probably more so than skeptics believe. I am, however, skeptical that government spending wouldn’t grow equally as fast.
Justin: Rand Paul himself uses a Tax Foundation estimate of just 10% in GDP growth over a 10-year period resulting from a low/flat tax rate. So if the Tax Foundation can be accepted as a prophet then this bump to GDP won’t fix the arithmetic.
[Anecdotally I would tend to agree with you, and disagree with the Tax Foundation. Given the huge amount of time and money that is wasted currently on tax avoidance I think that the taxable GDP at any rate would be boosted by much more than 10% in 10 years. Just imagine if Apple stopped piping all of its money through its various European shell companies.]
We already have a de facto flat tax, the alternative minimum tax. The government seems to think that the AMT rate (26-28% for income above the exemption) is the least a taxpayer should contribute. So I agree with Philip, 14.5% does not seem to make sense.
I really like the idea of a flat tax along with some further cuts to spending. Anytime anyone wants to read an article on WSJ behind the paywall, just go to Google News and search for the author, the topic, and WSJ and it will let you read the article. I’ve been doing it that way for years.
It’s not just an income ta. It’s a VAT.
http://www.nytimes.com/2015/06/19/upshot/rand-paul-and-the-vat-that-dare-not-speak-its-name.html?_r=0&abt=0002&abg=1
Aren’t you confusing stocks with flows )? That 14.5% is applied to a dollar each time it is transferred to buy something from someone else, as happens for a given dollar many times throughout the year.
Also if $1 is spent by someone and received by someone else, that counts as $2 of GDP activity (if its loaned to the first person its $3 total GDP!).
Having lived under the Hong Kong tax rates, I’d have to say that I’d hate to be taxed anywhere else. Calculating tax is trivial and the taxes are not onerous.
The government here often has a problem of “too much” tax money and often tries to give some of it back.
Reducing tax rates in the US would almost certainly result in increased tax revenue. The problem is the government would immediately start spending more.
Isn’t a substantial portion of government spending paying wages to citizens, a portion of which would then be recouped as taxes? So, your 20% vs 14.5% example would work out to be closer to 16-17% if you figure the gov will be getting back 14.5% of some portion of that 20%.