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Tom Ferris is a Consultant Economist specialising in Better Regulation.
He was formerly the Department of Transport’s Senior Economist.

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The upcoming elections in Ireland and in the USA and have raised the question of a flat tax. In Ireland, the Renua Party propose to introduce a flat rate of income tax at 23%. In the USA, the Republican presidential candidate Dr Ben Carson has announced that if elected, he would tax individuals and corporations at 14.9% and would eliminate tax deductions and loopholes. This post is not concerned with the politics of these proposals; rather, it is concerned with some of the economic and social implications of introducing a flat tax.

Why a Flat Tax?

A flat tax applies the same tax rate to all taxpayers, with no deductions or exemptions allowed. Its simplicity is considered its most significant benefit. A single tax rate makes for easy computation by the Revenue Commissioners and straightforward payments from taxpayers. Because the flat tax taxes only one income, it is easier to understand and to report. Taxpayers save the financial cost of complying with the current complicated tax rules, which often necessitate the involvement of lawyers and accountants and take up a lot of time.

The flat tax is attractive because it eliminates “double taxation”. If implemented in its purest form, it removes inheritance tax, capital gains tax and double taxation of savings and dividends. Families and individuals are not required to report dividends, interest or other business-related income; this income is taxed at the business level. The flat tax makes it unnecessary to pay interest, dividends and other business taxes at the individual levels.

Those in favour of a flat tax argue that it spreads the tax burden across all earners, which means that more people pay for the benefits of government that they receive. Those against a flat tax argue that the flat tax system penalises the low-income segment of the population. Low-income individuals and families must spend money on the same necessities required by higher-income people. However, after necessities are purchased, the poorer taxpayers, because they earn less, will have less money left over to pay taxes at the same rate as those earning higher income amounts. While poorer people might pay the same proportion of tax, the impact of a flat tax would be iniquitous, in that poorer people would have less disposable income than richer people. Dr Ben Carson recognises this dilemma and plans the following adjustment

“…to help lower income families, taxpayers will only pay the flat tax for income earned above 150 percent of the Federal Poverty Level. For example, a family of four will pay a 14.9 percent tax on income above $36,375. Families that do not earn more than the allowance amount will be asked to make a de minimis payment, ensuring that every taxpayer becomes a citizen-owner of his government”.i

In the same vein, to ensure a basic income, the Renua Party’s Manifesto proposes that

“Those earning up to €70,000 per annum will receive a pro rata (graduated) basic income payment of up to €3,600 per person in the household. The payment will decrease gradually as household income increases”.ii

 

The experience of Slovakia

What has been the experience of economies that have had flat taxes? The OECD recently produced an interesting report on the experience of one country:  Slovakia. The report is entitled “Moving Beyond the Flat Tax – Tax Policy Reform in the Slovak Republic”. In the context of its accession to the European Union (EU), the Slovak Republic adopted a fundamental tax reform in 2004 which introduced, among other changes, a single rate of 19% for personal income tax, corporate income tax and value added tax.  The OECD report records positive results, at first, but then points out the negative consequences. Here is the full quotation from the OECD report:

“The reform succeeded in making the tax system simpler and in enhancing economic efficiency. In addition, the introduction of the flat tax contributed to preserving the attractiveness of the Slovak Republic as a business location for domestic and foreign investors. However, the tax system continued to suffer from a number of weaknesses. Because SSCs  overflow visible social security contributions remained high, the overall tax burden on labour remained substantial. The tax wedge for low-income workers was particularly burdensome in light of the low skills of a large part of the labour force. The presence of high SSCs [social security contributions] means that there continued to be gains from income shifting between capital and labour income. In addition, various elements of the 2004 reform tended to change disposable income in favour of more affluent households including the move to a single PIT rate and the shift from direct to indirect taxation”.

In the light of a decade of experience, the Slovak Republic introduced a series of reforms to the taxation system in 2013. These reforms included the introduction of a second personal income tax bracket and rate to increase the progressivity of the personal income tax system as well as an increase in the statutory corporate income tax rate to raise additional tax revenues. More recently, the Slovak Republic introduced measures to counter VAT fraud, a minimum corporate income tax as well as a targeted social security contribution exemption for the long-term unemployed.

 

Some Responses from Irish Economists

What have the responses by economists been to the proposal to introduce a flat tax in Ireland? So far the responses have been mainly negative. Here are three sets of comments.  First, Cormac Staunton, Senior Policy Analyst at TASC; he concludes that

“A flat tax, even with some progressive elements, will lead to an increase in the tax paid by the bottom 1/3rd (who currently earn less than a living wage), with reduction in overall revenue for public services. The fact that this will be financed by significant tax cut for high earners means that inequality will dramatically increase”.iv

Second, Professor Karl Whelan, Head of the School of Economics in University College Dublin, produced some interesting flat tax calculations for Ireland as a prelude to his comments. He concluded that

“…it is possible to have flat tax rate that is a lot lower than the current top marginal rate without having a significant increase in inequality.  A system of this sort would likely have some positive effects in reducing tax evasion and could have some the positive supply-side effects described by RENUA. However, the idea that we can have a headline tax rate of 23% without greatly raising inequality does not hold water”.v

A third view is provided by Dr Stephen Kinsella of University of Limerick. He puts his conclusion in very stark terms

“A 23% policy would be harmful to the poorest in the current set-up, with the winners here being those at the top of the income distribution”.vi

A lot more research needed

Here in Ireland, the potential political, economic and social outcomes of a flat rate will continue to be the subject of academic and political debate. Promoting it is easy. In reality, it would be much more difficult to deliver such a comprehensive overhaul of the taxation system to incorporate a flat tax. Should we expect the setting-up of a dedicated commission, in the style of previous Commission on Taxation to address this issue?

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