MARCH 15, 2007


The deceptive appeal of a flat tax

It sure would simplify the tax code, but
would it be fair?

Tax time looms and the annual frantic search for documents to justify deductions is on. Executives at financial institutions are in their counting houses counting all the money they've received from RRSP contributions. Physicians huddle with their accountants to ponder the benefits and complications of incorporation with a single question on their lips: Will it save taxes?

Perhaps it's time to say goodbye to all that. Perhaps the time has come to dump our present progressive tax system entirely in favour of a flat tax.

What's that, you ask? A true flat tax would apply the same tax rate to all forms of income regardless of how that income was earned. Suppose, for example, the tax rate was 20%. Companies would pay 20% on their profits; wage earners would pay 20% on their pay packet; the rate on interest, dividends, capital gains and all other forms of income would likewise be taxed at 20%.

One of the reasons the flat tax is again being discussed in economic circles is that many countries in what was the East Bloc have adopted a flat tax, including Russia, and it appears to have given a boost to their economies. Whether it actually has or not is a matter of debate. Lithuania, for example, with a flat tax of 27% (down from 33%) has a rising standard of living and low unemployment. That said, the average monthly salary is about $600 Canadian, and the Ministry of Labour says that 360,000 workers have left the country for Western Europe since 2004, actually causing labour shortages. Estonia has had a flat tax, currently at 26%, since 1994 and is also doing well, but it's unclear whether it's due to the flat tax or to a rising value added tax (VAT) leveled on consumption and which economists call a "fair tax." Let's leave that one aside for the time being, but we'll come back to it later.

Opponents may question whether the scheme would help economies, but they do agree on one thing: a flat tax would make filing your income tax a heck of a lot easier — so simple in fact that anyone earning a regular wage could file their taxes on a postcard. All you'd need to do is mark down your total earnings, multiply it by the tax rate and that would be that.

That's no small advantage. The Canadian tax code runs to many millions of words; the rules for a straight flat tax could be written on a single sheet of paper. It would also save much of the $8 billion dollars we spend every year to fund the collection of taxes.

It's not time to celebrate yet though. The chances of Canada or any other western country adopting a simple flat tax are remote. It comes down to what system is fairest. Those of a liberal bent argue that the present progressive income tax system is the only way to go because it's the fairer of the two. By increasing the marginal rate of taxation as income rises, the idea is that the wealthiest pay the highest taxes because they can afford to do so, while the poorest in society need most of their earnings to cover the basic necessities. Flat taxers, on the other hand, say their scheme is fairest because it treats each individual in the same way, rich and poor alike.

They do recognize that not everyone might see it the same way. To make flat taxes more palatable, most suggest providing tax exemptions for the lowest earnings. For example, some members of the US congress promote a flat tax that exempts the first $30,000 in income for families and $25,000 for individuals. One difficulty: such a tax might discourage people from getting married. Indeed, any tampering with a pure flat tax is fraught with difficulties that open the scheme to criticism.

In the US, perhaps the best-known flat taxer is Steve Forbes, heir to the eponymous business magazine. Forbes made a flat tax the central plank in his platform when he ran for president in 1996 and 2000. The wrinkle was that he would exempt income earned from interest, dividends and capital gains, which would benefit the wealthy, especially those like Mr Forbes whose money was inherited. To offset that obvious inequality, he proposed a $42,000 exemption for a family of four before his 17% flat tax kicked in.

And so it goes. Perhaps we should go for that fair tax instead. That's one that taxes consumption, not income. Hey, don't we have one of those already? Something called the GST? So we do. Now suppose we jacked the GST up to 30 or 40% and eliminated income taxes entirely



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