A friend on Facebook was calling for a flat-rate tax, e.g. everyone is taxed at, say 10%, regardless of their income, etc. As I am employed by the tax sector of an accounting firm, I should disclose my bias against simplifying the tax code and losing my job. But considering I supply pretty general economic analytical skills, I think the overall impact on my life of a simplified tax code would be pretty minor–i.e. I’d probably be fine jumping into other types of consulting. Besides, it would be pretty awesome to forever do away with the stack of Interal Revenue Code reference books on my desk. Anyway, here is my response to my friend’s suggestion of a flat-rate tax being the most fair way to tax:

This argument [of a flat-rate tax] hinges completely on what is meant by “fair.” I think “fairness” is difficult to define, but the best attempt I have seen is one where individuals are asked if they were looking down on the world before it began and unsure where they would end up, how would they distribute wealth among people. Respondents typically call for an even distribution of wealth. This does not surprise me: Considering the way people smooth their consumption over the years of their life, it seems to me that wealth brings the most amount of “total happiness” when used more evenly. Why not use it evenly among people when possible? Notice that changing to a flat tax would be highly regressive and greatly increase the dispersion of wealth in the U.S (which is already extremely high relative to other developed countries). If we believe the gov’t is responsible for wealth redistribution, a flat tax does not do well. But it’s unclear to me whether wealth redistribution should even be the government’s role.

There is a strong argument against the government’s role in wealth redistribution. Taxes greatly reduce productivity. There used to be a saying in Hollywood, “Never make more than two movies a year” and that was because a third movie would put you in such a high tax bracket that you’d lose money doing it. I like movies, so taxing the rich makes me sad. (Then again, I like schools and roads, so maybe I like these taxes after all.) The U.S. has one of the highest corporate tax rates in the world, so it significantly reduces the competitiveness of U.S. businesses. (Japan’s is arguably higher, but very close anyway.)

It’s unclear, however, whether McCain or Obama would be more successful in achieving a corporate tax cut. If McCain is successful he keeps dividend taxes at 15%, but if unsuccessful, dividend taxes go back to 40%. Obama may be better positioned to keep them at 20%.

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