Because lifestyle audits are so broad, we can expect recordkeeping requirements to increase, not decrease, under a flat tax. Any income tax system is dependent on massive reporting to the government of income information. At present, this is accomplished through the annual filing of some 1.3 billion information returns, such as IRS Forms 1099 and W-2. Since enforcement of a flat tax is dependent upon income information, look for the number to triple as IRS traces every nickel you earn.
There is little about a flat-tax system that will trim the staggering cost of tax law compliance. At present, this burden is estimated at $700 billion annually. Much of the cost is associated with recordkeeping and tax law enforcement, neither of which is reduced by a flat tax. A flat tax certainly involves a simpler tax return, but return preparation is the smallest component of tax law compliance.
The solution to our tax problem is to adopt a national retail sales tax in place of the personal and corporate income tax. Only a sales tax can eliminate the invasiveness of the IRS, since one's income and lifestyle are irrelevant. When one spends money, the tax is simultaneously assessed and collected. That is why only a sales tax can reach the underground economy. The IRS's chief compliance problem is the alleged failure of citizens to report their income. A flat tax will not capture this income because to do so it must be voluntarily reported.
Best of all, a sales tax can eliminate the IRS. The 50 states could collect it in concert with their own sales tax. The federal government would bear the costs but they would be minimal as all but a few states already have a sales tax. For the same reason, virtually all businesses are equipped to pay it. Those businesses which do not now collect a sales tax would still see a reduction in compliance costs because of the elimination of the complex federal income tax laws.
The states would in turn pay the tax to the federal government. This reduces the federal tax collection points from 200-plus million (the number of tax returns filed annually) to just 50.
Only a sales tax eliminates the need for individual audits, recordkeeping, and enforced tax collection, and it can eliminate the staggering $700-billion annual compliance cost. In short, the national sales tax is the only way to get the federal government out of your life.
Daniel J. Pilla is a tax litigation consultant in St. Paul, Minnesota, and the author, most recently, of How to Fire the IRS (Winning Publications).
Flat-Out Better
By Bruce Bartlett
The best tax reform that could be enacted by Congress would be to adopt the Hall-Rabushka flat-rate tax proposal. Named for economists Robert Hall and Alvin Rabushka of Stanford's Hoover Institution, the Hall-Rabushka proposal was first put forward in a Wall Street Journal article on December 10, 1981, and has since been elaborated in three editions of their book, The Flat Tax. The most recent edition has just been published by the Hoover Institution Press. Versions of the Hall-Rabushka plan have been sponsored by Rep. Dick Armey (R-Tex.) and Sens. Richard Shelby (R-Ala.), Larry Craig (R-Idaho), and Arlen Specter (R-Penn.).
In brief, the Hall-Rabushka plan would establish a single tax rate of 19 percent on all personal and business income. Businesses would be taxed on their gross revenue less cash wages, salaries, and pensions paid (but not benefits); purchases of goods, services, and materials used in business; and all capital equipment, structures, and land. Individuals would be taxed on their wages, salaries, and pensions received, less a large family allowance. A family of four would have to earn $25,500 per year before it paid any income tax. Note that individuals would pay no tax whatsoever on interest, dividends, or capital gains received. Moreover, the system is so simple that businesses and individuals alike would be able to file their tax returns on a form the size of a postcard.
Although they have always referred to their proposal as a flat tax, I prefer to think of it as a single-rate tax plan. This is because the central element of the Hall-Rabushka plan is to tax all income only once. And it is not truly a flat tax because those with higher incomes will pay higher effective tax rates, although the marginal rate will be the same for all.
The importance of this distinction gets at what I believe is the major problem with our current tax system, which is that some forms of income are taxed two, three, or more times while others are not taxed at all. Thus we have close to confiscatory rates on some forms of capital income, while a considerable portion of labor income--in the form of fringe benefits--is entirely free of tax.
In the aggregate, we tax less than half of all personal income. In 1992, personal income as defined by the Commerce Department came to $5.2 trillion, yet taxable income as defined by the IRS came to just $2.4 trillion. This means that in theory a 9.2-percent tax rate on all personal income would raise the same revenue that the individual income tax raises today at an effective rate of 19.2 percent, with marginal rates between 15 percent and 39.6 percent.
However, the effective tax rate on capital income can go far higher than 39.6 percent. Consider a dollar of increased corporate profit. Looking only at federal taxes, we first take off 35 percent corporate income tax. Then whatever is paid out to the corporation's owners--the shareholders--is taxed again up to a 39.6-percent rate. This adds up to better than a 60-percent tax on the original dollar of profit. But we aren't finished yet, because if the higher profit leads to a higher stock price, we tax that profit again when the stockholder sells his shares, even though the stock price merely reflects the discounted present value of the future profits that are already going to be taxed twice. The capital gains tax, therefore, in effect is a third layer of taxation, going up to 28 percent, on the same dollar of profit. If we factor in state and local taxes and inflation, it is not at all difficult to get tax rates on capital up over 100 percent.
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