Interview with Mart Laar, the pioneer of Europe’s flat tax revolution

[Bono]

http://www.brusselsjournal.com/node/202

[A18]

If only it would happen here.

[A18]

I think we can get some guidance from the flat tax without actually implementing one. Taxes on savings and investment should be drastically cut, if not eliminated. Economically inefficient loopholes and 'junk deductions' should be traded in for lower marginal rates. And most importantly, the alternative minimum tax should be repealed.

[Emsworth]

I think we can get some guidance from the flat tax without actually implementing one.

I would tend to agree. It is not so important that the tax rate is uniform; rather, it is important that taxes are not too high. A "progressive" tax in which the top marginal rate is reasonable, would be perfectly acceptable to me. (For instance, the income tax scheme imposed under Andrew Mellon was excellent.)

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I am in absolute agreement here. The AMT is one of the most disagreeable parts of the tax system.

[Filuwaúrdjan]

What "flat tax revolution"? Sorry to be blunt here but a couple of tin pot countries with unstable/imploded economies adopting it and a couple of ideological drones with no original ideas supporting it does not a revolution make.

It's just yet more fad-onomics... want to know why so much of Europe (particularly out East) is an economic basket case? It's because clueless politicians with less knowledge of *basic* economics than your average citizen listen to a bunch of economists who live in la-la land and haven't done an honest day's work in their lives and who following the latest fad with more loyality than some z-list "celebrity"... is anyone here old enough to remember "Shock Therapy" (extreme free-market measures adopted by Eastern European Governments in the early '90's)? If so, how much do you know about it's effects? Not a lot I suspect; it was an utter failure when looked at objectively... if *sane* economic measures had been introduced Eastern Europe would be in a much better shape than the complete mess it is now... and why were these measures introduced? Because it was the fashion at the time...

</rant>

[Emsworth]

... is anyone here old enough to remember "Shock Therapy" (extreme free-market measures adopted by Eastern European Governments in the early '90's)? If so, how much do you know about it's effects? Not a lot I suspect; it was an utter failure when looked at objectively...

I would agree that shock therapy may have several undesired effects. In the long term, however, economic liberalization would lead to better results than the continuance of communism.

It is difficult to suddenly liberalize an economy that has so long been accustomed to a vastly different system. I would think that a more gradual change from communism to capitalism would have eventually produced positive results, without the problems associated with a sudden change (very high unemployment, and the accompanying increase in crime rates).

[afleitch]

I support the flat tax system. The current system is complicated and unfair. The average student pays a higher percentage tax rate (income tax, NI, student loans, top up fees etc) than a millionaire. Around 54% of their entire earnings from age 21-25. Disgustingly unfair and disgustingly New Labour.

[A18]

You consider loans and fees tax rates? Wow, what a socialist society.

[Emsworth]

The average student pays a higher percentage tax rate (income tax, NI, student loans, top up fees etc) than a millionaire.

I wouldn't count loans or fees under tax rates. They are paying them for specific services that they are receiving, but the millionares are not.

[Filuwaúrdjan]

In the long term, however, economic liberalization would lead to better results than the continuance of communism.

True (and I still feel strongly that liberalization was very important) but the sort of stuff done in Eastern Europe then was amaturish, crazy and downright dangerous...

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I agree with that

[opebo]

A flat tax is an absurdity.  Why not a poll tax or head tax?  After all isn't it unjust to have Bill Gates pay 10% of his income and some slob of a worker 10% as well?  Shouldn't they really both pay the same dollar amount?  After all they're both equal, right?

[Bono]

A flat tax is an absurdity.  Why not a poll tax or head tax?  After all isn't it unjust to have Bill Gates pay 10% of his income and some slob of a worker 10% as well?  Shouldn't they really both pay the same dollar amount?  After all they're both equal, right?

Good idea. At least then everyone would want the lowest taxes possible.

[Filuwaúrdjan]

A flat tax is an absurdity.  Why not a poll tax or head tax?  After all isn't it unjust to have Bill Gates pay 10% of his income and some slob of a worker 10% as well?  Shouldn't they really both pay the same dollar amount?  After all they're both equal, right?

Do you know what happend when the Thatcher government imposed a poll tax on us to replace the old local government rates system?

There riots on the streets of London. Big, big riots.

[ag]

Does anyone here realize, that unless accompanied by a major interstate redistribution of federal expenditure, a "flat tax" (either as a flat income tax or a national state tax) in the US would imply an enourmous transfer of resources from places like Alabama, South Carolina, Oklahoma and Mississipi to places like New York, Florida, California and Massachussets?

Actually, the overall tax system in the US is rather close to being flat (i.e., proportional) - it is only slightly progressive. Of course, the income tax itself is progressive, but there are so many flat and regressive taxes out there, that the overall effect is pretty much flat.  In fact, a lot of really rich people pay a smaller portion of their income as taxes than their secretaries. So, stop wishing for it - you pretty much have it. A "flat income tax" would actually make the system sharply regressive (i.e., the poor paying greater share of their income than the rich). And, as I said above, it would really screw the South in favor of the Northeast: simply put, a "flat income tax" would actually imply higher taxes on autoworkers in Alabama, making them less competitive.

In a funny twist, it would, probably, result in more blue collar job losses: since the taxes would be raised at the bottom of the distribution, the unskilled labor would become more expensive, which would have the effect of making the US less competitive, say, vis-a-vis Mexico! As for the skilled labor - well, that is where US has an advantage anyway, taxes low or taxes high, so the effect would be minimal.   Think of progressive income taxation as a subsidy to US manufacturing! True, flat income tax would be less distortionary, so the overall "cake" would likely be slightly larger - but Alabama's share would be smaller, almost for sure. It is New England that will gain! 

You could change that, of course, by changing the federal spending formulas to spend less in the rich states and more in the poor states.  Now, do you think such a thing would ever pass in the Congress without sparking a civil war? Do you imagine any NE, West, or even Midwest Republican voting for it and than surviving to be there in the next session? Great advert: "representative xxx has voted to deny New Jersey 10 bln dollars a year, of which 500 mln would have been spent in his own district.  He thinks, he represents Mississipi.  Let him make his dream true: send him packing!" And if the redistribution is not done, but the tax reform happens: "Senator yyy has sent 10 bln dollars from Alabama to Massachussets. He thinks he is already a Harvard prof: help him packing!" (likely amounts are, actually, much higher).

Of course, one might argue that taxes should be lower overall - but you don't need a "flat tax" for that.

As for small Eastern European countries - it made sense for a lot of them to set low and flat tax systems: for one, they might have actually been on the other side of the Laffer curve, unbelievable as it might sound; also they might have actually been unable to enforce a complicated tax systeml; finally, they really need to attract investor attention - they are new players. What works for Estonia, with a population less than that of Manhattan, might not work for the US.

[Emsworth]

Of course, one might argue that taxes should be lower overall - but you don't need a "flat tax" for that.

That's perfectly correct. Uniformity in tax rates is not what is significant; rather, it is important that they should not be too high.

As to your comments on spending: expenditure should ideally be cut throughout, not just redistributed. I hardly think it important whether pork barrel projects are going to West Virgina or California: the point is that they are going somewhere, when they should be going nowhere. The transfer of resources to the Northeast and West, accordingly, would not trouble me particularly.

[A18]

Payroll taxes represent money you get back at retirement. The gas tax is a user fee for the roads. Strip those away, and I doubt you get anything close to equitable taxation.

The effective individual income tax rate on the top 1 percent is presently about 21%, so a flat tax is unlikely to change much, except to eliminate distortions. Most flat tax proposals have a rate of about 20%, and a generous exemption based on family size (about $35,000 for a family of four).

As I said earlier, though, we don't need a flat tax to eliminate the inefficiency of the present tax code.

Taxes on savings and investment should be drastically cut, if not eliminated. Economically inefficient loopholes and 'junk deductions' should be traded in for lower marginal rates. The estate tax should at the very least be lowered to 15%. Etc., etc.

[ag]

All "pork barrel" together is relatively small peanuts compared to the budget as a whole. It's there, but you won't be able to cut taxes much by eliminating the obvious pork barrel excesses (and even that would be tough politically). 

Social security would not have been a tax if it went to your private account (it would have been forced saving). As is, it is a tax-redistribute scheme (admittedly, the redistribution component is somewhat sensitive to your income, though only in the last 15 years of employment, but it is even more sensitive to your health and life expectancy - so, yes, payroll tax IS tax, at least until the last 15 years before you retire).

By the way, even state-level sales taxes are somewhat regressive (the rich spend lesser share of their income, spend more of it abroad/out of state/ etc., so, on balance, the not very rich pay a greater share of their income in sales tax).

"Reform proposals" that are made without a real chance of being implemented are not "serious" by definition. To get a flat tax rate in the low 20's (still, probably, a couple of points higher than 20-21), you'd really have to eliminate all sorts of popular things in the tax code, such as homeowner deductions, etc. Basically, low 20's (anything much below 25%) tax rate is only realistic if you have almost no deductions whatsoever (wasteful or not wasteful). As a committed renter, I would be quite happy if the pro-ownership distortions were eliminated (I've always thought them evil), but this would instantaneously puncture the housing markets and make a lot of people mad.  Same with medical expense deductions, pension savings deductions etc. - low 20's tax rates means they are gone for good.  So, realistically, you are looking at the flat tax rate in the upper 20's, and even that does not leave much space for "generous family exemptions". 

Of course, you can cut government spending. Keep in mind though, that even cutting the entire non-defense discretionary budget to zero and eliminating, say, 10 departments (from education and commerce to homeland security) would barely close the current budget deficit (and would not even do that if we were not at the peak of the cycle).  If you want significantly lower tax rates than there are now, your options are: a) cut entitlements (major way, not tinkering - get rid of big chunks of Medicare, Social Security, Veterans' benefits, etc.), cut defense (not marginally, but in a serious way), or stop paying the interest on the debt (impossible).  Of course, a combination of the above is also possible. These are the really big parts of the expenditure. Which ones do you prefer to cut? Which one would not be a political suicide?

And, as I said above, unless you cut taxes from their current level, making the income tax flat would mean that more money comes into the Federal coffers from Alabama and South Carolina (it would be a real tax hike there) and less from New York and Connecticut (it would be a tax cut there). The only way to compensate for this would by radically changing the way federal expenditure is organized (not just discretionary expenditure, but also entitlements), so such a tax reform would require a wholesale reform of government finance. 

Now, the generalized benefit from a future improvement in efficiency would be real (long-term US would grow faster and lifetime income and consumption of most Americans would be higher), but hard for any voter without a graduate accounting and economics degrees to calculate or feel immediately.  In any case, much of it would come in the future. The immediate loss of a lot of goodies (e.g., homowner deductions) would be felt immediately and by a vast majority of the population, and would be easy to calculate. Add to this, that the complexity and unprecedented nature of reforms required would ensure zillions of transitional blunders, unintended and undesirable consequences of major proportions, etc. Adjustment costs would be non-negligible (quite a few people would go bankrupt in the process, since there would be a drastic reevaluation of assets).  In the short term, a lot of people might lose jobs, since some sectors would sharply contract, while others would expand (of course, those who lose jobs because of it would, eventually, get better ones -  in a few years and after retraining, and you can forecast how they would vote in the interim).

Trust me, if it ever got through the Congress so many people would be raging homicidal mad, that most Congressmen from both parties would be refugees selling insurance in Canada even before the next election, and that even if the reforms were passed by a bypartisan agreement (if one party were to push it through, it would be eliminated as a serious force for a generation, if not forever). The only way for it ever to happen is if the US falls into a crisis of Great Depression proportions (so that most people are rabid mad about the current state of affairs, so that anything seems an improvement). 

The current system is imperfect, but it is among the better ones out there, and it works quite well - you might tinker with it, reduce waste, cut some programs, may be reduce taxes a weeny bit more, but you eliminate it for something untested at your peril.  So, be prepared for the next depression - when everything falls apart, you might have a chance to do the right thing. But not before then.

[opebo]

A flat tax is an absurdity.  Why not a poll tax or head tax?  After all isn't it unjust to have Bill Gates pay 10% of his income and some slob of a worker 10% as well?  Shouldn't they really both pay the same dollar amount?  After all they're both equal, right?

Do you know what happend when the Thatcher government imposed a poll tax on us to replace the old local government rates system?

There riots on the streets of London. Big, big riots.

Oh yes, I remember.  I'm sure you realize I was being sarcastic in suggesting such a tax...

[ag]

Ideally, of course, taxes should be unrelated to individual decisions, so as not to affect them. So a lump-sum head or breathing tax would be most efficient in theory, but it would have horrid distributional consequences.  This is why economists usually think of things like inheritance taxes as "good taxes" - they are almost non-distortionary (unless people really care about what their children will inherit - and most empirical studies seem to show that people don't care much, most bequests are accidental leftovers from those who intended - or feared - to live longer), but are less cruel than the head tax.  Ditto about the land taxes - even if it is taxed you don't have much reason to take land out of economic activity.  If somehow it were possible to tax workaholics (who like working just for the fun of it) at a higher rate than everybody else, this would have solved lots of problems.  If it were possible to tax all economic activity (including leisure) at the same rate it would have been simply great! Imagine, a tax form in which you have to fill out the hours you were not working (and pay tax on them)! Of course, "corrective taxes" (taxes on tobacco, gas, etc.) are even better - they actually correct "market failures" and improve efficiency.

But all of this is theory. In practice, you can't generate enough revenue, achieve minimal distributional goals, and not distort economic activity.  Bummer.

[Emsworth]

All "pork barrel" together is relatively small peanuts compared to the budget as a whole. It's there, but you won't be able to cut taxes much by eliminating the obvious pork barrel excesses (and even that would be tough politically).

Of course it would be difficult to eliminate. However, I include not only the pet projects of several members of Congress, but also other narrow and locally tailored spending, including several appropriations relating to defense (remember the big fuss about BRAC?), transportation, agriculture, the interior, energy, and education.

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To a degree you are correct, but we can still consider the theoretical virtues of a hypothetical tax plan, regardless than a the probability of it being implemented in the first place.
 

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Of course, I don't think that we are necessarily advocating such flat rates, which would for the highest earners be pretty much the same as the current effective rate anyway.

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Naturally, it's non-discretionary spending that should be cut. I believe that it occupies about 2/3 of the federal budget. For example, assuming that we are considering politically realistic options, Medicaid spending could be cut by fixing the federal contribution at 50% of the total cost. Currently, the federal government on average funds approximately 60% of Medicaid. States, thus, are less likely to be fiscally responsible, when they know that the bulk of the tab is being picked up by the federal government. Reducing the federal contribution would encourage states to be more careful in Medicaid spending, and would probably save about $50 billion, if not more.

Similarly, the Prescription Drug Benefit should never have been approved. It's a highly irresponsible measure that will eventually cost the government billions.

Such measures, with respect to non-discretionary spending, would eventually add up sufficiently to ensure that the budget can be balanced.

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That assumes that lower tax rates would necessarily yield less revenue, which is at the very least a debatable premise. Lower taxes (especially lower corporate taxes and capital gains taxes, and an elimination of the AMT) would probably encourage more economic growth, and thereby increase overall tax revenue. It would depend, however, on one's perception of the Laffer curve.

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Here I would agree. The long-term effects of appropriate reform would undoubtedly be highly beneficial, though in the short term it would be politically suicidal. I feel that Lyndon Johnson's "War on Poverty" is particularly responsible for this mentality.

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It is curious that the current state of affairs was brought about precisely by such a crisis.

[ag]

Medicaid is peanuts - it is Medicare that is real money, especially long term, and that's federal. In any case, even eliminating federal funding of Medicaid won't save as much - State governments will be forced to pick up most of the tab (you'd save, but not really anything trully significant). As for the prescription drug benefit - you know who pushed it through. Tells you something of political incentives out there to cut Medicare.  The elderly vote, and let me tell you something: unless you impose a mandatory dying age of 65 (or at least disenfranchise the old geesers), ain't happening, not in a democracy.

Same agriculture - the subsidies are a disgrace, but ain't going anywhere. Transportation is a more complex issue - infrastructure development is needed, and while elimination of pork-barrel influences would change what you do, I suspect you can't save on how much you do (the last bill, while pork-laden, was not especially large as far as these things go, and cutting it to zero would not have changed much anyway). Poverty reduction - well, it might not be done right (in fact, it is not), but it is hard to argue there is too much spent on it.  Welfare has never been a large expenditure, but it is quite inconsequential these days.

Education is even more complicated (yes, some of it can be cut, yes, a lot should be done differently, but the person who proposes, even in a jest, to do it right will be lynched and dismembered before he finishes talking and the crowd will urinate on the grave of his parents - let me just say that the efficient way is so "unamerican" as to be beyond consideration).

Finally, on your "Laffer curve conjecture". The Laffer curve itself is a simple logical argument: we know that revenue of 0% tax = revenue of 100% tax = 0 and we know that in between it is positive, therefore there must exist a threshold beyond which the revenue declines. As far as a theoretical argument goes, it is straightforward and undeniable.  However, like many theoretical arguments it is of limited practical interest - it is by now almost universally accepted that few countries ever come close to the revenue-maximising tax level (and what is definitely true is that US is not even close to it). There might be strange exceptions (Estonians and Slovaks might have been sort of there, though it is hard to say for sure), but this is not the story in the US. So, rest assured: in practice, tax rates going down imply revenues going down (this might be obscurred by the simple fact that revenues always grow, since the economy grows, so the correct statement is: taxes go down - revenues go down compared to what they would have been had the taxes stayed where they are).