The two Steves (Forbes and Moore) pressed again for the flat tax in a New Year’s Eve Wall Street Journal editorial. While their arguments are sound, the title said it all: “Trump’s Tax Cuts Were Good. A Flat Tax Would Be Better.” While the flat tax would be far better than current law, we can do better still.
The Hall-Rabushka flat tax has been around for decades. Slowly but steadily, proponents are winning the argument. The federal income tax has become flatter in its rates and the tax base has moved steadily toward economic neutrality, especially with respect to the taxation of saving and investment.
Likewise, with the addition of Iowa and Louisiana, 16 states now have single-rate income taxes and 8 more have the ultimate flat tax, which is no income tax at all.
The progress is encouraging, and the two Steves are right that going all-in on a federal flat tax would be great. But for all its advantages, we have learned a few things since the flat tax was first proposed. We have learned that a unified flat tax for individuals would be even better.
To see the issue, suppose we adopted a federal flat tax. Essentially, that means we tax all labor income at a single rate while excluding saving and the returns to saving at the individual level. In short, it would be a payroll tax.
Great, so now we have three payroll taxes operating in parallel. We would have the new payroll tax cum flat tax. We have the Federal Insurance Contributions Act (FICA) payroll tax funding Social Security and Medicare. And we have the Federal Unemployment Insurance Act (FUTA) payroll tax backing the unemployment insurance system.
Why replace the current federal income tax with a flat tax only to add another federal payroll tax? We can do better.
The obvious solution is to replace the current three-tax federal mess with the unified flat tax, a single federal payroll tax with dedicated collections for FUTA, FICA, and the rest funding the federal government, resulting in a single flat-rate economically neutral tax.
To really do this right, one would also roll in the “employer’s share” of the FICA payroll tax. While employers collect and remit the tax, workers pay the tax as a reduction in apparent wages. This would improve the transparency of the tax system as few employees are aware of the enormous tax they pay that they never even see.
A unified flat tax would greatly improve transparency because taxpayers would see in a single calculation the total individual tax they pay to the federal government. Few workers grasp the amount of FICA and FUTA they pay annually, let alone the portion collected on their behalf by their employers. Under the unified flat tax, it’s all there in all its painful glory.
The tax base of the unified flat tax is the same as with the old model flat tax for individuals and businesses, and it would have a single rate, like the flat tax. So, it offers all the advantages of the flat tax plus additional simplification and tremendous additional transparency.
The journey toward a sensible and fully transparent tax system started with the 1964 Kennedy tax cuts, then got a major boost with the 1981 Reagan tax cuts. It continued with the Bush tax cuts in 2001 and 2003 and received another major boost with the 2017 Trump tax cuts.
It has been a long road. Now, let the journey continue.
To get the maximum benefit, let the destination be a unified flat tax.
J.D. Foster is the former chief economist at the Office of Management and Budget and former chief economist and senior vice president at the U.S. Chamber of Commerce. He now resides in relative freedom in the hills of Idaho.
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