In the tax trade there are a couple of phrases used: “above-the-line” or “below-the-line”. The line referred to is “adjusted gross income” (you’ll see this line at the bottom of the first page of the Form 1040). Below the line are the kinds of deductions that average people are familiar with: exemptions for kids, charitable contributions, mortgage interest, and so on. Back in 1986, in the spirit of tax simplification, Congress severely restricted these kinds of deductions, wiping out many of the benefits enjoyed by the average Joe. Above-the-line is where the action is now. Some above-the-line deductions are used by average people, like a deduction for contributions to an IRA. But above-the-line is mostly where well-heeled players play. When you hear about tax shelters, they target the above the line area. This can be anything from a Schedule E limited partnership or subchapter S corporation “flow-through” to some other similar kind of mechanism used to shelter real income. For example, way-back-when, I studied the effects of the 1986 tax changes for the gov’t, watching Schedule A deductions legislatively disappear and mysteriously reappear on Schedule C or Schedule E (and when I say Schedule E, I don’t just mean rental properties but partnership and S-corporation flow-throughs as well); such areas are unaffected by tax simplification. They are also left untouched by any flat tax proposal.

My point is that it doesn’t matter what numbers you use for tax rates (10%, 20%, or some other number). People like that are unaffected because they play with the definitions of income. You mention “no capital gains”. Now you are going beyond a flat tax into the arena of defining income. When you do that, you’ll meet stiff resistance because now you are crossing a line and affecting the definition of income. Now you’re goring somebody’s ox, a somebody with the financial wherewithal and political connections to make sure his unhappiness gets a hearing. Flat tax proposals don’t do that, except perhaps to wipe out some more below-the-line deductions for the middle class, such as the deductible donations that you mention. That’s what I mean by cynical. Tax simplification invariably and negatively affects the average taxpayer, but is sold as a benefit to the middle class.

Assume, though, that you truly could produce a flat tax, setting aside the gamesmanship with the definition of income. You asked for numbers. Imagine a micro country with 10 households. One has high income, six have middle income, and three have low income. The low income is $20K, the middle income is $50K, and the high income is $120K. Currently MicroLand has a progressive tax system with three rates: 0% for low income, 16% for middle income, and 30% for high income. This produces tax collections of $84K. In order to convert to a flat tax and collect the same amount of tax (“revenue neutral” as they say in Washington), you would have to impose an across-the-board tax rate of 18%. Those with middle income get hurt some, and those with low income get really slammed. If you say, well…I would leave those with low income alone, you would have to impose a flat tax of 20%. You have saved those with low income, but really hurt those with middle income. Under any scenario, those with high income make out great. The reductions in tax rates for the wealthy must be made up by raising the tax rate for those who are currently paying lower rates. In sum, you may have to pay only one rate—whatever it is—but it will result in your paying more tax than you do now, unless, of course, you happen to be wealthy. That is why flat tax proposals are favored by the wealthy. A flat tax acts to transfer wealth to them.

Such a flat tax system is called regressive. What is regressive? Well, here is how one person describes the relationship between a person’s finances and what they can afford to give (for taxes or any other purpose):

“And he sat down opposite the treasury and watched the people putting money into the offering box. Many rich people put in large sums. And a poor widow came and put in two small copper coins, which make a penny. And he called his disciples to him and said to them, ‘Truly, I say to you, this poor widow has put in more than all those who are contributing to the offering box. For they all contributed out of their abundance, but she out of her poverty has put in everything she had, all she had to live on.’”

Is a flat-tax, regressive tax system fair? That’s a question you have to decide for yourself.

p.s. My apologies for the long-winded post. This whole flat tax thing obviously bothers me.