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September 23, 2009

In Brief:

The single rate tax has recently gone from obscurity to popularity, with over 20 nations adopting it in the past 20 years.
Income is significantly a function of age, so higher rates on higher incomes tend to hit middle-aged taxpayers with dependents and mortgages hardest.
Discussions of income tax often talk about taxing people who “deserve” to pay more or less income tax. This may be a legitimate view for many, but the idea of voters using the tax code to fleece minorities deserves a moral consideration.
Discussions of multi-rate taxes often talk about taxing the “rich.” This is inaccurate as the tax is on income, not wealth. With this in mind the discussion would be more accurate if it talked about taxing income rather than wealth.

Five Thoughts on the Single Rate Income Tax

For decades, supporters of multi-rate taxes flippantly dismissed flat-taxers as some intellectual cousin of flat-earthers. Few challenged the narrative that higher-income earners could, and therefore should, pay not only the same percentage of their income toward government coffers as everyone else, but more. Recently though, events have intervened.

Thirty years ago, only Hong Kong and the quaint British territories of Jersey and Guernsey made up the miniature universe of flat-tax nations. Today there are now over 25 nations and a number of sub-national jurisdictions including Alberta which have a single rate tax on income. Of the nations that have adopted a single rate tax, none have gone back to a multi-rate structure, and that’s telling.

Most have experienced strong economic growth and swelling government coffers. Since it dropped its top rate of 30% for a single 13% rate in 2001, Russia has seen its income tax revenues grow faster than GDP, showing the power of a simple low-rate system when it comes to making people comply with the tax code. Estonia has had a similar experience, and has afforded to drop its initial 1994 rate of 26% to today’s 21%.

The fact that the single rate tax has been successful and politically durable in other countries is one thought in its favour; there are others that governments should consider.

Consider the net economic effect that a tax has on workers’ net incomes, and on prices of the products they produce. As Adam Smith once said; “though the laborer might perhaps pay it out of his hand, [the income tax] could not properly be said to be even advanced by him.” In modern English: Imposing any tax, including a higher rate on income above a certain level, doesn’t just decrease the taxpayer’s net income, it also increases the price of that taxpayer’s services. For example a dentist will respond to higher income tax by raising prices to some extent.

From the consumer’s perspective, part of the income tax on producers morphs into a hidden tax on goods and services they buy. Because poorer people spend more of their income on consumption, higher taxes on higher income earners don’t target higher income earners as tightly as first impressions might suggest.

Another thought is that income and the tax paid is very strongly influenced by age. In Saskatchewan for example, the average 20-24 year old likely has no dependents and earns $18,000, barely over the tax-free threshold. The average 45-54 year-old probably does have dependents, a mortgage to pay, earns $46,000, and is into the second bracket. Multi-rate taxes seem far less purposeful when seen as an inconvenient transfer of income between life stages rather than a great societal leveler.

Another thought is to ask whether the tax code should be a mechanism for the majority of voters to fleece some income earners. Single rate taxes already ensure that high income earners pay more. 10 per cent of $100,000 is five times more than 10 per cent of $20,000. Having a basic exemption means single rate taxes are even somewhat progressive, but multi-rate structures make high income earners pay more still.

One may argue that someone earning $100,000 doesn’t need their last dollar as much as someone earning $20,000 so it is just to have a tax code that redistributes it. That may well be their opinion, but a tax code which allows one group to impose their ideals on another can only create resentment. Reasonable people can disagree over whether it is right to treat all incomes equally or some more equally than others, but it is still a moral question which should not be ignored.

On the subject of class warfare rhetoric that often underlines tax discussions, it is worth remembering that income taxes tax income, not wealth. Warren Buffet’s observation that he pays a lower rate than his secretary serves as a reminder that higher rates on higher incomes might level reported income, but not wealth. “Tax cuts for the high income” is a completely different debate to “tax cuts for the rich.” This would not be verbal precision for its own sake; it would avoid catching high earners who are not especially wealthy in the cross-fire of class warfare.

For the moment, a single rate tax remains a radical idea in Canadian public policy. But looking closer at what it really means, it’s possible to see that maybe, just maybe, Canada and its provinces (ex Alberta) will one day embrace it too.

Five Thoughts on the Single Rate Income Tax

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