Politics

Created 10/23/1998
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Matt Fong's Flat Tax: Notes for a Press Conference

Bradford DeLong
October 23, 1998

When you listen to Treasurer Fong talk about his tax policy proposals, you hear two things:

I am here to point out that these two are inconsistent. That is what an economist does for a living: that is why it is called the Dismal Science, after all. If you want a tax cut for America's broadly-defined middle class, then you do not want the Fong tax. If you want the Fong tax, then you want a tax increase on the middle class.

You want a tax increase on the middle class because the biggest effect of the Fong tax--with its unspecified but revenue netural low maximum marginal rate--is to lower taxes on the rich: those making more than $150,000 a year. These reductions in tax colletions have to be made up somewhere, and the middle class is where the money is.

To argue that the Fong tax would reduce the tax burden on the middle class is to argue that 2+2=5.

And after the experience of the 1980s--when we cut tax rates and, sure enough, tax collections fell as a percentage of the economy's productive potential, and the deficit ballooned--it is very hard to make the argument that 2+2=5: for our $4 trillion national debt and the drag it places on U.S. economic growth are visible legacies of the last time.

We now--after nearly two decades of fiscal chaos--have a balanced budget. We still face long-run problems in financing the government. We need to deal with them. We need to deal with the Social Security problem, for our social insurance system was not designed to handle the retirement of the baby boom generation or the low productivity growth of the past two decades. We need to reduce our national debt so that we can reduce the $3,000 a year in extra taxes that the average family of four pays just to finance interest on the debt.

We don't need senators with tax policy views like those of Matt Fong.

Q: Who would benefit from Matt Fong's flat tax?

A: For the tax that he has outlined--a $36,000 or so family examption, a home mortgage deduction, and the elimination of the capital gains tax, the tax on interest income, the corporate income tax, and the estate tax--those who would benefit would be those who fell in the the richest twentieth or so of California's population. Maybe even all those in the richest tenth would benefit.

You would have to make somewhere between $150,000 and $190,000 a year before you would start to see a tax cut under the Fong tax.

And even among those who benefit, the benefits are skewed. I've seen some estimates that those making more than $500,000 a year would see an average tax cut of $145,000; while those making a measely $300,000 a year would see an average tax cut of only $10,000; while those making the pitifully small sum of $150,000 a year would see an average tax increase of $4,000.

But the Fong proposal is very rough, these numbers are only approximate: you need much more detail than he has provided to get more than in-the-ballpark estimates

Q: Why would anyone propose a flat tax?

Well, it's popular among campaign contributors...

You can be for a flat tax either (a) because you think that the rich deserve to be richer--that it is simply not fair that the rich are asked to pay a greater proportion of their income in taxes than the not-rich, or (b) because you think that a flat tax would unleash a big increase in economic growth because entrepreneurs today spend so much time worrying about minimizing their taxes that they don't do their jobs properly.

I think that for Matt Fong it is reason (a)--that he believes there is something fundamentally unfair about progressive taxation. Some people--Jack Kemp--believe in reason (b), but they are few: the failure of economic growth to increase in the 1980s was pretty conclusive.

Q: Wouldn't the flat tax eliminate the armies of tax accountants and lawyers--and all the time wasted preparing 1040s?

A: I should pass this question to Senator Bradley, who has worked longer and harder for tax simplification than anybody else.

But there is a big difference between a simple tax and a flat tax. You can have a complex, flat tax. You can have a simple, flat tax. You can have a complex, progressive tax. You can have a simple, progressive tax.

There's no connection between how thick the tax forms are and how progressive the tax is.

Q: But don't you want to have a broader-based tax with lower tax rates?

A: Almost always yes: to broaden the tax base and lower the tax rates is one of the principal goals of good tax policy.

But Matt Fong's proposal doesn't do a very good job of broadening the base. It includes fringe benefits as part of wages and salaries, but it eliminates the estate tax and exempts interest, dividend, and capital gains income from tax entirely. It eliminates the corporate income tax--which means that the government no longer levies any taxes at all on the income flowing to wealthy non-profit institutions like, say, Princeton University. It narrows rather than broadens the base.

I think the case for exempting all of these classes of income from the tax base is weak. (There is, however, a more general case for taxing spending rather than income).

Q: Isn't the flat tax fundamentally a fair tax?

A: Well, no, I don't think each taxpayer should pay the same proportion of income in tax. I think single mothers making $12,000 a year should pay no income taxes at all. I think tenured Berkeley professors with subsidized housing loans should pay a higher proportion of income in tax. A lot of differences in income in this country today are the result of skill, industry, and initiative, but a lot of differences in income today are the result of luck.

And I think that the burden of paying for the government should fall proportionately more heavily on the lucky and the rich--for whom the burden of higher taxes is that they can then afford one fewer luxury. That one of the key ideas of social insurance: that the tax burden should fall more heavily on the rich so that the extra money can be used to shave the middle-class tax burden and give a boost to the living standards of the poor.

If you want to have a political discussion about what a fair distribution of the tax burden would be, good. But you cannot have such a discussion if you insist on claiming that the flat tax is a fair tax that lowers taxes for everybody (except the working poor, for whom it raises them).

Q: Matt Fong says that all of the analyses you use are obsolete, that: "The scoring of tax reform plans and the generation of tax distribution tables ... will not work. It is simplistic and is not fit for use in the '90s world of high tech modeling."

A: We've been down this road before, in the 1980s. You can say that Ronald Reagan's presidency was very successful in many dimensions, but not in its tax policy. It left us with our current $4 trillion government debt: we are now paying $200 billion a year in extra taxes--$3,000 for a family of four--simply to pay the extra interest the government owes.

In the long run the Reagan tax cut of 1981 was, because President Reagan never proposed spending cuts to match it, the cause of the very big tax increases needed to raise the $200 billion a year to pay the extra interest on the national debt.

That's what the flat tax will really do--raise taxes on the middle-class and cut taxes on the rich today, and in the long run give an extra boost of $3,000 per family per year to the tax burden.

 

Professor of Economics J. Bradford DeLong, 601 Evans Hall, #3880
University of California at Berkeley
Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax
delong@econ.berkeley.edu
http://www.j-bradford-delong.net/

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