Don't Buy The Flat Tax Arguments

A short one today. People who advocate the flat tax keep promoting the idea that this will make your taxes simple: “You can send in your taxes on a post card!” And they make claims like the flat tax will eliminate the need for the IRS. This is simply wrong.

To understand why this is wrong, you need to understand something that a lot of people don’t seem to get: concepts like “income” are not specifically defined within the tax code. They aren’t specifically defined because the moment you provide clear boundaries, people slip their income outside the boundaries of the definition.

To give you an example, assume that you define income strictly as “Any money paid in exchange for services you provide.” Sounds like it would work, right? So what happens when people stop paying “money” and instead give property. Suddenly, you can avoid paying taxes by taking “property” that can then be easily converted back into cash. Unless the IRS wants to allow this, it then needs to change the above-definition to add “money or property” or it needs to re-define “money” more broadly to include “anything of value.”

Now we have it though, right? Income is “anything of value paid in exchange for services you provide.” That works. Well, no. Now people stop paying each other for services. Instead, they give “gifts” to people who provide them with services. Again, people have escaped the income definition. Thus, again the IRS must change the definition. What if a third party pays for them? What if you value the property you give the person at $1 when its real worth if $10,000? What if you pay with an option that has a $1 value today, but $10,000 value tomorrow? Etc.

Suddenly, the thing so many people think is easy, (“After all, who doesn’t know what income is?”) turns into a multi-page definition with attached explanation and examples of what is or is not income.

This is how the tax code has grown to become what it is. From day one, people tried to find ways to avoid having their income fall under the definition of income. To fix that, the IRS issued rulings, guidance, and new definitions to catch up to these people. And with each one of these, the code grew until it all resulted in a massive, complex book which spends hundreds of pages defining what is actually income and what isn’t.

This is the problem.

And when people say, “All you do is write your income on the card, so there’s no need for the IRS,” they are speaking quite ignorantly because they don’t understand that the word “income” requires the existence of an IRS to decide what counts as income and what doesn’t. In other words, so long as we are taxing “income,” there will be a need for the IRS to decide what constitutes income.

Further, the people who advocate this have a total blind spot when it comes to deductions. They think that “deductions” are simply 3-4 numbers that you get on a 1099 or out of a tax booklet and everyone will be willing to forgo those for lower rates. They totally ignore the fact that for anyone running a business, “deductions” are ultra important because they define income.

Indeed, if we were to eliminate “deductions” for businesses, we would kill most businesses. How? Consider this. If you took in a million dollars in income through your business, but it cost you a million dollars in things like salary, rent, and supplies to make that happen, then your current tax burden is $0. That’s fair since you have $0 in profit at the end of the year. If we go with the vision promoted by the flat taxers, you would be paying 20% taxes on that million dollars in income... as you have no deductions to reduce it to “profit.” So you will pay $200,000 in taxes on $0 of profit under their system. How long will most business last paying that?

And if they respond, well, we should only tax “profit,” then all those deductions they claim should vanish reappear and your taxes are identical to what they’ve always been... except for individuals who have lost their deductions but still must face the IRS determining what constitute their income.

The flat tax argument is a delusion. It is a delusion spun by people who don’t understand how the tax system works and who are selling you a false view of reality. It is impossible to “eliminate all deductions.” It is impossible to eliminate the IRS so long as income and/or deductions exist. All a flat tax does is lower the rates and shift the tax burden around slightly. It does nothing to make taxes less complicated. It does nothing to make taxes less onerous. It does nothing to end the disincentive to hire people or to start a business.

It is not real reform.