The Progressive Flat Tax

The flat tax fanatics are back. They say that if there were only one rate of income tax, the system would be simpler, and the rich couldn’t reduce their tax by converting one kind of income into another kind taxed at a lower rate. In the case of a pure flat tax — that is, a tax with one rate and no tax-free threshold — the tax rate could be lower, and the rich couldn’t claim multiple thresholds by splitting income between persons or between financial years.

But of course such reforms would make the tax system less progressive — a “progressive” tax being a tax that takes a higher fraction of income as income increases.

Well, it so happens that the more income people earn, the higher the fraction of their annual income that they tend to have tied up in assets. This fraction rises very rapidly with income; for example, if you can barely pay the mortgage on your home, you probably know of people who own numerous properties but whose salary is only slightly higher than yours.

So a pure flat tax on asset values — that is, a certain small percentage of the value per year, with no tax-free threshold — is highly progressive because “progressiveness” is defined in terms of income, not assets. With no threshold, there is no possibility of juggling assets to claim multiple thresholds. What if your income was high in the past but is now low — e.g. because you have retired — leaving you asset-rich but income-poor? No problem: you can defer the tax until you sell or bequeath the asset; deferral takes the place of thresholds. If the flat asset tax is confined to assets that taxpayers can neither create nor destroy nor move out of the taxing jurisdiction — assets such as land and monopolies — taxpayers’ efforts to minimize their tax by rationalizing their asset holdings do not affect the total stock of assets and therefore do not cause any overall loss of revenue. So all the advantages claimed for a pure flat (income) tax are retained.

We don’t have to choose between flat taxation and progressive taxation. By taxing assets instead of income, we can have a tax that is both flat and progressive!

1 Comment

  1. Lea Pond29-01-2012

    I truly appreciate this post. Cool.

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