The charge of the flat-landers

Yesterday's piece talked about the tension between tax simplification and tax fairness, the idea being that treating people fairly tax-wise often involves paying attention to the details of their financial lives, which in turn means adding complexity. So increased fairness often trades-off with decreased simplicity.

Let's take that further down the road, shall we? Yes, let's do that -- let's look at simplification . . . in more detail.

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San Franciscans recently voted on a very simple tax, via Prop K, which iminposed a very small tax on a business's gross receipts -- i.e., on a business's revenues, not on its profits.

In essence, that amounts to an income tax that brooks no deductions. It's a tax on money-in. Period. And what a ruckus that raised.

The proposition failed -- and for good reason, too. Take two businesses, a consulting practice and a grocery store, the former typically being thought of as a high profit margin business and the latter typically being thought of as a low profit margin businesses. And let's assume that the consulting practice has a profit margin of 50 cents per each dollar of revenue while the store has a profit margin of 5 cents per each dollar of revenue. And let's also assume that both businesses do $ 1 million in revenues per year, so that the consulting practice has an annual profit of $500k (50% of $1 million), while the grocery store has an annual profit of $50k (5% of $1 million). Finally, let's say that the gross receipts business tax is 1%.

So here we have two businesses, both paying a 1% tax on $1 million in gross receipts, which is $10k (the zeroes go like this: 10% of $1 million is $100k, 1% of $1 million is $10k). And that means that here you have two businesses, one making $500k per year and the other making $50k per year, but both paying the same $10k gross receipts tax per year.

So the consultant loses 2% to the tax ($10k divided by $500k is the same thing as 1/50, which is the same thing as 2/100, or 2%) while the grocery store loses 20% to the tax ($10k divided by $50k is the same thing as 1/5, which is the same thing as 20/100, or 20%).

Does that seem fair to you? To most people it does not.

Now, we're using extreme examples here, and, in doing so, oversimplifying things quite a bit, but that's the idea, right? The Prop K tax was, after all, a very simple tax

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Let's look at another extreme example. Let's look at a 100% simplified federal income tax.

Short of getting rid of the income tax all together in favor of a consumption tax or whathaveyou, by most people's reckoning that would mean having a flat tax.

Most flat tax proposals call for, at the very least, the elimination of different tax brackets, so that, to the extent a tax ever applies, the tax is always at the same percentage. And most flat tax proposals also get rid of pretty much all deductions -- even, in some proposals, that most hallowed of all deductions, the deduction for mortgage home interest payments.

So living in a flat-tax world, all of us would be able to, with a bit of seventh grade math spun easily within our own little brains, be smart decision-makers insofar as the impact of the tax code is concerned.

The thinking would go something like this: Let's see, 17% of this gain is . . . and 17% of my salary is . . . so if I do such-and-such now, why then . . . . eh, forget about it. If it's gonna be 17% regardless of which way I turn, what's the use in thinking about the various turns?

Now that is nice and simple, and, all things being equal, simple is good, right?

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But could it fly? Could a flat tax ever become reality?

Most people think not, because there are so many self-interests that cut against a flat tax -- so many special interests out there that depend on a complex, divoted Internal Revenue Code, or IRC, for their livelihood -- that it's hard to imagine it happening.

Think of it: in a flat tax world, financial services professionals and providers would have less to offer because such a big chunk of financial services is tax-driven. Now that's a big powerful industry, yes? So there's a huge industry that would be pulling long and hard against the flat-taxers.

CPAs would get hurt too. You can just hear their thoughts now: first we lose the consulting business, and now the tax advising, what's next, auditing goes down the tubes too?!

But we're just getting warmed up here. Lobbyists would get hurt too, because lobbyists' stock and trade is whacking some nice little special interest divots into the tax system, and, if the whole idea of the tax system is to have no deductions -- no divots -- then there is no chance of getting a divot in there, is there? (Aside: do the lobbyists have lobbyists?)

And how about those interests the lobbyists work for . . . ouch, now there's some entrenched power for you, and a power, at that, cutting across every industry and every interest group you can imagine. Schools have a big stake in the current tax system. Churches have a huge stake in the current tax system. Charities have a big stake (and they already just took a big hit, via the big corporate tax bill of a month ago, that put substantial roadblocks into their "give us your car" business).

And that's not even mentioning real estate. Getting rid of the mortgage interest deduction would really get people up in arms. Everyone but the rich, that is, who have had caps placed on their mortgage interest deduction for years, would take to the streets.

That's right: the mortgage interest deduction is already capped for rich people. And, not only is it capped, but the deduction is capped at the same level for married people as it is for single people which, to most people's way of thinking, isn't at all fair. So, if the flat tax ever takes hold and the mortgage interest deduction goes away, tax historians will, no doubt, look back at what happened to that deduction vis a vis the rich and characterize it as the beginning of the flat tax world.

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In the end, most members of the punditocracy can't imagine the flat tax world taking hold. So, charge as they might, the flat-landers are apt to go the way of the Light Brigade.

Famous last words? Perhaps. But most prognosticators never saw the 15% dividend tax coming either.

My, but haven't there been a lot of surprises lately . . . .