Under a flat tax, all income is taxed; it is taxed at the same rate; and it is taxed only once, at its source, when it is realized.

Surprisingly, the amount of revenue the federal government collects from the personal income tax is only 9.5 percent of total personal income. If corporate income is included, federal income taxes take only 11 percent of income. Thus, in principle, government would have just as much money if it levied an 11 percent, across-the-board tax on all personal and corporate income. Today, more than half of all personal income is not taxed at all.

Most flat tax proposals require a tax rate higher than 11 percent - say 17 or 20 percent - because they allow a generous personal allowance and an immediate write-off of all investments in capital goods.

Under the current system, investment income can be taxed several times: first, at the corporate level; second, when dividends or interest are received; third, through a capital gains tax when a business is sold; and fourth, through the inheritance tax.

Today, less than half of dividend and interest income is reported on individual tax returns. The flat tax would tax all business income at its source:

• The corporation (or business) would pay taxes on corporate income and would not be allowed to deduct any interest or dividend payments.

• Thus the tax on interest and dividends would be paid at the corporate level, rather than by individuals.

The capital gains tax forces people to pay taxes today on income that is expected to be earned many years in the future. The better approach is to stop taxing expectations and to tax all income if and when it is actually realized.

Most flat tax proposals allow individuals to deduct a personal allowance from their gross income. For example, legislation introduced by House Majority Leader Dick Armey (R-TX) provides for an allowance of $33,000 for a family of four, which means that as many as half the households in America would pay no income tax.

Armey's plan also allows businesses to write off capital investment immediately instead of depreciating assets by a certain amount each year.

One can do only two things with income: save it or spend it. Allowing full, immediate expensing of capital equipment and taxing all income only once removes savings and investment from the tax base. Thus the flat tax is truly a consumption tax.

Source: John C. Goodman, "Principles of the Flat Tax," NCPA Brief Analysis No. 195, February 8, 1996, National Center for Policy Analysis, 12770 Coit Rd., Suite 800, Dallas, TX 75251, (972) 386-6272.

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