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The Economic Effects of A Flat Tax
Effects on Income
Effects on Income
Critics of the flat tax allege that fundamental tax reform would benefit the rich at the expense of the middle class.7 Some maintain that low income families would also be worse off if the Earned Income Tax Credit (EITC) were removed,8 as it would be under the Armey-Shelby proposal or the Hall-Rabushka proposal.
These criticisms, however, are based on a simple-minded application of the tax law to existing incomes. The critics ignore the fact that the flat tax will affect different people in different ways and will effect changes throughout the economic system. We cannot know whether a particular income group would be better off or worse off until we know how that group's aftertax income changes. The model makes it possible to account for these changes, and finds:
- The elimination of inefficiencies produced by the current tax system
will cause the economy to be larger than it would be otherwise, and the
gains are widely distributed; every income group will gain as a result
of the flat tax.
- Among all income groups, the lowest-income Americans will gain
the most (in percentage terms) even with the elimination of the EITC.
- In percentage terms, the gains of the highest income group will be third highest among the six income groups.
Land, Capital and the Lowest Income Group. An additional and extremely important factor is that the lowest income group receives a relatively high percentage of its income from land and from capital, as shown in Table V. This does not mean that this group owns a large percentage of all land and capital, but rather that the group benefits more than others on a percentage basis from the increase in land rents and in the return to capital after the flat tax is imposed.
The percent of income from capital for the lowest income group may be surprising. It may be due to several reasons. Some in this group are self-employed and take little in salary while ownership of the company yields income from capital; some are retired or semi-retired individuals; and some are temporarily in this group (individuals who depend on interest and dividends that usually would place them in a higher income group).
The second highest percentage gain in disposable income (2.5 percent) is realized by the third lowest income group ($20,000 - 29,999). This is largely an aftertax wage effect. This income group gains considerably from allowances under the flat tax, resulting in a sizable increase in the aftertax wage rate. Hence, individuals in this group are willing and able to supply a larger quantity of labor, and enjoy a relatively high gain in disposable income by doing so.