Rand Paul has proposed a flat 14.5 percent tax on personal and business income (somewhat sadly for Democracy, he chose to publish his proposal in a subscription-only article in the Wall Street Journal). Except that it isn’t truly a flat tax because he is preserving subsidies to realtors and home builders:
I devised a 21st-century tax code that would establish a 14.5% flat-rate tax applied equally to all personal income, including wages, salaries, dividends, capital gains, rents and interest. All deductions except for a mortgage and charities would be eliminated. The first $50,000 of income for a family of four would not be taxed. For low-income working families, the plan would retain the earned-income tax credit.
He adopts one of my pet ideas (see 2008 economic recovery plan): “All capital purchases would be immediately expensed, ending complicated depreciation schedules.” (I actually proposed more flexibility than this.)
Rand Paul’s idea would seem to fit Singapore very nicely. This page says “Government expenditures are equivalent to 14.4 percent of the domestic economy.” But how could it possibly work in the U.S., especially considering that Paul proposes to eliminate payroll taxes (currently themselves close to 14 percent)? Government spending is roughly 40 percent of GDP (chart). Only about half of the total is spent by the federal government, however, so in theory Rand Paul’s idea isn’t as crazy as comparing 40 percent and 14.5 percent. But comparing 20 percent and 14.5 percent still leaves a deficit of roughly 5.5 percent of GDP, no? Or even larger if you consider that Paul is preserving subsidies for housing and exempting lower-income Americans. This chart shows that the federal deficit is not typically as high as 5.5 percent.
Currently the federal government collects about $3 trillion per year in revenue (Treasury) and spends $3.5 trillion (Wikipedia), resulting in a deficit that is 3 percent of GDP ($16.77 trillion). If all of GDP were taxed at 14.5 percent there would be only $2.43 trillion in revenue. It would take a flat tax of at least 18 percent, with no housing subsidies built in and no exclusions for people earning less than $50,000 per year, to yield the current level of revenue. A tax of 21 percent would be required to collect as much in taxes as the federal government currently spends (and spending is forecast to rise from Social Security and Medicare for the elderly plus various kinds of welfare for Americans whose labor is not worth the new, higher minimum wages (see The Redistribution Recession)).
[The Feds do get some revenue from excise taxes, e.g., on alcohol, tobacco, aviation fuel, etc., (pie chart) but I don’t think these are large enough to change the analysis. These boosts have to be balanced by reductions due to fraud. Here’s an LA Times article on how Americans created 7 million fictitious children for tax purposes. Also see “History of Divorce” in which Americans in the aggregate claim to be paying more alimony than they admit to receiving.]
How could Rand Paul’s idea possibly work?
- Steve Forbes’s 2014 proposal for a 17 percent flat tax (closer to the 18 percent number that would be revenue-neutral)
- Wikipedia on the flat tax (Hong Kong has an interesting “alternative maximum tax” of 16 percent of gross income)