Letters by a modern St. Ferdinand III about cults

The tax rates in Canada and the USA are not ‘progressive’ but regressive, resulting in crushing tax burdens, curtailed investments and job losses. The worst taxes are those on income and capital and these need drastic reform and in some cases outright abolition. Importantly many developing areas in the rest of the world are moving to a Flat Income Tax structure taxing consumption and not capital or income. For Canada and the USA to remain competitive, and continue to develop and attract capital, tax reform will become necessary. But as you would expect the elitist media and its big government sympathizers view the Flat Tax concept with fear and loathing. As the debate proceeds they will describe the Flat Tax as inimical to Canadian or US values leading to a hollowed out and weak social infrastructure. The truth is that the exact opposite would happen and the economy and perforce government revenues, would actually grow. But don’t expect the shrill socialists to listen. The fight over Tax Reform will be a hard one.

Progressive Taxes are Regressive
There is a mountain of evidence showing the negative effects of high and increasing marginal tax rates. This body of factual reference grows yearly. Many studies are in the public domain, which use empiricism and not emotionalism to accurately describe the ill effects of high progressive taxation. Such studies would include; Marsden (1983), Koester and Kormendi (1989), Easterly and Rebelo (1993), Mullen and Williams (1996), Becsi (1996), and Engen and Skinner (1996) and Carroll, Holtz-Eakin, Rider, and Rosen (1998). In Canada Jack Mintz and the CD Howe Institute as well as the Fraser Institute present the same conclusions forcefully. In general these experts conclude that high and increasing marginal tax rates contribute to lower rates of economic growth, reduced rates of personal income growth, lower rates of capital formation, aggregate labor supply that is lower than expected, and reduced social welfare. In short, high and increasing marginal tax rates reduce economic growth by creating strong disincentives to hard work, savings, and investment.

Tax reform is obvious, and the Flat Tax concept is overdue. There are 2 mandatory reasons for Tax Reform. First, there is the competitive tax structures emerging in Eastern Europe which will over time force Western Europe to readjust its tax models towards a Flat Tax regime. Such competitive tax structures will necessitate reform in North America to maintain foreign direct investment levels and build up domestic capital pools and investments. Second, to generate long term economic yearly GDP growth of 3.5 % or more, in Canada and the US, [which is the level at which jobs are created in the private sector], tax reform energizing an increase in available capital is mandatory. The US economy appears headed on a long term economic growth pattern, but the Canadian economy, burdened by high taxes, including double taxation, and taxes on capital, is growing at 50-60% of the US rate. This is not good enough to provide long-term private sector job creation. Most of the jobs created in Canada are part-time and are public sector based. For both Canada and the US, job creationism, will depend in part on Tax Reform. Part of the solution is a Flat Tax replacing the various levels of individual and corporate taxation.

Emerging Economies
Eastern Europe is leading the way with Flat Tax reform. The Eastern Europeans will be putting pressure on Western Europe to reform the crushing Nanny State and initiate long overdue tax relief. It remains to be seen how the Technocratic elite running Europe’s failing nation states will respond to the competitive threat posed the emerging economies of Eastern Europe. The evidence is becoming clear that larger European firms are being attracted to Eastern Europe by non-unionized cheaper labor, and a simplified and fairer tax regime. It is estimated for example that Germany has lost hundreds of thousands of jobs, if not millions, in the past few years as firms relocate from the rigidified and moribund German economy to its more dynamic and aggressive eastern neighbours. In Germany or in Europe when you hire a worker for $1 you will pay $.50- $.75 per dollar in taxes and social benefits almost doubling your cost of labor. Besides this inequity the income tax rates are between 40-60 % for individuals and about 35-50 % for corporations, with both systems subject to complicated schemes of tax write-offs, avoidance and rules. It is an unsustainable model.

Thankfully Eastern Europe is eschewing the European socialist model. Every nation in this area has or will have, a Flat Income tax structure. Estonia was first, implementing a 26% flat tax in 1994. The relatively high rate was set to balance its budget, a requirement of its new constitution. Since then, buoyed by strong economic performance, Estonia has eliminated the corporate tax on retained earnings, taxing only distributed profits. This year the rate has been lowered to 24% and will fall to 20% in 2007. Latvia implemented a 25% rate in 1995. Russia followed in 2000 with a 13% flat tax, replacing its previous three-bracket system that topped out at 30%.

In Russia the results were enormously beneficial for the cash strapped government, which had been plagued for years by tax cheating citizens and non-paying corporations. The Flat Tax reform allowed the Russian economy four years of sustained growth with real (inflation-adjusted) ruble revenue from the personal income tax rising 25.2% in 2001, 24.6% in 2002, 15.2% in 2003, and 16% in the first half of 2004. At the end of just four years, total receipts have more than doubled. The share of consolidated budget revenue received from the personal income tax increased from 12.1% in 2000 to 17% at the end of 2003. It has become the third largest source after corporate income tax and value added tax and is almost as important to Putin’s government as Oil revenues.

Elsewhere we see the same story. In 2003 Serbia implemented a comprehensive 14% flat tax on personal and corporate income. The recently liberated Ukraine implemented a 13% flat tax in 2004, replacing five brackets ranging from 10% to 40%. Dividends and interest on bank deposits are taxed at an even lower 5% rate beginning 2005. Ukraine officials maintain that incentives and revenue have risen and that the underground economy and tax evasion are in decline. In 2004 Slovakia implemented a 19% flat tax on both individual and corporate income. The 19% flat tax replaced five brackets from 10% to 38% and a corporate rate of 25%. Georgia now has a 12% flat tax on personal income, replacing the previous system of four rates from 12% to 20%. The flat tax, which took effect on Jan. 1, 2005, reduced the size and weight of the old code by 95%.

Even Romania is doing it. The new reform minded President Basecu and his Parliament have passed a 16% flat tax on both personal and business income, to replace a complicated system of five rates ranging from 18% to 40% on personal income and 25% on corporate income. Opposition parties in other Eastern European countries, such as the Czech Republic and Poland, have promised to enact a 15% flat tax if they are elected. It is certain that these nations at some point will follow the lead of their neighbours and will be forced to implement a Flat Tax in order to maintain their competitiveness.

The contagion is spreading even to the Socialist Ninny states of Western Europe. Spain's government is considering a flat tax recommending a very high 30% flat tax on personal income in place of the current complex system with its top marginal rate of 45%. Even the socialist government in Germany is musing over the introduction of a flat tax of 30% on all personal and corporate income. It would replace the current personal income tax with a top rate of 45% and an effective corporate rate of 38.3%. If either country adopts a Flat Tax rate it will spread throughout Western Europe and force a radical change in what and how government taxes. It would also profoundly readjust the social-economic model of government based dependency and force a realignment between governments and business. It will also destroy EU wide tax harmonization – a thoroughly ridiculous idea.

Whither North America ?
In North America the tax code’s complexity and unfairness and sheer size makes reform mandatory. It makes little sense for advanced economies to saddle business and individuals with complicated, out of date, and abusive regressive tax regimes. What is needed is a simple, clear, fair and flat tax model to ensure the economic vibrancy of the North American region. North America should follow the Eastern European example.

The most widely discussed North American Flat Tax model is the Hoover Institution’s 1995 ‘Hall-Rabushka’ flat-tax reform. The H-R model would tax all types of income once only and at one rate. The H-R model would replace the five personal US federal rates (15%, 28%, 31%, 36%, and 39.6%) and the various business tax rates with a 19 percent federal tax rate for both individuals and businesses. Currently the national average in the US is 22 % for individuals and about 19 % for corporations depending of course on what state they are resident in. In Canada the average rates would be approximately 35 % and 28 % respectively.

Importantly the H-R reform effectively moves the income-tax system away from taxation of income towards taxation of consumption. A consumption tax is levied on any income that is consumed, i.e., spent rather than saved. Economists generally agree that the taxation of consumption is one of the most efficient manners in which to raise tax revenue. It is far more efficient and beneficial to the economy than the current regime of capital and income taxation, with double taxation being common in Canada [for instance dividend tax rates, capital taxes etc.].

It is also simple which provides obvious benefits. First it contains no tax credits, deductions, or exemptions except for the personal, spousal, and child exemptions. The complex set of tax credits and deductions found in the current system would be eliminated. This would result in a savings of time, money and IRS fees. It also simplifies the calculation of income, which constitutes much of the complexity associated with the current tax system. As well it importantly does not tax savings. This is vital to create capital pools and to allow increase investments and consumption.

Second, the H-R reform is fair since both business income and personal income are taxed once and only once. This type of approach to taxation achieves social equity, since people with similar incomes will bear similar tax burdens. The personal exemption ensures vertical equity is achieved; that is, as people earn more, they pay more in aggregate. Importantly in the US, the family threshold would be $36.800 meaning that families under this income level would pay no Federal Income tax. Approximate 50 % of households would thus be tax exempt. In Canada the average family income level is about the same, and it should be expected that about 50 % of Canadian households would likewise enjoy exemption.

There are however some downsides to a Flat Tax. In the US it would eliminate deductions for mortgage interest payments, a drawback for homeowners creating a potentially damaging political liability. In both Canada and the States deductions for charitable donations would no longer be allowed likewise infuriating some voting sects. As well Corporations in both countries would still deduct all wages and salaries, but benefits like social security, health or life insurance would no longer be tax exempt. Also Corporations of all sizes would no longer be able to deduct interest payments on debt though they would be able to write off investments and avoid complicated depreciation schemes.

These drawbacks make the Flat Tax a politically difficult proposition to sell and this is one reason why politicians are reluctant to champion it. However, given economic conditions and global competitiveness issues, they will eventually have to face up to tax reform. Creating a fair, equitable and simple system has much to offer voters. In any event, economic reality will mandate Tax Reform.

For more information see:
http://www.fraserinstitute.ca/shared/readmore.asp?sNav=pb&id=151
http://www.taxreform.com/flat_tax.html
http://www-hoover.stanford.edu/PRESSWEBSITE/FlatTax/contents.html