Alan Reynolds

President Bush appears serious about tackling "fundamental tax reform" within the next four years, although enhancing alternatives to Social Security and Medicare may well deserve his first turn at bat.

 Whenever we do get down to talking seriously about serious changes to the tax system, one question that will inevitably arise is whether there should be one individual tax rate or several. Smart people often form hasty opinions on this topic. Some may be surprised to learn that the most rigorous case for a single tax rate did not come from proponents of various "flat tax" proposals, who treat the topic as self-evident, but from President Clinton's chief economist Joe Stiglitz in his "Economics of the Public Sector."

 The main economic reason for a single, low marginal tax rate is that graduated tax rates impose rising penalties on additions to income, and therefore on additions to national output. Punish added income and you punish added output -- economic growth. A single tax rate puts a lid on marginal tax rates -- on the share of added earnings a worker, saver or entrepreneur gets to keep.

 In terms of incentives, however, there is no clear reason to prefer a flat tax of 25 percent to progressive rates of 15, 20 and 25 percent. A flat tax is not necessarily better than a low tax. Yet there are at least seven technical reasons for preferring a single tax rate, regardless how the tax base is defined (consumption, income or both). These reasons have to do with making the tax system simpler, fairer, more efficient, less vulnerable to political manipulation, and less prone to tax avoidance and evasion.

 First, a single tax rate makes it much easier to integrate business and individual taxes. Income originating in business (and used to pay interest and dividends to investors) can be taxed at the business source, rather than distributed to individuals and taxed at different rates depending on what their annual salaries happen to be that year.

 As Stiglitz explained, "the uniformity of (flat) marginal tax rates means that income can be taxed at its source; taxing income at its source will reduce compliance costs and increase compliance rates."


Alan Reynolds

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