Wednesday, April 14, 2004

America’s complicated tax system needs a complete overhaul, not minor fixes. The large role that system plays in many of the political dramas dominating the daily headlines shows why.

Republicans and Democrats, for instance, are fighting over the “outsourcing” of jobs to foreign countries. But instead of sniping at each other, they should look at the corporate tax system. Our 35 percent corporate tax rate is one of the highest worldwide — higher even than the rate in socialist countries such as France and Sweden. Should we be surprised that some jobs leave America when the tax code punishes investors for creating jobs here?

Another issue is corporate “inversions,” which take place when a company defends the interests of its workers and shareholders by moving its charter from the United States to a jurisdiction with better tax law. Some politicians call these companies traitors, even though they are keeping their factories and headquarters in America. Others want to blame Bermuda and the Cayman Islands for having better tax laws than us. But wouldn’t it be a better idea if politicians fixed the problems in the tax code — such as the fact that the Internal Revenue Service imposes a second layer of tax on companies trying to compete in global markets?

Politicians also have been squabbling about a recent General Accounting Office study showing more than 60 percent of corporations paid no tax in the late 1990s. It’s difficult to make sense of this study because we don’t know whether these companies paid no tax because of special interest loopholes or whether they paid no tax because they were losing money.

But we do know this: The entire debate would disappear if we had a flat tax. Under a flat tax, companies would get no special deductions. They would simply add up all their revenues, subtract the wages they pay, as well as other costs and pay a flat rate on their net income.

The problem isn’t just with business taxation. There are plenty of disputes about personal income taxes as well. Republicans and Democrats love to argue about whether the “rich” pay their fair share. Much of this debate is nonsensical, especially since supporters of big government frequently assert that any household making more than $80,000 is “rich.”

In any event, there is little doubt our tax code is grossly unfair. We have no idea whether people like Bill Gates and Shaquille O’Neal pay too much or too little. We don’t want America to be like France, an envy-ridden nation that punishes people for being successful. But we also don’t want rich people to dodge their taxes simply because they can hire lots of lawyers, lobbyists and accountants.

This is why the flat tax makes so much sense. Every household would get a deduction based on family size, but then every dollar of income above that level would be subject to tax. Such a system would ensure that the rich paid their “fair share,” but it would avoid the punitive tax rates that have caused so much economic misery in Europe.

If you make twice as much as your neighbor, you pay twice as much tax. And if Bill Gates makes 10,000 times more than you, he pays 10,000 times more in tax. The flat tax could even have specific measures to make sure rich people couldn’t evade taxes on dividends and interest. Taxes on these kinds of income would be withheld and paid by businesses and financial institutions.

Sound too good to be true? Well, it’s already working in many other nations. Hong Kong has had a flat tax for a long time and has boasted the world’s fastest-growing economy for the past 50 years. Estonia, Lithuania and Latvia adopted flat taxes in the 1990s after getting their independence from the Soviet Union. They’ve been growing so fast Russia decided to go to a 13 percent flat tax in 2001. Now Russia is booming, and Slovakia and Ukraine just adopted flat tax systems too.

Maybe it’s time for America to board the flat-tax bandwagon. It’s frustrating to see former communist nations adopt the flat tax while the United States struggles with an unfair tax system that combines the worst of class-warfare ideology and the worst of special-interest deal-making.

A flat tax wouldn’t be good for everybody. Many IRS agents and tax lawyers would have to find new jobs. But that seems an acceptable price to free America of a broken tax system.

Daniel J. Mitchell is the McKenna fellow in political economy at the Heritage Foundation.

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