Gilmour, G. “Flat Tax Ideology” 
The New Federation 5.1 (1996): 7-11.

Flat Tax Ideology
by Glenn Gilmour

The latest trend in tax reform is the flat tax. In the United States, the flat tax became a campaign issue in the Republican primaries for the American presidency.

For example, under the flat tax plan proposed by Malcolm (Steve) Forbes Jr. during those primaries, “you would take your salary and self-employment income, subtract $26,200 for a couple filing jointly, subtract an additional $5,300 per dependant and pay 17 percent of what’s left.” However, not all income would be taxed. “Investment income – interest, dividends and capital gains – would be wholly free from taxes. There would be no inheritance tax. There would be no itemized deductions, such as those allowed for mortgage interest ....” (In the United States, unlike Canada, a deduction is allowed for mortgage interest on a home.)
Supporters of a flat tax claim that it would reduce the complexity of the current tax system (e.g., one could have an income tax form the size of a post card); that it would spur investment and entrepreneurship (either because the rate of tax that would be imposed would in most cases be less than the highest tax rates currently in existence, or because there would be exemptions allowed for individuals receiving investment income such as dividends); that it would be more honest, since the rate of tax actually paid could not be reduced by resort to a variety of deductions or loopholes; that the cost of administering the system would be cheaper; and that the resulting tax system would approximate a neutral tax system that enables persons to make better economic decisions free from the distortions of a present, complex tax system riddled with loopholes that punishes different activities differently. Moreover, it is argued that a flat tax system can be made progressive by reason of basic exemptions that would exempt persons from paying any tax at all up to a certain amount. Put concisely, a flat tax system, would, according to its supporters, be simpler and more understandable, efficient, and fair. These arguments are indeed impressive. Let us now examine these more closely.
One of the great flaws of our present income tax system is its lack of simplicity and clarity. Most persons probably know about our income tax system, not through their knowledge of the Income Tax Act, but through the annual income tax form with its enclosed, user-friendly guide book. The creation of a flat tax system with extremely limited exemptions undoubtedly would have the effect of making the tax system easier to understand. And the ease and simplicity of a flat tax system whose essentials can be placed on one page is most appealing. However, a flat rate tax would not necessarily get rid of complexity, since this would depend on the tax exemptions that would be allowed and how they would be defined. For example, suppose one wanted to create an exemption for investment income. How would the difference between regular income and investment income such as capital gains be defined so that the person on the street would understand it? Thus, it may be that a flat-rate tax system would still be complex or difficult to understand depending on the nature of the exemptions to it. Nonetheless, it would appear to be more understandable and simpler than the present tax system.
On the other hand, a progressive tax system, while arguably more complex than a flat-rate tax system, could be written in an understandable manner. The government could, without changing the substance of the present law, commit itself to rewriting the Income Tax Act in plain language. Other Commonwealth countries have launched such initiatives. For example, the Australian Government has created a three-year “Tax Law Improvement Project” that is rewriting Australia’s income tax law so that it is more easily understood. This is not just a quibble about grammatical structure. Clarity of legislation more effectively prevents the possibility of avoiding paying tax (even tax in the millions of dollars) because of ambiguous laws. For example, the Auditor General of Canada in 1993 examined the deficiencies of a tax regulation that allowed the resource sector (petroleum and mining companies) to use a resource allowance to reduce income taxes payable. The legislation failed to convey clearly the government’s intent. A taxpayer argued that the amount of the resource allowance should be reduced by deducting certain expenses from it and won in court. The Auditor General estimated the income revenue lost or at risk of being lost to the government from the resource sector to be $1.2 billion.
Moreover, the removal of exemptions or loopholes is entirely consistent with a progressive tax system, i.e., one having more than one tax rate. Since less money escapes the system, the system becomes more progressive. Also, a tax system having a number of different tax rates, without more, is not really all that complex. The time difference in determining whether you pay 20% in taxes versus determining whether you fall into a 20%, 30%, 40% or 50% tax rate is not that great, if all you look at is a chart setting out the rates. In short, what causes complexity is not the number of marginal tax rates, but the exemptions that make it difficult to determine what the amount of taxable income is in the first place.
The flat-rate system is also claimed to be more efficient because it encourages entrepreneurship and fosters wealth creation. Supporters of a flat tax argue that the high tax rates that are a necessary part of our current progressive tax system act as a disincentive for people to work hard. Usually, under a flat rate proposal, the flat-tax rate is set lower than the maximum rate under the present tax system. Also, because one rate applies to all, persons are not tempted to waste time and money on seeking ways to avoid paying the tax or to even evade paying tax. Some support a flat tax structured to bring in the same amount of revenue as the current system, by coupling the lower rate with the removal of many exemptions, such as the favoured treatment of capital gains, thereby expanding the tax base. Others, however, such as Malcolm Forbes, Jr., favour exemptions for investment income such as capital gains. Forbes argues that the consequence would be an increase in government revenues as the economy booms. A flat tax that is a revenue-loser along these lines is what The Globe and Mail called the “supply-side snake oil at the heart of the flat-tax rhetoric.”
These arguments raise a number of questions. When are taxes so high that they prevent people from working? One may accept, for example, that a maximum 90% tax burden is excessive, but what about a 60%, 50% or 40% tax burden? Moreover, in times of economic uncertainty and arguably limited employment, perhaps there is an advantage to high tax rates precisely because they discourage persons who are earning more from working more. It seems logical that if they choose not to work, the opportunity is created for someone earning less to do that work. Finally, whether persons try to avoid the tax system is dependent on the extent to which they can actually do so. If there are no exemptions available in the first place, there is not much even the best tax lawyer can do, irrespective of whether the tax system is a progressive or flat rate system.
Of all the principles governing a tax system, arguably the most important is that of fairness. In 1966, the Royal Commission on Taxation, commonly known as the Carter Commission, called for fundamental reform of the Canadian tax system. As a blueprint for reform, it arguably has yet to be equaled. It proposed changing the Canadian tax system to achieve fairness. Among these changes: that all capital gains should be included in a person’s taxable income (“A buck is a buck is a buck”); that the discriminatory treatment of employees be ended (expenses reasonably related to employment should be able to be deducted from income just as those who are self-employed may deduct the cost of doing business); and that there should be a maximum lifetime limit to the amount of money put into registered pension plans that is given favourable tax treatment by the government.
Central to the Commission’s analysis was the belief that a person should pay tax in accordance with his or her ability to pay. This means that a rich person should pay more in taxes than someone who is poor or from the middle class. As a result, the Carter Commission strongly embraced the concept of a progressive income tax system. For a person to pay tax in accordance with his or her ability to pay there could not be just one tax rate. Instead, several tax rates were preferable, increasing in percentage as a person’s income increased. In fact, the Commission recommended about 20 different marginal tax rates. More recently, the Ontario Fair Tax Commission noted that “ability to pay” has its scholarly roots in notions of distributive justice. Among the concepts on which distributive justice is based is that of equal sacrifice: the cost of supporting the goods and services offered by government should be borne equally by persons. But equal sacrifice does not mean that everyone should pay the same proportion of income as taxes. Instead, as a person makes more income, the less value is placed on the additional unit of income (declining marginal utility of income). Thus, a dollar means more to someone who is poor than to a millionaire. This is the point of the story of the widow’s mite, where Jesus, observing the difference between the large amounts of money paid into the treasury by the rich and the two mites (a farthing) paid by a poor widow, said: “Verily I say unto you, that this poor widow hath cast more in, than all they which have cast into the treasury: For all they did cast in of their abundance; but she of her want did cast in all that she had, even all her living.”
Unlike a progressive tax system, a flat tax, in theory, is a proportional tax, since the same tax rate applies to all incomes. Thus, a progressive tax system based on ability to pay and a flat-rate tax system are very different models. However, supporters of a flat tax argue not for a pure flat tax system, but one that is altered to make the flat tax system a truly progressive one. This is done by creating a basic amount below which a person would not be taxed at all. Moreover, unlike the United States, mortgage interest is not deductible in Canada, so any flat tax imposed in Canada would not place any additional burden on homeowners. But while elements of progressivity can be built into it, a flat tax system remains at heart a proportional tax, because it refuses to tax all citizens, particularly those in the highest income range, on the basis of their ability to pay. At the top end of the scale, multi-millionaires, even in a worse case scenario, would still pay only one flat tax rate, and presumably a lower rate of tax than they do now. And its effect on the middle class? The Globe and Mail noted that “[t]he fact that in its purest and most honest version taxes for everyone with annual incomes between $30,000 and $90,000 would rise, while those with higher incomes watch their taxes fall, gives pause for thought.” In short, the adoption of a flat-tax system collides with the principle of fairness as defined by the Carter Commission. Progressivity arguably becomes an add-on to make the flat tax politically saleable.
Why is the “ability-to-pay” principle so readily jettisoned by the proponents of a flat-rate income tax? Many supporters are true believers in the virtues of the free market; thus, it should come as no surprise that support for the flat tax largely comes from the right of the political spectrum, such as the Republican Party in the United States or the Reform Party here in Canada. Indeed, the Reform Party appears certain to adopt a flat tax proposal at their convention in June, 1996. These persons appear to view a progressive tax system as something akin to socialism, because the money raised from the wealthy through such a system ends up being redistributed to those less well off, thereby depriving those who earn wealth of the legitimate fruit of their labours. For example, the Fraser Institute, in its annual Tax Facts series, says of the concept of redistributing income from the rich to the poor that “[t]he extreme form of this prescription is ‘from each according to his ability [to pay] and to each according to his need’ – the rule advanced in the Communist Manifesto.” Not surprisingly, those who attack the flat tax are less inclined to view an unbridled free market as the best way to fairly treat wealth. Their concern is that under the flat tax the wealthy will be able to avoid paying their fair share of taxes. For example, Citizens for Tax Justice, an American liberal organization, calculates that under the flat tax proposal of another Republican, Richard Armey, those earning from $25,000 to $85,000 per year would effectively see their taxes increase by thousands of dollars annually (ranging from about $2,400 to $4,600 the higher the income) while families earning over $500,000 per year would see their taxes cut by between $78,000 and $93,000 annually.
For some, the attraction of the flat tax lies in its claim as a revolutionary or radical change to the status quo. But arguably our current tax system already approximates a flat-tax system. Tax reform over the years has reduced the number of tax rates in our tax system. Also, a 1994 study of tax incidence in Canada based on 1988 data concludes: “[F]or all three levels of government combined, the pattern of tax incidence is very moderately progressive for families with broad incomes up to about $42,000 and proportional for those with incomes that are higher (with a hint of progressivity for the very rich.). ... We did not find that the middle income class in Canada is burdened by excessively high taxes, in comparison to other income groups. ... Quite the contrary, at least for families with broad incomes from $42,000 to $300,000, total tax incidence is virtually proportional: for these families, a flat rate tax system is already in existence! ... We did not find a steeply progressive total tax system. The average effective tax rate for the richest 1 percent of families with broad incomes in excess of $300,000 is 35 percent, compared with 30 percent for the poorest 8.3 percent of families with incomes of $10,000 or less.” In short, for wealthier Canadians, Canada’s tax system is in reality more akin to a flat tax system than to a progressive one. If what is desired is a “revolutionary” change, arguably the only way to go would be to move towards a more progressive tax system.
Thus, a flat tax has both advantages and disadvantages. Simplicity, certainly, and efficiency, probably, would be its strengths. However, by jettisoning the concept of paying tax in accordance with ability to pay, it is profoundly unfair, without more. If a flat tax were to be seriously considered, the issue becomes how to ensure that a flat-tax system becomes fully progressive in scope. This involves more than just creating large personal exemptions from tax for those earning the least. One must also consider how to tax more fully wealthier Canadians.
The following four additional measures would help make the flat-tax tax system more progressive in such a circumstance:
First, tax capital gains just like regular income thereby broadening the tax base.
 Secondly, impose a wealth tax. Canada is one of the few OECD countries that does not have a wealth tax of some kind – a tax on wealth either on an annual basis or when transferred through death or as a gift. Such a tax is controversial. Objections can be raised to it. Would the cost of implementing the tax really bring in much additional revenue? Would the tax cause those subject to it to leave the country for greener pastures? Still, the argument for such a tax is more substantial. At the very least, such a tax could ensure that the wealthiest persons in Canada are required to pay taxes according to their ability to pay. Indeed, the Ontario Fair Tax Commission recommended that an agreement be sought with the federal government and the other provinces to establish a national wealth transfer tax (which would have a generous exemption level, e.g., over $1 million before taking effect.) A study for the Commission estimated that such a tax could raise in Ontario $640 million annually. Even in the United States, land of flat-tax mania, such a proposal has surfaced. A 1995 study by the Twentieth Century Fund argued for the creation of a wealth tax modeled on that of Switzerland in order to moderate the growing gap in wealth inequality in America. That study estimated that under such a tax only three percent of American families would see their overall tax bill rise by more than 10 per cent; a full 78 percent would see their tax bill rise by no more than one per cent, if at all. And it would raise about $40 billion annually. Nor is this concern over growing inequality limited to America. Income inequality is also growing in the United Kingdom.
Thirdly, reform the present scheme of tax assistance for retirement savings. In his 1994 report, the Auditor General of Canada briefly analyzed the present schemes. Tax assistance for retirement savings (TARS) is provided through provisions of the Income Tax Act that makes contributions to these plans by individuals and employees deductible from taxable income, within defined limits. Also, the investment earnings on these assets are tax exempt until the funds are withdrawn from the plans. The primary purpose of these schemes – although not the only purpose – is to enable persons to save for their retirement in a manner that enables them to avoid disruption in their standard of living upon retirement. Some facts about this particular tax expenditure: the amount of deferred federal tax revenue the government did not collect in registered pension plans (RPPs) and registered retirement savings plans (RRSPs) was in 1991 about $15 billion. In 1992, the assets accumulated in these plans amounted to $417 billion: $270 billion in RPPs and $147 billion in RRSPs. Needless to say, this is a lot of money. The question is: Given current debt difficulties, is not this tax expenditure too generous? One reform could be to not allow the money contributed to these plans to be deducted from taxable income, since these plans already have the advantage of not taxing the investment income generated until, generally, the plan expires. 
Another alternative is that proposed by the Carter Commission. It recommended that there be a lifetime limit on the amount of money that could be placed in these retirement schemes. Specifically, it recommended that there should be no annual limitation on contributions based on a percentage of earned income. Instead, the maximum allowable benefit for all registered pension plans would be the equivalent of a single life annuity with a guaranteed term of ten years, of (in 1966 dollars) $12,000 per year, payable for an individual from the age of 65. The amount contributed would be fully deductible from income until this maximum allowable benefit was reached. Such an approach, updated to today’s dollar value, would be consistent with the principle of fairness: If reducing government debt requires massive lay-offs of government employees, should not the government’s role in subsidizing a person’s retirement also be reduced? 
The final proposal for tax reform is an especially controversial one – the Tobin tax. Some years ago, James Tobin, the 1981 Nobel Prize winner in economics, proposed a tax to penalize short-run speculative transactions in the international money markets. In a 1995 speech he gave in Ottawa, Tobin summarized the tax as follows: The rate of tax could be 0.5% on each such transaction. This tax would not act as a barrier to non-speculative transactions, because such investments would stay in the country of investment for a longer period of time and when the investment is later recouped the tax would be minor compared to the profit made. Not only would the tax act to discourage speculation, it would help create more room for autonomous national monetary policies. With trillions of dollars of transactions in the international money markets every day, Tobin estimated this tax could raise perhaps a half a trillion dollars a year. This tax should be a universal tax. One way of doing this would be by making it a condition of membership in the International Monetary Fund. However, even if this were not done, and the transactions moved to jurisdictions that had no such tax, governments could act to penalize companies that made that move – Tobin argues that governments could regard funds sent to tax-free havens by banks as if they were purchases of foreign currency and therefore subject to the tax. Being a universal tax, most of what is collected should be used for international purposes, arguably by channeling the funds to the World Bank or sending such tax revenue to the United Nations. However, this would be done by agreement of the countries and the agreement would specify how much of the revenue they would keep for themselves. Thus, it seems that such a tax could be used to raise revenue for Canada. If so, the revenue could be used to help pay off the debt and even to provide funding for imaginative schemes that could help the country in the long-term. For example, why not use this revenue to help pay the tuition of students attending university? This would relieve many parents of the burden of how to save enough money to send their children to university in tough economic times.
With these changes, a flat tax system would become more truly progressive by ensuring that those who are wealthiest pay their fair share of taxes.

Glenn Gilmour is a lawyer/researcher living in Ottawa, Ontario.