The economy has most certainly become the central discussion point for both the Obama and Romney campaigns during this election year. With the addition of Congressman Paul Ryan to the Romney ticket in August, discussions of the Ryan Plan have reemerged. Ryan has largely shied away discussing a flat tax option, although he did suggest a flat tax plan in the past, and found some merit it candidate Rick Perry’s optional flat tax plan last October. On Tuesday, Ryan appeared on GMA where he argued with anchor George Stephanopoulos that a reduction of tax rates was necessary for economic growth. With all the tax reform talk, it’s left me wondering if the Eastern European model of flat taxes will affect the political rhetoric before the November elections.
Since 1994, 24 countries (the bulk in Eastern Europe) have adopted a flat tax system. This spread of the flat tax has been quite remarkable during the past 15 years, and it has contributed to the widespread economic growth throughout Eastern Europe. Additionally, the flat tax in many of these countries has helped create a simple system of revenue collection that saves millions in implementation and collection costs.
Is the European model the ticket to U.S. financial recovery? Let’s first consider the complexity of the U.S. tax code. It is estimated that taxpayers and firms spend over 6 billion hours per year attempting to correctly file tax returns. Not only does this figure represent the equivalent of millions of workers, but it also pulls billions of dollars out of more productive uses. According to the IRS Taxpayer Advocates, who reported to Congress in 2010, the complexity of the American tax code is driven in part by the continual changes to the system as the federal government attempts to squeeze more and more out of taxpayers. In the past decade there have been approximately 4,400 tax code changes resulting in an additional 3.8 million words to document the U.S. tax code.
It is clear that this complexity costs billions of dollars each year just for taxpayers to comply with the laws, yet it also costs the Federal government billions in tax fraud and avoidance. Again, Eastern Europe provides a lesson here where compliance of Russian taxpayers increased by over 30% after the adoption of a flat tax system.
In addition to the massive waste of resources due to complexity, the American tax code is a drag on economic growth and progress. U.S. households and firms make decisions with their resources that are based not on market returns but on tax sheltering and loopholes. Foreign firms weigh the costs of locating in the U.S. based on a tax rate that is the second highest in the world. Congress and the White House are continually using the tax code to regulate. The tax code has become the primary means of legislation, and the continual additions and changes imposed on the tax system contribute to uncertainty and fear among firms which eventually lead to decisions that hinder economic development.
Objections to a flat tax almost always hinge on fairness rather than economic efficiency or outcomes. A progressive tax is deemed “fair” because higher income earners pay a higher marginal tax rate, and thus any talk of a flat tax is immediately rejected by those who see unnecessary benefits to the rich. Yet, with a flat tax the more you earn the more you pay (as with a progressive tax system) and with a true flat tax you no longer have the countless loopholes and deductions to hide behind. A flat tax system is more “fair” by any economic measure as taxpayers do not have to spend time and resources gaming the system in order to shelter their income (a practice that certainly benefits the rich).
If America wants to move past the stagnation of the previous four years and begin to see consistent economic growth again, tax reform is necessary. The examples in Eastern Europe demonstrate that flat tax reform is possible and can have a significant economic impact. What these examples also show, is that strong executive leadership is a crucial component of any successful tax reform. The Romney-Ryan ticket has a clear opportunity to set the agenda early and champion the necessary reforms to unburden American individuals and firms with an outdated, inefficient, and costly tax system.
Dr. Peter Frank is co-author of a recent study entitled “The Flat Tax: Has its Time Come?” which can be read in its entirety at www.jessehelmscenter.org. Frank is also the Jesse Helms Free Enterprise Fellow at the Jesse Helms Center and a professor of economics at Wingate University. You can reach him by email at PeterFrank@jessehelmscenter.org