Get Ready for the Flat Tax Debate

Supporters counter with a familiar pair of arguments - less tax evasion and higher growth. Even if flat taxes helped curb tax evasion in Eastern Europe, there is no reason to think they would have the same effect in Western Europe or Australia. It assumes tax evasion on a scale nobody seriously believes happens in any western country. As to higher economic growth, supporters invoke the dubious Laffer Curve to suggest that the reform stimulates economic growth which eventually replaces the lost tax. David Walker wrote in The Guardian that even if true, “eventually is a long time in politics” and in the interim services would be slashed.

The alternative to slashing services is to raise other taxes, which is what some East European countries are doing. Romania is currently raising VAT and excise to plug the gaps in revenue. Other countries now have specific social security payments, of up to a third of income, on top of the flat income tax, so the amount of tax taken from salaries is not as low as the headlines suggest. Taken together, these make you wonder how beneficial their flat taxes really are.

Proponents argue that current systems are extremely complicated and difficult for ordinary people to understand. A modern economy is made up of people earning or acquiring money in an enormous range of ways, from an enormous range of sources and doing an enormous range of things with that money. There are also huge differences in the total amount of income people have. The complexity of the tax system is what makes it relatively fair and simplifying it will not necessarily make it fairer. We have accountants and tax specialists to navigate the tax system, in much the same way that we have solicitors for the law, doctors for medicine and mechanics for cars. No one argues that it would be better or possible to simplify the law, medical principles and cars to the point where anyone could be an expert.

To make flat taxes more palatable, proponents argue that they will benefit those on low incomes. This is a smoke and mirrors exercise. The poor benefit from generous thresholds, but this actually makes it a two tier system - a lower rate of 0% and an upper rate of X%. This benefits the poor only because it removes the “flat” element. A progressive tax system could equally well have a generous threshold.

Flat taxes also are not flat because, despite claims that the system does away with the need for exemptions and complexity, these survive. Under the models being pushed in Western countries share dividends, interest, rental income and some other taxes are variously made exempt, despite clearly being income - unsurprisingly this would mainly benefit the rich. Similarly the tax system is currently used to encourage behaviour which is seen as good, either for us or for others. So superannuation contributions and charity donations need to be treated differently. Furthermore, the elderly are also suggested as a special group requiring different treatment. This is just the start of the list, and it is making a simple flat tax look decidedly complicated and not very flat.

The only way flat taxes can be made to “work” is through cuts to services or increases in other taxes, as well as modifications that mean they are fundamentally not flat - such as thresholds and exemptions. It is hard to escape the fact that they are promoted by those who also push for fewer public services, increased incomes for the wealthy and a smaller role for government. The flat tax concept is simply window dressing for good old-fashioned greed.

The flat tax debate will arrive here. John Howard has successfully promoted two ideas about personal taxation. One is that the top rate of income tax should match the corporate tax rate. The other is that personal taxation needs to be “internationally competitive” i.e. the top rate should be lower. This provides fertile ground for flat tax supporters.

Being internationally competitive depends on a range of factors, including investment in R&D, infrastructure, education and ICT - all of which are currently below standard. Income tax is peripheral as most people are not willing or able to move around the globe chasing a few cents in the dollar. Besides, there is still plenty of scope for adjusting rates and bands within a progressive system, as contributions from Craig Emerson, Bill Shorten, Steve Bracks, Peter Costello and others demonstrate.

Australia’s economy is broadly in good shape and does not need the kind of boost for which flat tax supporters argue. But then, Britain’s economy is equally sound and the debate has now reached the political mainstream there.

Ultimately a flat tax could not work in Australia, but that does not mean the debate won’t happen. Australia is a modern economy with good public services and low levels of tax evasion. A flat tax would lead to a huge drop in tax receipts, which may or may not “eventually” be regained through higher economic growth. In the interim, the loss of revenue would need to be offset by swingeing cuts to the services Australians rely on and value dearly. Alternatively, services could be maintained if a flat tax was set at a level which left total receipts where they are. Whilst this would benefit high and low income earners, it would torpedo the finances of those on middle incomes - the very people everyone is currently so keen to help.