The University of Chicago Magazine April 1996
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Will this tax bridge the wage gap?

Forget, for a moment, about the huddled masses, yearning for a simpler 1040.Why do economists fancy a flat tax? Most say it's because the flat tax, bydropping the tax on savings, taxes consumption-it mimics a sales tax or aEuropean value-added tax (VAT) in its macroeconomic effect. Money just sittingin the bank would accumulate tax-free. The current income tax, expertscomplain, penalizes savers because it taxes their money twice: first when it'searned, then when it brings in a return.

To Joseph Isenbergh, ending that double tax will do more than boost America'ssavings rate, now among the lowest of its peer nations. He sees a consumptiontax as a vital step to raising real wages, which have been declining since the1970s. Instead of the usual suspects-technology and foreign trade-Isenberghblames a tax code that leads to "income redistribution" from savers tospendthrifts, and that makes scarce the investment capital needed for long-termgrowth.

Politicians, too, promise growth from a flat tax, an America reborn overnight.Actually, admits Isenbergh, "You can't usher in arcadia by a flat tax. The cureto low real wages and sluggish capital formation takes a lot of time." Othersdoubt whether it's a cure at all, even ten years out. Sherwin Rosen, for one,calls tax policy an "overrated" factor in the individual decision to save orspend.

Still, Chicago's consensus opinion says any change in savings would be upward,and advantageous. But consumption taxes like the flat tax also have a subtlervirtue. They are, say the experts, "efficient."

An efficient tax doesn't distort economic behavior. If the sweet deductibilityof mortgage interest is what clinches a home-buyer's decision, that's fine forher, but not for the economy. Minus the deduction, she might buy the houseanyway, or find something cheaper and invest the savings. Whatever she does,the economists concur: When the urge to avoid taxes is zapped from theequation, people make better choices-better because money is free to flow toits most productive uses, yielding more economic growth.

The flat tax stifles the tax-avoidance urge by closing loopholes faster thanyou can say "registered lobbyist." Efficiency-minded academics aren't likely tomourn the loss: One trashes Clinton's proposed $500-per-child tax credit as"another dumb expenditure"; another lampoons the mortgage subsidy by asking, "Iblow my nose a lot-why can't I deduct the cost of Kleenex?"

One person's giveaway, though, is another's socially responsibleincentive-like empowerment zones for urban and rural areas. Such programs needto change, not end, counters Austan Goolsbee. The tax code wasn't built for"social engineering," he says. "Subsidies or direct spending are much betterways to accomplish goals."

  • Return to Opener
  • How low can a flat tax go?
  • Is flat fairer?
  • Simplicity: Are we already there?
  • Will this tax bridge the wage gap?
  • Will the flat tax fly?

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