Saturday, April 7, 2012

Why the Flat Tax Rate Ought to Simply be 10%

I believe that there should be a flat tax, and that this rate ought to be 10%.  First I will explain the basic idea of the Laffer curve, which I'll use as a visual aid; then I will explain how it's perceived by political regiment.  Lastly, I will try to explain why I believe taxes ought to be this exact rate.

The purpose of the Laffer curve is to illustrate the notion that there's an optimal tax rate point (that is, a peak) for generating the maximum amount of revenue.  It also illustrates how revenue first increases as the tax rate goes up, then decreases beyond this peak.  The following figure shows a basic Laffer curve that assumes a tax rate of 50% as the optimal point for maximizing the amount of revenue that can be generated.

One simple variation of this curve involves a peak that skews towards a lower tax rate, as shown in the following figure.  I call this the Individualist's Version of the Laffer Curve (as in fiscally conservative or libertarian minded political leanings).

Another simple variation of this curve involves a peak that skews towards a higher tax rate, as shown in the following figure. I call this the Socialist's Version of the Laffer Curve (as in the "central planning" type of political leanings).

To show why 10% is the best tax rate, consider this: what is the difference between calculating 10% and 12.5% of a value, such as income?  The answer is simple and straightforward - with 10%, there is a convenient shortcut - no calculation is necessary to determine the amount; all that is necessary is to move the decimal point one digit (or place) to the left...and BOOM!  You're done doing your taxes.  On the other hand, with something like 12.5%, it is necessary to perform a calculation to determine the amount.  Yes, I know that taxes are much higher than this for many people, and I'm just not going to get into how convoluted and absurd taxes actually are today (which is what I think we ought to get away from in general).

This calculation shortcut trick can be used with other rates besides 10%, such as 1% (i.e., move 2 decimal places instead of 1), 0.1% (move 3 decimal places...), 90% (move the decimal point 1 digit to the left to determine how much a taxpayer keeps rather than pays), 99% (move 2 decimal places...), etc.  In the following figure, I show a variation of the Laffer curve that makes the assumption that the revenue generated at these rates jump to a significantly higher amount, and that at 10% and 90% they could conceivably be higher than the peak of the curve itself.

Tax rates of 1%, 0.1%, 0.01% probably aren't going to be as effective at generating revenue, and even get into fractions of a penny at smaller rates (for most income levels), and 90%, 99%, 99.9% would probably be very politically unpopular, so 10% seems like the only feasible option.  The name of the game here is psychology. If the average taxpayer can easily figure out how much they have to pay in taxes, they'll be able to more easily get it taken care of and over with, and much sooner as well so they can go on with their life as an employee and consumer (which some might argue is probably good for the economy).  A 10% rate might encourage more people to pay taxes (rather than avoid or dodge them) as a result of being very low.

I would imagine that taxpayers would also be happier with a low and simple flat tax rate of 10% every year.  They'll have more money to spend, which in turn could lead to less unemployment, poverty problems, and a healthier economy in general.  By keeping it this way year after year and having increased revenue each time, there's also the potential benefit of the government being better funded, reducing the national debt, and further improving the economy.  I don't think this sounds bad for career politicians who favor a flat 10% tax rate.

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