Why the GOP's Flat Tax is a Terrible Idea

Over the past few weeks, GOP presidential hopefuls began offering their views on US tax reform. From Rubio to Cruz to Ben Carson, the idea of a flat tax, a single tax rate applied to all taxpayers, has become the rallying cry of GOP candidates. Simple, swift, fair, except for the fact that it would be an outright disaster. 

In October, the Wall Street Journal ran an opinion column by GOP candidate Rick Santorum entitled, A Flat Tax is the Best Path to Prosperity, heralding the coming of a new, just and simplified tax system. In it, Santorum proposes a single tax rate of 20% that would be applied to all income in the US. His plan would eliminate the marriage penalty, the death tax and the alternative minimum tax, pernicious taxes paid by a great number of Americans. In its place, each taxpayer would be given a $2,750 standard deduction, as most other deductions and credits would be eliminated. Santorum estimates that his tax plan will reduce federal tax receipts by $1.1 trillion over ten years, to be paid for in part, he explains, by repealing Obamacare. Hmm.

But a flat tax ignores several important realities about the US economy and its tax base. First, among these is the fact that 43% of American taxpayers pay nothing in federal income tax. Moreover, roughly 14% of US households pay neither federal income taxes nor payroll taxes (with two-thirds of these taxpayers being elderly). The reason for the low rate of tax participation, according to the Tax Policy Center, is fairly straightforward: half simply earn too little, while the other half reduce their taxable income through the earned income and child tax credit.

Now we can argue that these individuals are not paying their fair share, but the fact is, a flat tax would devastate these households, already stressed to make ends meet on marginal incomes. Moreover, tax collections from this population, in light of their resources would make this proposal not only unfair, but also highly unlikely.

Now the question remains, if 43% of taxpayers pay no federal income taxes, who does pay? Apparently, 83% of the $1.26 trillion in total US income taxes collected in 2014 came from the top 1/5th of taxpayers. The top 20% accounted for 51% of total US personal income and 83% of total personal income taxes (the reason the latter number is higher than the first is, of course, due to the progressive tax system currently in effect).  

A flat tax of 20% would greatly reduce the income collected from this higher income group, while doing little to raise tax collections from the 80% of US taxpayers that account for the remaining 17% of total federal income tax. In short, a flat tax would be a disaster. And while proponents of the flat tax will argue that lower tax rates will incentivize greater production and therefore raise the total level of income subject to tax, there's simply no reliable data to support this conclusion. As we enter the new year, the GOP needs to drop the flat tax and move on to a more sophisticated tax plan if it intends to capture the imagination of the voting public.

Award-Winning Finalist in the Business: Personal Finance/Investing Category of the 2015 USA Best Book Awards

Up In Smoke: How the Retirement Crisis Shattered the American Dream was awarded the Finalist designation in the 2015 USA Best Book Awards category of Business: Personal Finance/Investing.  The book was one of two finalists in the category and the only self-published work to receive this award. Up In Smoke chronicles the underpinning of a crisis in American retirement funding from Social Security to public pension systems, 401(k), IRA and private retirement savings accounts. It is required reading for anyone interested in the state of US retirement savings, the implications for the US economy and the crisis facing 70 million baby boomers now approaching their retirement years. The full list of 2015 USA Book Award recipients can be found here.

Why You Need to Pay Attention to the Retirement Crisis (even if your retirement is fully funded)

A recent survey in Forbes of attitudes toward retirement revealed 18% of Americans believe they are very prepared for the expenses of retirement. A report of the Employee Benefit Research Institute, however, estimates that 43% of Americans believe they are unprepared. The remaining 39% are uncertain about their ability to support themselves in retirement. Many of those who are unprepared believe the government will find a way to support them in their golden years. While those comfortable in their own plans believe the retirement crisis is simply "not their problem". Both groups are wrong. Here's why.

Currently in America, half of pre-retirees (age 55-64) have no retirement savings, while the half that do show median savings of $111,000. The median retirement savings of this age cohort as a whole (including both those with and those without funded accounts) is only $14,000. By 2030, just fifteen years from now, Americans age 65 and over will total 70 million. Half, or 35 million people, will have no retirement savings. The median balance of those with savings will support retirement income of about $370 per month. So, another 17.5 million will be grossly underfunded in their retirement savings. Roughly 9% of this group, or 6.3 million work for public sector agencies, often with good retirement plans and benefits. This means roughly 46 million people will neither have the benefit of public employee pension plans, nor adequate personal retirement savings. By 2030, US total population is projected to be on the order of 375 million people, so this group of economically distressed seniors will represent an estimated 12.3% of the nation's population.

First, as to why the government can't make this problem go away. The 2015 Trustees Report of the Social Security Administration shows a projected date of insolvency of the Social Security Trust fund of 2034. By that date, the Trustees predict, Social Security will only be able to pay roughly 75% of annual benefits. Now, median annual benefits of Social Security last year were just $15,000, so (in current dollars) median benefits would be reduced down to $10,000 per year (75% of $15,000), substantially below the poverty line. For the fund as a whole, the present value deficit of Social Security today, again per the Trustees report, is a staggering $10.7 trillion.

Now, why this is your problem, even if you believe it is not. If you've been reading along, you have a sense of the magnitude of the retirement crisis and can begin to imagine the consequences to the economy of a burden of 46 million seniors living in poverty. But consider this. In addition to the under-funding of personal retirement accounts and Social Security mentioned above, US state and local government pension plans are underfunded by an estimated $4 trillion. These are funds that governments are legally responsible to pay retirees. To raise the funds necessary to pay their pension obligations, governments will turn to...taxpayers. There is no one else. Now, don't shoot the messenger, as bad as the problem is, it's still better to be aware of the issue now, while some solutions still exist. 

If you'd like to read more about the retirement crisis and what can be done about it, please check out my new book, Up In Smoke: How the Retirement Crisis Shattered the American Dream, available now on Amazon.com.