A flat tax code has many detractors, but flatter taxes mean huge gains in efficiency for innovation... and the subsequent benefits for jobs.
"Cut rates and eliminate deductions", as a bumper sticker (ahem, Twitter) length quote, started to reenter the public consciousness again during the recent Presidential election. The phrase came to be associated with Mitt Romney, although, to be fair, he was almost forced into a position on rates by refusing to detail his stance on taxes during the primary debates. Regardless of source, the quote pretty much boils down to two things:
- Gather up all sorts of styles of deductions - personal and corporate - and strike them from the law
- Since people will now be paying more money in taxes, the overall rates can be cut down with no net impact to revenues
Net impact to treasury: none. Net impact to average citizens: none.
It wasn't a flat tax code, but it was close - the flatter, the better... at least innovation wise. We'll explain, from the perspective of an Engineer.
The Earth is Flat!
"Well, PK..." you're thinking... "enacting a flat tax code sounds like an incredibly stupid idea and waste of political capital for a net benefit of... zero. Well, dear reader, as with most theoreticals on our site here, we have to turn to Frédéric Bastiat to explain the rest to you.
Bastiat was obsessed with the effects of policy and decisions on the unseen. Yes, Government spending can produce a shiny new highway bridge, a tape cutting ceremony, and a ticker tape parade - but at what actual cost? Maybe the Government spent $80,000,000 on that bridge - but was there a more productive project possible in the economy? Was the bridge the low lying fruit? Could a different process have produced two bridges? Would less worked have been idle under a different bid process? The fundamental question: was there a superior alternative to invest the funds? What effects are being felt that will never even be seen?
And, yes, that's the issue with Economics as a 'hard science': There is no control group.
You can't pause time and relaunch a country's economy with both sides of decisions - you can only find comparable inflection points and compare the differences (see: Econometrics). That doesn't mean that we can't think our way through the thought processes of participants in a theoretical market - and that's just what we're going to do for this example.
The Bad.
Let's say we live in a country called "Nowhereland", and the Government (like the US Government) has set up a similar tax code - very progressive, but with multiple lucrative discounts and write-offs available. I'll turn my attention now to 'Alternative Energy', since it's become a buzz word - Nowhereland's Government has enacted some Alternative Energy laws, where Research and Development for higher efficiency selenium solar cells is basically free after a credit. It's a huge benefit - most shops are paying upwards of 40% - 50% in tax rates under the current code. (For the nerds in the audience worried about my use of the word selenium - pretend it's the 1950s).
You can imagine what happens next in Nowhereland... anyone even tangentially working on solar cells and alternative energy immediately switches their research to selenium cells, since that's what is newly in vogue and now heavily subsidized.
Efficiency rises to a certain degree (the original cells were around 6% efficient, so there is room), but level out after some time. You see, Government invested in a known quantity (as it so often does), at the expense of other, unknown technologies. What technologies did it miss? Well, that was the 1950s, so let's take a look!
<Click for larger> Solar Technology Since the 1970s... A Flat Tax Code Doesn't Need to Understand this... (Wikipedia)
The Better
Obviously, the Nowhereland Government jumped the gun on that one.
If you think I'm just tilting at windmills, I'm sorry to tell you you're wrong - there are tons of examples in the current United States tax code where an early technology was advanced way too far based upon lawmakers jumping the gun. The ultimate example, of course, was federal subsidies for corn ethanol. Those subsidies, enacted 30 years ago, recently "expired" (the subsidy now allows all fuel research, as if that's better). Paging Bastiat: what sort of improvements in technology would we have made if we hadn't subsidized the first mover?
Heck, there are probably other grains which are better at producing fuel than corn!
Paradise lost? Well, maybe not, but certainly opportunity lost.
Let's say Nowhereland gets their act together and finally changes the code to subsidize all forms of solar cells. Certainly an improvement, right?
Wrong, actually.
The government is slightly better this time, but they are still subsidizing technology at the expense of alternatives. Think inside the box - what if there is another way to harvest solar energy that doesn't involve solar cells? What if there are other, more efficient forms of, ahem, alternative energies that could be developed - such as geothermal energy, wind power, hydro-power, and nuclear fusion and fission? What if there are power capturing technologies that haven't even been developed on a large scale - something like piezoelectricity? (As first world countries get heavier, on average, we could recapture more of that mechanical energy!)
I know your resistance is breaking down now, but let's pretend that you're such a fan of subsidizing particular research that you thrown up your hands and say, "fine PK, you're right. Let's subsidize any alternative energy that looks promising. Isn't that good enough?". Well, I detect the sarcasm and defeat (and rolled eyes!), but no - it isn't. Since subsidies will draw research from tangentially related fields, that's still a horrible idea.
Why is that? Elementary - what if the biggest breakthroughs have nothing to do with generating power at all? What if new products revolutionize consumption as opposed to generation?
(And I don't pretend for a second that our government has been good on the consumption side. Government effectively subsidizes Compact Fluorescent bulbs, which are an inferior technology to LED bulbs, as anyone light-sensitive who has spent an extended time reading under a first generation CF bulb can attest!).
Moore's law in effect, most consumer products increase in efficiency over time - my fridge no longer needs it's own branch from the sub-panel, my computer completes more cycles per watt, and my TV produces better (and larger!) pictures for 1/100th the power of 1990's top of the line CRTs. Even my cell phone rivals the computing power of the (still working, yet idle) computers in my closet.
The Best? A Flat Tax Code?
So what is the best?
This article mainly looked at corporate (and research) deductions, but this applies to every other aspect of the tax code as well. Raise dividends at the expense of capital gains? Treat carried interest different than... interest? Tax savings accounts higher than CDOs?
Truth is, Government can't foresee the best path in any field - whether that field is finance, farming, energy or any branch of science. So, like the solution to WarGames (SPOILER ALERT)... "The only winning move is not to play". So, we should stop fighting yesterday's war - subsidies only help the entrenched at the expense of technologies that don't even exist yet (and maybe haven't been considered).
That's right - eliminate and flatten: a flat tax code is best. I want to see piezo power under Times Square!
