Saturday, November 1, 2008

Hong Kong, Russia and the Flat Tax

BOULDER, Colorado -- I may have been a little too hard on the flat tax in my last post. It is not an utterly bankrupt idea, but it is one that is usually floated as a populist ploy - it is popular because it is easy to understand, not because there is any real evidence supporting it.

Hong Kong's tax system is often cited as an example of either a flat tax or an "alternative minimum tax." In fact, it is neither; the system does have tax brackets with graduated rates, but at the highest income level, filers pay a flat rate of 16% with no deductions or credits. Hong Kong's system is admired because it is efficient and straightforward. Workers pay taxes on their income, and companies pay taxes on their profits. There are no additional levies like payroll or sales taxes, meaning the revenue stream is simple. As Alan Reynolds from the Cato Institute argues, even with the much lower rates in the Hong Kong system (ranging from 2% to 20%), government revenue would not be substantially lower if this system were adopted in the US. Hong Kong collects about 7% of GDP in income and profit taxes, while the US rate is 8-9%.

The arguments in favor of a purely flat tax system are far less convincing. It has really only been adopted by the former socialist countries of Eastern Europe, and there is little evidence to suggest that it has increased government revenue or attracted more investment. A simplified tax code just makes collection slightly easier in countries that are plagued by official corruption and low levels of compliance by taxpayers. Here is a list of the countries that currently have a flat tax system:

Czech Republic
Guernsey and Jersey
Gangster pseudo-state Transdnistria

And of course, John McCain's favorite country and Russia's whipping boy, the Republic of Georgia. Because today, my friends, we are all Georgians.

I don't know how I got onto this topic, as John McCain is certainly not a proponent of the flat tax; I just think it is a rather interesting debate. But it is unlikely that we will see any substantive changes in the tax code, regardless of who wins the presidency. The government will simply make slight changes to the brackets and rates of what is a pretty confusing and inefficient system.

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