The Flat Tax – The Time Has Come

Steve Forbes, in his excellent book How Capitalism Will Save Us, urges the adoption of a flat tax to replace the cumbersome IRS code we currently have to struggle with every April 15^th.

He points out the obvious advantages:

1.     Every type of income, both personal and corporate, is taxed at the same rate.   He suggests a rate of 17% (currently the tax ranges from 10% to 35%).

2.    He would eliminate all other special taxes.  (currently we pay 15% for capital gains in addition to city, state and local taxes).

3.    He advocates a personal and family exemption schedule.

Forbes has a lot of company with the flat tax concept.

Another advocate is Daniel Mitchell of The Heritage Foundation.  Mitchell says that our present system has to be reformed.  He notes that many nations around the world are lowering their tax rates with positive results to their economies as

jobs and capital flow

to those nations

with the most favorable tax laws.

Even nine countries of the former Soviet Union bloc are implementing flat tax policies.

The flat tax treats all taxpayers equally, lowers the penalties for productive behavior, work, risk-taking and entrepreneurship.

Mitchell parts company with Forbes on exemptions as he is not infavor of any exemptions and eliminates all deductions, credits and other loopholes in his proposal.

All proponents of a flat tax stress that there is no double taxation on capital formation, savings, dividends or other investments.  There would be no death tax, capital gains or other taxes to contend with, either.

The Heritage Foundation uses Albania as a prime example of the advantages of a flat tax:

Albania now has the lowest taxes in Europe

and their GDP has shown the greatest increase in the world

with a 42% jump (since 2007).

This former Communist country instituted a flat tax when they adopted a Capitalist Democracy in the late 1990’s.  Since that time, they have operated with a 10% flat tax and have seen their unemployment drop, their poverty rate has declined, their infrastructure has undergone extensive repairs, corruption in government has been reduced and organized crime has become increasingly controlled. Albania is experiencing great increases in trade activities, improvements in property rights and increased foreign investment as well.  In June 2006, they took the first step towards joining the European Union by completing the formal application.

Albanian billionaire Sahit Muja says that the United States and the European Union should move to a flat tax. Tax revenues in Albania now generate 23.3% of GDP while government spending is only 29.3% of GDP.  Even with less bureaucracy, most of the government spending has been on education and infrastructure.  Albanians think that the United States and the European Union waste money on worthless social programs.

Our annual skirmish with tax forms consumes countless hours of time and great expenditures of our incomes which could be put to much more positive use with the introduction of the flat tax.  This is not to mention the savings at the federal level by the dismantling of the most despised government agency:  the Internal Revenue Service (all 115,000 agents and their staffs) – not to mention the elimination of thousands of lobbyists whose only reason for being in Washington is to influence the members of the Ways and Means Committee and the structure of the tax code.

Forbes sums it up best:  “The flat tax would allow the United States to once again become a business-friendly environment.  Nations around the world that have instituted a flat tax: from Lithuania and Romania to Mongolia and Russia, have seen their economies roar almost immediately.”

Why Aren’t We Learning From Japan’s “Lost Decade?”

President Obama has requested another round of stimulus spending with expanded unemployment benefits and additional money for infrastructure projects to jump-start economic growth and reduce unemployment. Although this stimulus package is meeting with more opposition than the first, our elected officials do not seem to have learned anything from other countries who have unsuccessfully tried similar stimulus policies in the past. Take Japan for example.

Following strong economic growth and low interest rates in the 1980’s, an asset bubble developed in the Japanese economy consisting of inflated real estate and securities prices. Recognizing that this bubble was unsustainable, the Japanese central bank raised interest rates in 1989, leading to a massive sell-off in securities and a dramatic decline in real estate values. In short, the bubble burst.

The government responded with several rounds of stimulus which consisted of massive infrastructure spending. All over Japan, roads were paved, dams were built and bridges were erected to connect numerous land masses all in an effort to stimulate the economy. In the process, Japan accumulated trillions in national debt which now totals 180% of it’s nearly $6 trillion dollar economy. So large is Japan’s debt that it now ranks number one of the developed countries in terms of leverage.

So how well did this entire stimulus program work? Well, economists generally refer to this period in Japan’s history as the “lost decade” because the policies failed. Miserably.

Between 1989 and 2003, the Nikkei Index fell by 80% and real estate declined by 50%. Homeless camps sprung up on the banks of many rivers as people abandoned their homes due to foreclosure activity of the banks. The suicide rate skyrocketed when unemployment doubled. Even today, exports still continue their downward spiral, prompting fears of a second wave of recession for the Japanese economy.

The Heritage Foundation says that no nation is sorrier than Japan for endorsing John Maynard Keynes brand of economics and for squandering vast sums of national wealth in a vain attempt to stimulate their economy.

It now appears that these policy mistakes cost Japan the chance to lead the world in economic growth. Indeed, The Japan That Can Say “No” learned the hard way that fiscal stimulus programs financed by debt won’t stop bankruptcies, declining real estate values, foreclosures, job losses or a falling stock market.

Richard Koo, the chief economist at Nomura Research Institute calls our current recession “a balance sheet recession.” In the United States, the housing and credit bubble created several trillion in assets. It also created several trillion in debt. When the bubble burst, the value of the assets declined as housing prices plummeted and mortgage backed securities became worthless. Unfortunately, the debt remains.

The only solution now is for banks to remove these assets from their balance sheet by taking the write-offs. Likewise, individuals and business have no choice but to pay down their debt. This reduction in debt takes huge sums of money out of the economy. Koo maintains that Federal Reserve Chairman Ben Bernanke and popular left-of-center economist Paul Krugman, who often writes for The New York Times, do not understand this yet as demonstrated by their vain attempts to prop this bubble up even more through massive government stimulus plans financed by equally massive increases to the national debt.

When one compares one financial indicator: The Nikkei 225 Index to the Standard and Poor’s 500 Index, there is a frightening similarity. If the United States stays on its current course, we are likely to suffer the same fate as Japan, and perhaps even more so, because while the savings rate cushion in Japan was 17%, the United States savings rate is considerably lower.

Furthermore, Japan had very little population growth during this period while the United States continues to grow from substantial immigration, both legal and illegal. Where most of the bad debts in Japan have been written off and removed from balance sheets, most banks in the U.S. have not written off their bad debts and we continue to prop up vast sums now owned or backed by Freddie Mac and Fannie Mae.

American businesses are truly beginning to see the same level of declines that the Japanese experience. Brian Dunn, the President of Best Buy, recently commented: “In 42 years, we have never seen such difficult times for the American consumer.”  If the United States does not curtail its current government spending frenzy and stabilize our sovereign debt level, we are destined to suffer a period of low economic growth, historically high unemployment, stagnating living standards, all while the world around us resumes prosperous growth.

In short, we, too, will experience our own “lost decade.”