by Peter Bearse

When might our yearning for simplicity lead us astray? – When dealing with the economy. We see this happening now with schemes for tax reform. We recognize that current tax arrangements have become mind-numbingly complex and rather unfair. So we seek a simple tax. Enter Steve Forbes with a “Flat Tax.” Never mind that it fails to address the root of our economy’s failings. Never mind that it’s just another income tax with which Congress can play its social engineering via tax incentives’ games. It’s flat; and since, according to Tom Friedman, the economic world is also “flat,” flat must be good.

And so we have the all three Republican candidates for Congress in the 1st C.D. competing on flatness -- on how quickly and strongly they recommended the Flat Tax. Unfortunately, they’re informed by ideology, not economic understanding. Why would a Flat Tax be good for the economy? What basic economic problem would it help to solve? What good would it do besides providing less business for accountants, lawyers and H.R. Block?

The major source of our economic problems is that we have been living far beyond our means. Savings have been very low and sometimes negative (dis-saving). Consumption has been unsustainably high. We have financed higher spending by drawing down equity in our major asset, our homes. Our trade deficit has been consistently negative, with imports far higher than exports. Our federal deficit has ballooned. Private debt has risen like the flames of a house afire. China and oil exporting countries have supported our excess spending by buying our country’s debt – to the extent that their “Sovereign Investment Funds” are buying our industry. How does a Flat tax address these problems? It doesn’t. It is simply a simple-minded, politically inoffensive expedient.

What would help us get a grip on our economic future? – a Consumption Tax [CT], otherwise (though somewhat misleadingly) called a “national sales tax.” As you can tell from the name, it taxes spending on consumption, not income, savings or investment. Thus, by its very nature, it provides disincentives to excess consumption and positive incentives for higher savings, investment and earnings.It is not nearly as simple as a Flat Tax. Members of Congress can still try to play games with it to favor some interests over others. Yet, it’s better than the current income tax and the proposed Flat Tax in its ability to help us strengthen and rebuild our economy.

Another advantage is that the CT would force our government to live within its means. This is because calculations show that a “reasonable” CT rate (say, 7-12%) would not generate enough revenue to finance the U.S. government at its current, excessive rate of expenditure. So what!, says this economist. It’s about time that Washington has to live within its means. To the extent that this is deemed to be a serious issue, we can consider another so-called tax which is not a tax but a fee on undesirable pollutants – a “Carbon Tax”. This would, in turn, be better than the highly touted “cap and trade” arrangements to reduce carbon emissions and fight global warming. But this calls for more discussion.

International Consulting Economist
March 16, 2008