High-Income Earners' Higher Burden Under a Flat-Rate Tax | Eastern North Carolina Now

    Publisher's note: The author of this post is Mitch Kokai, who is associate editor for the Carolina Journal, John Hood Publisher.

    RALEIGH     Government requires money to do its work.

    Anarchists disagree. But for the vast majority of us, the real debates involve, first, how much money government needs and, second, how government ought to collect that money. The rest of this discussion focuses on the second question.

    A recent Daily Journal described the "progressive nature" of North Carolina's flat income tax rate. It discussed how an increase in the standard deduction would make the flat tax even more "progressive."

    It's worthwhile to ask: How does a flat tax with increased progressivity address government's need to raise money? How does that option compare with others?

    Let's use a simple example. First, we assume that legislators want to collect $20 billion to fund a state's General Fund budget. Second, we peg the taxpaying population at 10 million people. Third, we assume the average taxpayer's income is $40,000. Fourth, we assume that the income tax will fund the entire General Fund bill. (None of these assumptions is meant to reflect facts about North Carolina.)

    How could the state raise its $20 billion?

    Perhaps everyone should pay the same bill. This option has the benefit of simplicity. Tally up the price tag for government, divide that total by the number of taxpayers, and you end up with $2,000 per taxpayer.

    This is called a "head tax." It's identical for every member of the taxed group.

    Is it fair? Some might say yes. But support for this type of tax tends to drop once people consider the impact on taxpayers with a wide range of incomes.

    A $2,000 tax represents 10 percent of the income of a household with $20,000 of income, 5 percent of the income of a $40,000 household, 2 percent of the income of a $100,000 household, and just 1 percent of the income of a $200,000 household. Those percentages represent the "effective" tax rates for those households.

    While each of these households is paying for the same group of services, the head tax takes a larger chunk out of the budgets of the lower-income households. It's a textbook example of a "regressive" tax.

    It's worth noting that no one in today's political debates makes a serious argument about instituting a head tax. In fact, one of the most common forms of head tax - the poll tax - is banned by the 24th Amendment to the U.S. Constitution.

    Among those making policy decisions in North Carolina, there's general agreement that those with more resources to pay taxes ought to pay a larger share of the tax bill.

    Those who earn more pay more. The question is: How much more?

    This brings us to the next option: a flat-rate tax. Rather than assess every taxpayer $2,000, apply one tax rate to income at all levels. We've noted above that the average taxpayer in our example earns $40,000 and that a $2,000 tax equals 5 percent of that taxpayer's income.

    Apply a flat-rate income tax of 5 percent to every taxpayer, and you'll generate the $20 billion for the General Fund. The $20,000 household pays $1,000. The $40,000 household pays $2,000. The $100,000 household pays $5,000. The $200,000 household pays $10,000. A household with $1 million in taxable income would pay $50,000.

    Once again, it's important to note that each taxpayer is paying for the same bundle of government services. But the share of the bill assigned to those with higher incomes is larger. Note the 50-1 difference in the bill between the $1 million taxpayer and the $20,000 taxpayer. It mirrors the 50-1 difference in their incomes.

    Leaving our example for a moment, it's worth noting that the flat-rate tax's real-world implications are even more generous to lower-income households. While all taxpayers have access to public roads and police protection, many government programs are designed specifically to serve those with lower incomes. Requiring higher-income households to pay larger tax bills essentially transfers income from one household to another.

    This is why it's misleading for a politician or pundit to argue against a flat-rate tax by saying those with higher incomes ought to pay more. Those with higher incomes do pay more - substantially more.

    And that's before factoring in a standard deduction, or zero tax bracket, that exempts a certain amount of income from any taxation.

    Even if you see the flat-rate tax as fairer than a head tax, you might argue that the $1,000 tax bill is a more significant burden to a household with $20,000 in income than a $10,000 bill for a $200,000 household.

    Proponents of a flat-rate tax, including members of the N.C. General Assembly, agree. That's why they have shown interest in exempting larger chunks of a household's income from any taxation. The tool for accomplishing that goal is the standard deduction.

    In our example, let's add a standard deduction of $10,000. That means the first $10,000 every taxpayer earns is taken out of the tax equation. Looking at the taxpaying population as a whole, $100 billion is removed from the tax base.

    To generate the same $20 billion, the flat tax rate would need to be roughly 6.7 percent. Our $20,000 household would pay $670 (an effective tax rate of 3.35 percent). The $40,000 household would pay $2,010 (5.02 percent). The $100,000 household would pay $6,030 (6.03 percent). The $200,000 household would pay $12,730 (6.37 percent). The $1 million household would pay $66,330 (6.63 percent).

    Note that the standard deduction adds progressivity to the effective tax rate: The higher the taxpayer's income, the higher her effective tax rate. It's also important to see that the $1 million household pays nearly 100 times as much tax as the $20,000 household ($66,330 versus $670), even though the ratio of household income is 50-1.

    Critics argue that higher-income households should pay an even greater share of the tax burden. But they can't argue that a flat-rate tax leaves no room for making distinctions between those with lower and higher income levels.
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