Crawl Across the Ocean

Monday, March 05, 2007

The 5 Bracket Tax, The Flat Tax and the Two-Bracket-Flat Tax

OK, time for another look at right-wing tax rhetoric (previous edition here). Many of the same people who support income splitting for couples also support what the call a 'flat tax.'

Currently, at the federal level, Canada has 5 tax brackets as follows:

* 0% : on taxable income of $7999.00 or less
* 15.25%: on taxable income of $36,378 or less
* 22%: on taxable income of more than $36,378, but not more than $72,756
* 26%: on taxable income of more than $72,756, but not more than $118,285
* 29%: on taxable income of more than $118,285

Now, there are lots of reasons why you might expect those earning more to pay a higher marginal rate of tax, one of the main ones being that a relative equal distribution of income is good for society, and another being that progressive taxes compensate for many of the ways in which the rest of the tax system is regressive, but what I'm going to focus on in this post is the concept of minimizing the harm caused by the tax system.

Under this argument, it is logical for a person to pay a higher rate of income on, say, their income between $120,000 and $130,000 than they do on their income between $10,000 and $20,000 because there is less harm inflicted on the person by depriving them of more of their income once they have already made a significant amount of money. i.e. As the economists say, there is diminishing marginal utility to income.

Or, as non-economists say, taxes which prevent you from buying your third car are less of a hardship than taxes which prevent you from buying your first car. Taxes that prevent you from buying a third home are less harmful than taxes which prevent you from being able to afford rent and food at the same time.

Supporters of a true flat tax argue either that this isn't true or that it is true but it is not a big deal (or is the price of progress as high marginal tax rates will send the wealthy fleeing, killing the golden goose that lays the golden eggs and only sleeps on the golden pillow and all that). They argue that it is only fair that everyone pay the same rate of tax on each dollar of income. With a true flat tax, someone who can't afford to even eat properly will pay the same rate of tax on their first dollar of income as someone else pays on their $500,000th dollar of income.

'Now wait just a minute', I hear the 'flat-taxers' saying, 'that's not what we mean by a flat tax at all.' What they mean is that when they say 'flat-tax' they really mean 'two-bracket tax' or, as I call it in their honour, the 'two-bracket-flat tax.' The 'two-bracket-flat-tax' they propose would have roughly the following structure:

* 0% : on taxable income of $7999.00 or less
* 24%?: on taxable income of $8,000 or more

I don't know what the number for the second bracket here is, I'm just guessing at 24%, hence the question mark.

By supporting the two bracket flat tax, people are acknowledging that the argument I made earlier about harm reduction is valid. That is, they agree that taxes cause more harm to the poor than to those with more money. But what they are also arguing is that this effect disappears at the $8,000 threshold. That is, they are arguing that once you've made $8,000 in income, there is no more diminishing marginal utility to having more income. Or in plainer language, having your income go from $8,000/year to $18,000 year has the same impact on your quality of life as having your income go from $108,000 to $118,000. Or, to put it in language plainer still, the premise of the two-bracket-flat-tax is nutty.

As best as I can figure, the two-bracket-flat-tax is viewed as a compromise by advocates. A true flat-tax would be too crazy to ever pass, even in these days of the right-wing noise machine, so they tacked on just enough compassion for the poor to try and make it salable. But they still kept the name flat-tax, in order to try and pass the idea off as some sort of fairness (there's that word again) plan, rather than simply being a plan to tax the rich less and the poor more.

You have to admire the ingenuity of the right-wing folks who are constantly advocating for lower taxes for the rich. I mean, I guess you have to be imaginative if you want to push an agenda which runs counter to the interest of a large majority of the population, but still.

Anyway, when you hear people advocating for a flat tax I recommend asking them two questions: 1) Do you mean a flat tax or a two bracket tax? When they admit that it is really a two-bracket plan they support you can ask: 2) Why are two brackets better than five? If one acknowledges the marginal decrease in harm caused by taxes as income rises, how does one contend that this effect disappears at a mere $8,000/year of income?


  • Bravo! The immediate rebuttal once the two-bracket flat tax is simple: "So it's not that you actually think it's fairer that everyone pay the same rate of income tax, but that we should give big tax cuts to to the best off, while leaving the poorest off (not to mention large swaths of the middle class) in pretty much the same state."

    By Blogger Josh Gould, at 9:59 PM  

  • All of the arguments i've ever seen for a flat tax have a much higher initial personal exemption. Your example starts at $8,000, but every example i've ever seen would see the first $15,000 to $20,000 of income be untaxed. I'm not coming out for or against here, i'm just saying i've never seen a flat tax argument that had such a low ceiling as the example you use here.

    By Anonymous Radical Centrist, at 5:09 AM  

  • One of the other arguments you'll actually hear from time to time even though it's completely absurd is that a flat tax `greatly simplifies calculating income tax'. This statement may seem like it makes sense if you've never actually done your own taxes before, but inexplicably you still see people of working age make it.

    All of the effort in doing your taxes goes into figuring out what your actual taxable income is -- figuring out which deductions you are eligable, keeping reciepts, etc. Actually calculating your tax once you know your taxable income is just looking up a number in a table, or having your computer/online program do it.

    Now, I'd be all for simplifying taxes by resisting the temptation of using income tax as a place to dump/hide disparate incentive programs, but the idea that reducing the number of brackets from 5 to 2 is an enormous simplification is ridiculous on its face. Which of course doesn't stop anyone from pushing it as a serious argument, because those pushing a flat tax aren't doing it for serious policy reasons, but exactly for the reason Josh suggested; redistributing the current tax burden even further off the wealthy and onto the middle class

    By Blogger Jon Dursi, at 5:16 AM  

  • Only complete innumerates would seriously argue that 5 tax brackets is "harder" to calculuate than only 2. I should note that "flat tax" is usually said to mean both a single-rate (well, two brackets) of income tax without deductions, but as Jon mentioned, tax brackets are entirely separate as an issue from deductions.

    By Blogger Josh Gould, at 6:41 AM  

  • Y'know, I was pretty sure that calculating federal tax was one of the least complicated parts of preparing a tax return, but in fairness, let's try it step-by-step.

    With 4, 5, 7, or whatever brackets:
    * Look up your tax bracket
    * Subtract your bracket's lower income limit from your taxable income
    * Multiply this amount by your marginal rate
    * Add the tax payable on your first $x income

    Oh, the agony. A flat tax would make it so much simpler
    * Subtract the base exemption from your taxable income
    * Multiply this by the tax rate

    Wow -- one less arithmetic step. That'll save seconds; over a working life, it adds up to minutes.

    Some flat-tax theorists try to tart up the message by saying that their prososal gets rid of most tax breaks and deducations. I'm a realist on this; most deducations are going to be near-impossible to end, especially when they're politically popular or accomplish social engineering goals. (Canada's New Government are experts at that stuff.)

    By Blogger Ian King, at 6:42 PM  

  • Radical Centrist - fair enough. I haven't seen many concrete 'two bracket flat tax' proposals so I was just guessing.

    Of course, the point at which the bracket goes from 0 to over 20% doesn't change the general argument about whether the transition should be more gradual or not.

    Jon. I avoided the 'simplicity' argument because that is a separate rhetorical issue. Having said that, I definitely agree. In my 4th post on this blog, entitled ' Flat Tax Does not Equal Simple Tax' I made that exact same point. The income tax act is hundreds of pages and the brackets account for one paragraph.

    As Josh says (and I say in my old post) the deductions are a separate issue from the brackets and as Ian rightly points out, getting rid of those deductions would be quite a political battle. Although I guess it would be easiest to start by removing the big pile of deductions that the Conservatives just introduced in their last budget.

    By Blogger Declan, at 10:28 PM  

  • You are always so elegant in the way you point out what should be obvious.

    By Blogger KevinG, at 9:53 PM  

  • If you make the initial deduction refundable at the same marginal rate, the flat tax morphs into a guaranteed minimum income. So you can have one rate and improve the lot of the worst off at the same time.

    That doesn't make it a good idea. I'm just refuting the two-bracket strawman.

    By Anonymous Anonymous, at 10:31 AM  

  • "So you can have one rate and improve the lot of the worst off at the same time."

    Indeed. Is anyone on the right advocating this?

    FYI, a straw man is when you attribute views to someone that they don't hold.

    By Blogger Declan, at 1:27 PM  

  • You socialists can continue to promote your freedom-hating agenda but in case you haven't noticed, the barbarians are pounding at the gate.

    I would give you, um, let's see, another election before we bust through it.

    By Anonymous Anonymous, at 5:32 PM  

  • It's getting hard to tell satire from reality these days.

    By Blogger Declan, at 5:51 PM  

  • Interesting post, but I don't agree with your analysis of what drives us so called flat-taxers. First of all, no one would ever have a flat tax that started taxing people at 8000 and at 24%, that would bring in sooo much revenue into the government that Parliament hill would explode under the weight of money bags and gold bars. Look at the example of Alberta, when they switched to flat tax (10%), they immediately boosted the excemption to $12k, at a time when most other provinces had theirs lingering around $6.5k. So, while someone making only $20k might pay only 7% of their income in another province on monies made between 6.5k - 20k, that still works out to more than asking them to pay 10% of income from 12k to 20k. I have NEVER seen a single flat tax proposal that would ever call for an increase in taxes on the poor. Never. Ever. Actually, most of the time flat tax proposals are accompanied with a reasonably high set level of income required to purchase the basic nessesities of life, and anyone earning under that level has a "negative tax" whereby the government redistributes money to them, so the more they approach that level the less government assistance they recieve, and the further they are from that level, they progressively get more money. This type of program is designed to provide poor people with money, but eliminate the mishmash of government assistance programs (welfare, OAS, etc) that are somewhat regressive in nature and are critisized for providing a disincentive to work and being inefficient, cumbersome, and administration heavy. I personally believe taxing a flat tax which essentially reduces the burden on the rich is better for our economy, and I understand why you and many others might disagree with that assessment, but at least be fair and recognize that no flat tax proposal EVER calls for shifting the tax burden to the poor in society. Not now, not ever, that's just plain 100% false and incorrect. Flat taxes shift the highest burden of taxes from the rich to the upper-middle class, it's not like the rich make out like bandits, it's just we soak them under our current system and a flat tax reduces that, but by no means do the poor lose out under such a system. Finally, perhaps I am wrong, but I think one thing that many people on the left of the spectrum in Canada get wrong is this believe that all right wingers are a selfish bunch of punks who just want to keep their own money and hurt the poor. Have you asked yourself, if 1% of Canada's richest people pay 40% of all taxes, WHY the heck are so many people, people who may be in the bottom half of all earners, supporting these policies that call for reducing in taxes on that 1% of millionaires? Certainly that 1%, due to sheer numbers, don't have the electoral votes to push these kinds of policies through. I think people support these policies because they actually believe in the long run it will help them and the economy, and rather than countering with reasoned arguments, many people (not you in your post, but many people) simply just call these people who may be making only 25k a year selfish and greedy, missing the entire point, and certainly not winning over any votes.

    By Anonymous Bayboy, at 6:01 PM  

  • I believe that at the point of the flat tax introduction, the initial plan was to convert Alberta's tax rate of 44% of the federal rate to a flat tax of 11% (later reduced to 10% thanks to rising oil prices).

    So working backwards from the Alberta situation, 11% * (1 / 0.44) = 25% so I'd say I'm about right with my estimate of the bracket if we use Alberta as the base.

    Federal taxes have been lowered since then so maybe the right number would be 22 or 23%. You may be right though that the basic minimum would be increased to $10-$15k under a flat-tax proposal. Of course we could do that now if we wanted to and just adjust the other brackets accordingly.

    As for flat taxes never increasing taxes on the poor, the fact is they generally make the tax system less progressive, so that on average more taxes are paid by people with less income.

    I am supportive of guaranteed-income type plans such as you describe in your comment (more on that in a later post), but I think you overstate both their prevalence and the support for such schemes generally among the right-wing.

    "Have you asked yourself, if 1% of Canada's richest people pay 40% of all taxes, WHY the heck are so many people, people who may be in the bottom half of all earners, supporting these policies that call for reducing in taxes on that 1% of millionaires?"

    Indeed, I ask myself that question all the time. Personally I think the primary answer is that people see a tax cut as a savings to them and don't think of the lost government services as a result, because they have bought into a line of propaganda that tells them that government does nothing for them, but that's just speculation on my part.

    By Blogger Declan, at 8:20 PM  

  • I understand your point of view on this but I think you've forgotten to add one little detail.

    What is the difference between a low income paying 20% of $10,000 and a high income paying 20% on 100,000... hmmm about $18,000... flat tax is still progressive on your income just no the percentage rate.
    I'm personally still learning about flat tax and so far your argument is not quite strong enough.

    By Blogger Sara, at 4:36 AM  

  • In the context of taxes, the word 'progressive' means that you pay a higher *rate* of taxation as your income rises - in contrast to a flat tax where the *rate* of taxation does not change as your income rises.

    That's just what the words mean. So to say that a 'flat tax is progressive' is actually a contradiction, like referring to a straight circle, or a poor billionaire.

    You could imagine that someone with $100 in income might be asked to pay $100 in taxes. While someone with $1,000,000,000 in income might be asked to pay $101 in taxes. It would not be logical to say that this tax system is progressive because the billionaire is paying more tax than the person left with nothing - the rate is what matters.

    By Blogger Declan, at 7:52 PM  

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