Friday, November 28, 2008

The Flat Tax Expands its Ambit in Georgia

October 31, 2008

By Alvin Rabushka

Two recurrent issues in the United States are reforming the federal income tax and saving Social Security. The complexity of the federal income tax code, surpassing 66,000 pages of laws, regulations, and instructions, needs little elaboration. With baby boomers beginning to retire, the solvency of Social Security, with fewer workers supporting more retirees, is at risk. Politicians have been willing to propose various tax reforms, with little success since 1986, but have been more reluctant to take on Social Security. President George Bush tried, but failed, to push through a reform of Social Security that included private accounts.

In an article I published on December 4, 1998, in the editorial pages of the Wall Street Journal, I proposed linking Social Security and tax reform. My proposal called for extending the Social Security payroll tax of 12.4% to all wage income, rather than limit it to a wage cap of $68,400 (just under $100,000 today). Removing the cap would reduce the regressivity of the payroll tax, which taxes the first dollar of wage income, but ceases for wage income exceeding the cap. The additional revenue would make it possible to reduce the payroll tax rate by nearly 2%, and put Social Security and Medicare taxes on the same playing field. Subjecting capital income to the payroll tax would permit an even larger-reduction in the payroll tax rate.

The other half of the proposal, tax reform, would consist of a flat tax of 20 percent or less on income, with a large personal allowance that then would exempt the first $30,000 ($40,000 today) of income for a family of four. Taken together, the two taxes would be progressive, because a flat income tax would exempt the first $40,000 of income. The higher payroll taxes on wealthy Americans would by offset by a reduction in their marginal income tax rates. Altogether, a flat tax of 30-32%, with a substantial personal allowance, would fund both Social Security and the federal government, and greatly simplify the tax code.

Effective January 1, 2005, Georgia (the country, not the U.S. State) adopted a flat tax of 12%, replacing its previous four-bracket system. The flat tax was augmented with a 20% tax on corporate profits, 20% on social insurance (reduced from 33%), and 18% (reduced from 20%) on VAT.

The new, simpler system has had a dramatic effect on economic growth, averaging 10% a year for the past three years, and taxpayer compliance. Tax revenue increased from 14.5% of GDP in 2003 to 22% in 2006, and should reach 24% in 2007.

Between 2003 and 2007, the reforms reduced the number of taxes from 22 to 7. In 2008, the personal income tax and payroll tax are to be merged as a single tax at a flat rate of 25%. When this merger is consummated, Georgia will be the first country to adopt a single flat tax in lieu of both personal income and payroll taxes. Although Georgia is a small country of 4.4 million people, perhaps its tax reforms can serve as a model for the United States.

No comments: