Stephen Foley: Flat tax is a seductive idea that just might survive the Republican pandering season

 

US Outlook: Could the world's largest economy really switch to a flat tax?

In US politics, the idea of a flat-rate income tax has usually been the preserve of wingnuts or rich businessmen standing for President, so it has been alarming to watch the issue move up the political and academic agendas.

Herman Cain and and now Rick Perry, two of the top three candidates for the Republican presidential nomination, have spotted the seductive appeal of a flat tax in their bid to be the anyone-but-Mitt-Romney contender and to appeal to the party's right. This sort of thing sometimes happens during pandering season, the last few weeks before the primaries begin, when the fringes of the political parties are at their most powerful.

What is new is the sense that mainstream and even elite opinion is taking the flat tax seriously.

The reason is that introducing a flat tax could unlock solutions to a few intractable problems for the federal government's finances and for the US economy, namely the need to simplify an impossibly complex tax code, the need to raise taxes overall to deal with the country's long-term deficits and the need to rebalance the economy away from debt-fuelled consumer spending.

As is typical for supporters of a flat income tax, Mr Cain, the pizza chain boss who has popularised the idea this election cycle, says it should be accompanied by a nation-wide sales tax. The more you earn, after all, the more you spend, so taxes can be both flat and fair, they say.

Mr Cain is making political hay out of his 999 plan to deal with America's economic emergency. It proposes a 9 per cent flat-rate income tax, a 9 per cent sales tax and 9 per cent on corporate profits.

The idea for a federal sales tax already has considerable support as part of a deficit reduction plan. And by the by it could prove a neat piece of natural justice for Amazon and other online retailers, who have managed unfairly to avoid state sales taxes.

The introduction of a flat tax would just be the most dramatic manifestation of a trend that is going on elsewhere in the West, where politicians are finding it easier to put up VAT and the like than have to put up income taxes.

Here's the new economic justification: by shifting taxation from income to consumption, it encourages people to save and not to spend, thereby rebalancing the US economy towards investment. The sugar-rush of consumer spending will be replaced by investment that boosts jobs and long-term growth. Meanwhile, a flat income tax wipes away all those marginal disincentives to work hard and to invest well.

See – I told you it was seductive.

The miscalculation, though, is that encouraging saving does not necessarily encourage investment in the US economy, since fund managers are as likely to be chasing returns in emerging markets as at home, and even US-listed companies include some of the world's most geographically broad multinationals. Stoking consumer spending, which accounts for around 70 per cent of US GDP, is vital to keeping the US economy on the rails.

All this is before we even start to talk about the regressive horrors of scrapping the tiered income tax system, which, I'm optimistic, will ultimately keep the flat taxers at bay in the end. But after the past week, I'm reducing my bets on that and watching the Republican race more closely.

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