Flat tax makes a comeback
Every now and again, along comes a wave of strong public interest in the “flat tax,” a.k.a. the single-rate personal income tax. It’s happening in Alberta, again, where Jason Kenney’s United Conservative Party voted at its policy convention for a return to the single-rate tax brought in by former premier Ralph Klein. It’s happening in Italy, where the 5 Star Movement and the League party are working to form a coalition that might introduce a flat tax of some kind. Some Eastern and Central European countries have already shifted to flat personal income taxes. And Denmark, Finland, Sweden and Norway all levy a single rate on all capital income, such as dividends, interest, capital gains, and corporate income (well below the top personal rate on other income).
Yet, lately, some of my esteemed colleagues in Canadian economics have been dismissing the benefits of an Alberta flat tax, much to my disappointment. Their favourite argument is to show that the adoption of the flat tax primarily benefits the rich, compared to the current system (as if the current system were the ideal). This values-based approach to tax-policy analysis ignores an important point: Middle- and upper-income Canadians are already largely the only people paying income taxes in the first place. In Ontario, for example, almost 70 per cent of provincial income tax is paid by people earning more than $80,000. Obviously tax cuts will benefit higher income Canadians. They bear most of the burden.
No wonder it is so difficult to talk about personal income tax cuts. Governments keep piling hikes on higher earners, making the system more progressive every year. Now, any attempt to flatten the income tax structure now becomes contentious, even though a little less progressivity may not be bad policy.
Let’s get back to first principles. Tax experts would generally agree that a “good” tax system is one that is simple, fair and minimizes distortions. It is the “fairness” principle that is most subject to value judgments. I think most people would agree that those with similar ability to pay taxes should be taxed at the same rate (which also minimizes distortions and makes for a simpler system). The more interesting philosophical question is whether a tax system should redistribute income.
Most of us believe government should provide a social safety net to help those in need. But that doesn’t mean we should immediately assume that the tax system is the best way to redistribute wealth. Supports can also be provided through spending programs, like public health care, education, social assistance, old age supports, and unemployment benefits, not just through uneven taxation. So the question is which approach — spending or progressive taxation — is better for helping those who need it.
(That’s also the fundamental question at the heart of the renewed debate over guaranteed income proposals. Supporters often claim that replacing our hodgepodge of spending programs with a refundable tax credit — as a “guaranteed income” — would be more efficient. But maybe it wouldn’t. Different situations call for different kinds of support, not just a formulaic cash handout. Unemployment challenges are different from disability challenges, for example.)
If we decide we want to use the tax system to redistribute income, that can be achieved in different ways. We can have graduated tax rates, exempt income below a certain level, or both. We can give tax credits to people facing specific burdens, for instance raising children or coping with the cost of a disability. Consumption taxes, such as the GST, can exempt necessities, including food, rent and children’s clothes. But while each of these mechanisms makes the tax system more redistributive, they come with an economic cost: the necessary higher tax rates to pay for them, which discourage work, risktaking and investment, and the costs to government to administer the system and to taxpayers in navigating it.
That brings us to Alberta’s formerly single-rate tax. To be clear, it wasn’t really a single tax rate, but two rates: it was zero per cent on roughly the first $18,000 earned, 10 per cent on the rest (that was in 2015). It was a policy that Alberta clearly benefited from. It helped attract badly needed skilled workers, especially from the U.S., to staff its high-wage industries. And it lured wealthy tax refugees away from income-expropriating provinces (like Ontario, with its almost 54-per-cent marginal tax rate — soon to be two points higher if the NDP get elected).
As Phil Bazel and I showed in a 2013 paper examining the possibility of a provincial sales tax, Alberta had the highest proportion of households with more than $500,000 in family income compared to any other province. Since the NDP government later raised taxes on high-income households in 2015, it will be interesting to see when data become available how much of that tax base was lost. There are certainly many anecdotes around about rich people shifting income out of Alberta, or physically moving out altogether.
A flat personal tax has its benefits. It’s simple, it minimizes distortions, and it’s not necessarily any less “fair” than the current system, except to those who have a political preference for higher tax rates on the rich. But the decision over whether a flat personal tax is good policy or not is exactly that: a political choice. Economists should stick to talking about the various trade-offs, not their personal value judgments, and let voters decide what they want.