The Progressive Income Tax Is Not Progress

After my two posts about the minimum wage laws (here and here), I guess I am on a political bent. Today I want to talk about killing off the progressive income tax system and replacing it with a flat income tax.

The current progressive tax setup is grossly unfair and serve as a disincentive to move ahead. The progressive system is based on the principle that taxpayers should pay more income tax as a percentage of their income as they earn more. This has been achieved, traditionally, using progressively higher income-tax rates applied on progressively higher incomes. Canada have four marginal tax rate while the US has six. The top rate kicks in at $120,887 in Canada and $336,551 in the US.

The Government Has It Backwards

The problem with progressive income tax is the government has it backwards. It shouldn’t be the more you make the more they take. It should the be more you make, the less they take! That is how businesses work. Many ad networks will give you a progressively bigger share of income as an incentive to produce more. Imagine how their business would do if they did it backward like the government.

The problems with increasing marginal tax rates are lower rates of economic growth, reduced rates of personal income growth, lower rates of capital formation, aggregate labor supply that is lower than expected, and reduced social welfare. In short, high and increasing marginal tax rates reduce economic growth by creating strong disincentives to hard work, savings, and investment. Why would you want to make that second $100,000 if the government is going to take half of it? A flat income tax would eliminate this disincentive.

Hall-Rabushka flat-tax reform

There are a number of well-known flat-tax proposals but the most discussed is that developed by Robert E. Hall and Alvin Rabushka of the Hoover Institution. It taxes all types of income once and at one rate. In their most recent analysis of the United States, Hall-Rabushka recommended replacing the personal federal rates and the various business tax rates with a 19 percent federal tax rate for both individuals and businesses.

People against a flat tax would say 19% is not enough to fund the operations of the country but they fail to take into account the increased incentive to make more money when people know that the government won’t be taking more when you make more. Would you try to make more if you only pay 19% tax instead of 50%?

I don’t expect to see Canada or the US go to a flat income tax anytime soon. However, if you are a Canadian living in Canada, there is a way to pay a flat 17% tax on your net income – as long as that income doesn’t exceed $400,000 in a year. I’ll talk about that in a future post.