One of the principle arguments against the flat tax, as proposed by House Majority Leader Dick Armey (R-Tex.) and publisher Steve Forbes, is that it would be too good for the rich. That is because the top income tax rate would fall from the current 39.6 percent to just 17 percent under the Armey-Forbes plan. Better we should keep oppressing and penalizing all taxpayers with ungodly complexity and punitive tax rates than allow wealthy taxpayers to keep more of their money, the liberal Washington establishment says.
Although class warfare may immobilize tax policy within the beltway, it has not diminished support for the flat tax among average Americans. Polls continue to show strong support for the flat tax even among those who pay little taxes now and would not benefit much from the reform. One reason is that many believe the rich pay little, if any, taxes now. They believe that the Tax Code is so riddled with exemptions, deductions and exclusions of various kinds that no self-respecting rich person needs to pay any taxes at all, if they so choose.
The flat tax appeals to many of the non-wealthy precisely because it puts them and the rich on the same footing. Since there are, in essence, no deductions, exemptions or exclusions under the flat tax, there is no way to avoid paying one's fair share.
Everyone pays the same 17 percent rate, rich and poor alike. Thus to many non-wealthy Americans, the flat tax actually constitutes a tax increase for the rich. In their minds, the rich will go from paying nothing at present to paying 17 percent.
Of course, the perception that the wealthy are getting away scot-free is not correct. In 1993, almost 1 million Americans reported adjusted gross incomes above $200,000. Of these, just over one thousand paid no income taxes due to various deductions and credits. IRS data show that the top one percent of taxpayers, those with adjusted gross incomes above $209,105 in 1995, paid 28.5 percent of their income in federal income taxes on average. In total, this group accounted for more than 30 percent of all federal income taxes paid in 1995.
The rich do not escape taxation because of a section of the tax law called the Alternative Minimum Tax (AMT). This provision was enacted in 1986 precisely to make sure that no one avoids paying taxes just because they have a lot of deductions. Under the AMT, taxpayers lose many deductions that are ordinarily available. These include deductions for charitable contributions, depreciation, state and local taxes, and the standard deduction among others. After losing all these deductions, taxpayers get a large exemption – $45,000 for couples and $33,750 for singles – and pay either 26 percent or 28 percent, depending on their income. If their AMT liability is higher than under the regular income tax, they pay the higher amount.
The interesting thing about the AMT is that it is really just like the flat tax, except that it operates within the existing income tax system. It is like a separate, parallel tax system in which there are a few deductions, a large personal exemption and a low flat rate. And it exists for the sole purpose of soaking the rich.
So, the question is: if the AMT soaks the rich now, why wouldn't a flat tax do the same thing? And save us all a lot of time and effort and paper pushing at tax time?
In 1986, the fathers of the flat tax, economists Robert Hall and Alvin Rabushka of Stanford's Hoover Institution, wrote an article for The Wall Street Journal explaining how the AMT could be used to replace the income tax altogether – as a transition to the flat tax. They wrote: "One of the principal political obstacles to true tax reform is the public's view that a flat tax is unfair because it puts too little of the tax burden on the rich. By linking tax reform to an improved Alternative Minimum Tax, where it is clear that the rich are effectively tax, this barrier can be removed."
Of course, it would be a lot simpler to just sweep away the current Tax Code and adopt a flat tax. But if concerns about the wealthy are a stumbling block to reform, then perhaps the AMT can be a vehicle to the flat tax.