Flat taxes – don’t dismiss them out of hand

I have always had a theory that governments like having a byzantine, multi-layered and highly complex taxation system because a) it virtually ensures that no one ever really knows how much they actually pay in taxes and b) it allows them to use the tax code very strategically (surgically) to win votes.    Think about the highly targeted tax breaks offered by the Harper government in the past couple of elections.

A flat tax would eliminate both a) and b).  First, you pay x on your total income.  It doesn’t get much simpler than that.   Second, the flat tax model assumes no targeted tax breaks (or very limited tax breaks) otherwise the spirit of the thing would be violated.

Of course the big concern (which I share) is that flat taxes put more of the tax burden on lower income earners.   But I would still argue that the more income you earn, the more deductions you get and you end up paying far less than the marginal rates anyway.

In New Brunswick, I think the top marginal rate is over 50% – meaning that on anything over $130k or something you pay more than 50 percent in income tax.

However, we know from Statistics Canada, that the highest implicit income tax rate in New Brunswick is 18.9% – that is the highest quintile of earners only pay 18.9% on their total income (see the table).

Now, all we have to do is set the flat tax rate at 19% and then set the floor at a level where the other quintiles slide in.  The floor is the amount at which under – you pay zero income tax.  For example, if you set the floor at $20k per  year income, then a family earning $20k would pay no taxes at all and a family earning $25k would pay $950 worth of income tax (19% of the $5,000).  A family earning $300,000 would pay $57,000 in taxes – or about what they would pay now after their myriad deductions and accountants pouring over the books.

In essence, I think you could go to a flat tax and end up with families paying similar amounts of taxes they pay today but without the huge CRA bureaucracy, the multi billion dollar industry that has built up around tax filing, compliance, loopholes, etc.

Estonia has this model and it seems to be working there.

The biggest problem?  Again, come back to the first sentence.  There is a huge industry that would lose out if the system was simplified and I am not sure the government wants people to know just how much they pay in taxes.  The average middle class family is already paying an effective rate of around 8% of their disposable income on HST.   If they pay 19% income tax – they are paying more than a quarter of their total income on HST and income tax.  Throw in property tax, gas tax and other taxes the average middle class family could be paying more than 30 percent of household income in taxes.  Do you think government wants to make it that obvious?

Implicit Income Tax Rate (NB) – 2009*

Lowest quintile 2.5%

Second quintile 5.9%

Third quintile 9.3%

Fourth quintile 13.6%

Highest quintile 18.9%

*2009 for all family units.  Source: Statistics Canada.