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Posts Tagged ‘Flat Tax’

Fundamental tax reform such as a flat tax should accomplish three big goals.

The good news is that almost all Republicans believe in the first two goals and at least pay lip services to the third goal.

The bad news is that they nonetheless can’t be trusted with tax reform.

Here’s why. Major tax reform is based on the assumption that achieving the first two goals will lower tax revenue and achieving the third goal will generate tax revenue. A reform plan doesn’t have to be “revenue neutral,” of course, but politicians would be very reluctant to vote for a package that substantially reduced tax revenue. So serious proposals have revenue-raising provisions that are roughly similar in magnitude to the revenue-losing provisions.

Here’s the problem.   Notwithstanding lip service, Republicans are not willing to go after major tax loopholes like the healthcare exclusion. And that means that they are looking for other sources of revenue. In some cases, such as the proposal in the House plan to put debt and equity on a level playing field, they come up with decent ideas. In other cases, such as the border-adjustment tax, they come up with misguided ideas.

And some of them are even talking about very bad ideas, such as a value-added tax or carbon tax.

This is why it would be best to set aside tax reform and focus on a more limited agenda, such as a plan to lower the corporate tax rate. I discussed that idea a few weeks ago on Neil Cavuto’s show, and I echoed myself last week in another appearance on Fox Business.

Lest you think I’m being overly paranoid about Republicans doing the wrong thing, here’s what’s being reported in the establishment press.

The Hill is reporting that the Trump Administration is still undecided on the BAT.

The most controversial aspect of the House’s plan is its reliance on border adjustability to tax imports and exempt exports. …the White House has yet to fully embrace it. …If the administration opts against the border-adjustment proposal, it would have to find another way to raise revenue to pay for lowering tax rates.

While I hope the White House ultimately rejects the BAT, that won’t necessarily be good news if the Administration signs on to another new source of revenue.

And that’s apparently under discussion.

The Washington Post last week reported that the White House was looking at other ideas, including a value-added tax and a carbon tax… Even if administration officials are simply batting around ideas, it seems clear that Trump’s team is open to a different approach.

The Associated Press also tries to read the tea leaves and speculates whether the Trump Administration may try to cut or eliminate the Social Security payroll tax.

The administration’s first attempt to write legislation is in its early stages and the White House has kept much of it under wraps. But it has already sprouted the consideration of a series of unorthodox proposals including a drastic cut to the payroll tax, aimed at appealing to Democrats.

I’m not a big fan of fiddling with the payroll tax, and I definitely worry about making major changes.

Why? Because it’s quite likely politicians will replace it with a tax that is even worse.

This would require a new dedicated funding source for Social Security. The change, proposed by a GOP lobbyist with close ties to the Trump administration, would transform Brady’s plan on imports into something closer to a value-added tax by also eliminating the deduction of labor expenses. This would bring it in line with WTO rules and generate an additional $12 trillion over 10 years, according to budget estimates.

Last but not least, the New York Times has a story today on the latest machinations, and it appears that Republicans are no closer to a consensus today than they were the day Trump got inaugurated.

…it is becoming increasingly unlikely that there will be a simpler system, or even lower tax rates, this time next year. The Trump administration’s tax plan, promised in February, has yet to materialize; a House Republican plan has bogged down, taking as much fire from conservatives as liberals… Speaker Paul D. Ryan built a tax blueprint around a “border adjustment” tax… With no palpable support in the Senate, its prospects appear to be nearly dead. …The president’s own vision for a new tax system is muddled at best. In the past few months, he has called for taxing companies that move operations abroad, waffled on the border tax and, last week, called for a “reciprocal” tax that would match the import taxes other countries impose on the United States.

The report notes that Trump may have a personal reason to oppose one of the provisions of the House plan.

Perhaps the most consequential concern relates to a House Republican proposal to get rid of a rule that lets companies write off the interest they pay on loans — a move real estate developers and Mr. Trump vehemently oppose. Doing so would raise $1 trillion in revenue and reduce the appeal of one of Mr. Trump’s favorite business tools: debt.

From my perspective, the most encouraging part of the story is that the lack of consensus may lead Republicans to my position, which is simply to cut the corporate tax rate.

With little appetite for bipartisanship, many veterans of tax fights and lobbyists in Washington expect that Mr. Trump will ultimately embrace straight tax cuts, with some cleaning up of deductions, and call it a victory.

And I think that would be a victory as well, even though I ultimately want to junk the entire tax code and replace it with a flat tax.

P.S. In an ideal world, tax reform would be financed in large part with spending restraint. Sadly, Washington, DC, isn’t in the same galaxy as that ideal world.

P.P.S. To further explain why Republicans cannot be trusted, even if they mean well, recall that Rand Paul and Ted Cruz both included VATs in the tax plans they unveiled during the 2016 presidential campaign.

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February 5 Addendum: For my left-wing friends and others who are bending over backwards to misread this column, saying nice things about Russia’s flat tax doesn’t mean (as noted below) that Russia’s overall economic policy is admirable. And it obviously doesn’t imply anything favorable about Russia’s dismal political system or Putin himself. I like the Russia flat tax for the same reason that I like trade liberalization in China and Social Security reform in Chile. Every so often, bad governments stumble upon a good policy and I think that’s laudable because I want people to have better lives. Sadly, I don’t think the Putin-Trump “bromance” will lead to a flat tax in the US, but that would be an unexpected and nice silver lining to that dark cloud.

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I’m obviously a big fan of a simple and fair flat tax.

In part, my support for fundamental reform is driven by my desire for a low rate, for no double taxation, and for the elimination of loopholes. Those are the economic reasons for reform.

But I also am very much motivated by the moral case for tax reform. It offends me that we have 70,000-plus pages of special favors for the friends and contributors of politicians. I value the rule of law, so I want everyone in America to play by the same rules.

And I confess that I’m jealous that other nations have adopted this common-sense reform while we’re still stuck with a punitive and unfair internal revenue code.

But the silver lining to this dark cloud is that we can learn from the experiences of other nations.

A recent report looks at what’s happened in Russia following the introduction of the flat tax.

On December 23, 2016, in his annual end-of-year press conference, Russian President Vladimir Putin said that despite his “many doubts” at the initial stage of introducing a flat 13-percent personal income tax in 2001, tax reform in Russia has been a major success. …Putin claimed that in 2001, when the tax reform was introduced, he was “concerned that the budget would lose revenue, because those who earn more would have to pay less.” He said he was also concerned “whether social justice would be ensured and so on.” However, as the reform gained traction, “personal-income tax collection has increased – pay attention – seven times,” Putin said. …Daniel Mitchell, a senior fellow at the Cato Institute, told Polygraph.info that two factors contributed to a significant increase in personal income tax revenue: “the low rate made tax evasion and avoidance much less attractive, and increased incentives to earn income.”

I appreciated the chance to talk to the reporter and get quoted in the story, but I am naturally suspicious about the claims of government officials. So I wondered about Putin’s claim about a seven-fold increase in income tax receipts.

I know there were good results in the first few years after reform. I authored a study for the Center for Freedom and Prosperity last decade, and there was data at the time showing an impressive increase in revenues from the personal income tax. That data certainly bolstered the argument for tax reform.

But we now have almost another full decade of data. Has the Russian flat tax continued to produce good results? Is the low tax rate continuing to encourage both the earning of income and reporting of income?

To answer these questions, I had my intern cull through various IMF Article IV consultation reports on Russia to get up-to-date data on personal income tax receipts in Russia. And what did I learn? Was Putin wrong?

Yes, Putin’s claim of a seven-fold increase in tax receipts was completely misleading. There was actually a 10-fold jump in personal income tax revenue.

In other words, the flat tax is a success. In today’s Washington, you would say the Russian government is winning bigly.

But there are caveats.

  • Russia has experienced significant inflation, at least compared to the United States. So if you factor out increases in the price level, personal income tax revenues are “only” about three times higher today than they were before the flat tax was implemented.
  • Moreover, a flat tax is not a panacea. Notwithstanding the good results it has delivered, Russia has an unimpressive ranking of #102 from Economic Freedom of the World. In other words, there’s still a long way to go if Russia wants to become a rich nation.

But these caveats don’t change the main conclusion, which is that the Russian flat tax works. Just as it works in Hong Kong. And just as it works in Jersey. It works wherever it is tried.

Let’s look at another example. Writing for Forbes, Fahim Mostafa explains that the Hungarian flat tax also has been a big success.

A fair number of Eastern European nations have…chosen this system of taxation over its progressive counterpart. Among the latest to join this club is Hungary, replacing progressive rates from 17% to 32% with a flat tax of 16% on income effective from 2012 onward… There is reason to believe that the implementation of this system has largely benefited the Eastern European nation. …The results from the following years have been remarkable. Total government revenue in 2015 (the last year for which OECD data is available at this time) stood at 23.8% higher than the maximum prior to the flat tax reform… According to the OECD, public debt in Hungary has been decreasing steadily since 2011. Increased revenues allow for this debt to be paid. …The flat tax has boosted consumption in Hungary, greatly increasing taxes collected from sales. Total tax revenue has shot up despite the massive cuts made to income tax. Politicians seeking to implement this policy in their own nation would do well to point out the example of Hungary.

I’ll add two comments.

First, the same caveats I applied to Russia apply to Hungary. The country is ranked #57 from Economic Freedom of the World, so it’s great that there’s a successful flat tax, but a lot more reform is needed for Hungary to become a role model for overall market-friendly reform.

Second, the author should probably make a change to the column. Instead of writing that “tax revenue has shot up despite the massive cuts,” it might be more accurate to write that “tax revenue has shot up because of the massive cuts.”

Yes, every so often you can find examples of nations being on the downward-sloping portion of the Laffer Curve, either because tax rates are ridiculously high (the U.S. before Reagan) or because a nation is developing or transitioning and needs low tax burdens to boost growth and encourage compliance.

It’s never my goal to boost revenue for governments, of course, but there’s surely a lesson to be learned about the benefits of low tax rates when both taxpayers and the government wind up with more money.

P.S. If we really want to learn from other places about the ideal tax system, we should check out Bermuda, Monaco, and the Cayman Islands.

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On December 24, I wrote that all I wanted for Christmas is a spending cap.

Alas, Santa did not manage to stuff that long-overdue policy down my chimney.

But I’m not surprised. For years, the flat tax was on my Christmas list and that never happened either. I guess I must have been bad. Or maybe Santa is a leftist or socialist.

So instead of simple and fair tax system under the tree, I kept getting lumps of coal in my stocking, which are cleverly disguised as new provisions of a metastasizing internal revenue code.

I’m still allowed to dream, however, so I want to share a new video about the flat tax from Prager University. It’s narrated by Steve Forbes, who (along with Dick Armey) helped popularize the flat tax in the 1990s.

Very compelling. Perhaps even more so than my video on the flat tax.

So what are the chances that we’ll ever get this type of reform?

In a column she wrote last year for Time, Amity Shlaes was somewhat optimistic that a flat tax has untapped support. She cited the fact that most GOP candidates either endorsed some form of flat tax or proposed changes that would move us closer to a flat tax.

The simple levy hasn’t been this popular since 1996, when Steve Forbes campaigned with the promise of a universal 17% income tax rate. Several of this campaign’s flat taxers are actually out-Forbesing Forbes. Ted Cruz is calling for a flat 10%. Ben Carson, Mike Huckabee and Rand Paul also propose some kind of flat rate. Jeb Bush, Marco Rubio and Donald Trump pay their respects with plans that reduce the number of tax brackets.

She explains why the current approach is arbitrary and unfair.

…tinkering is the great weakness of a progressive structure. For if one authority wins license to tinker, so may another. Eventually every interest group convinces others that it is only fair to introduce its ornaments, its exceptions, or its doodads to a tax code. A progressive structure grows organically and disproportionately, becoming a monument to…crony capitalism.

And even though people get tricked when they equate “progressivity” and “progress,” there’s an underlying belief in equal treatment that pushes them in the direction of a flat tax.

In a paper recently presented at the American Accounting Association, scholars Michael and Theresa Roberts report that nearly 8 in 10 business students they polled believe a progressive income tax to be fairer than a flat tax. Still, when asked to actually ascertain a fair amount for a tax payment, the vast majority of the same pollees, even self-identified liberals, picked an amount that correlated to a flat, or even a regressive, rate. This suggests that while Americans like the sound of the word “progressive,” even educated citizens don’t necessarily love progressivity’s effect. Whatever they say at a party, people may quietly prefer proportionality to disproportionality… The Roberts-Roberts paper concludes that “a majority of both liberal and conservative Americans may view a flat income tax rate as fairer than progressive income tax rates.”

Amity’s point about “self-identified liberals” is a natural segue to a Forbes column by Rick Ungar. He approaches the topic from a left-of-center perspective and has considerable sympathy for the flat tax. Not because he likes proportionality, per se, but because he recognizes that the current system has been perverted by special interests.

I’ve long been open to the possibility of trying something new… How can a progressive come to the conclusion that the flat tax might be a better way to go? …American progressives have long had an allergic reaction to the very notion of a flat tax…and with good reason. On it’s face, a flat tax (and the many variations of policy included under the name flat tax) is, indeed, a regressive system more likely than not to benefit the wealthy at the expense of the less wealthy. …However, you have to ask whether or not our current progressive system is truly progressive or, in reality, a system that has been so perverted by special interest tax breaks and benefits as to no longer be legitimately described as progressive. …what do you think is contained in all of those 74,000 plus pages in the United States tax code? …When the higher earner is, in reality, paying at a lower tax rate than her employees who earn far less, thanks to all the special interest perversions built into the tax code, that is very much a regressive tax system. …maybe the time has come to try something new.

Though Ungar isn’t quite willing to embrace the flat tax.

There are, however, some conditions to my willingness to get on board—two to be exact. First, I worry about how the flat tax would impact on those who do not earn much money and have to support their families on a salary that makes both feeding and housing that family a constant, painful challenge. …my second concern…what assurances do we have that this new system will not be corrupted just as the present system was corrupted?

The first concern is easy to address. Every flat tax plan has a generous allowance for all households based on family size. This “zero-bracket amount” would be more generous than the combined standard deduction and personal exemptions in the current tax system. Indeed, because of my concerns about people viewing government as being free, I actually think the amount of tax-free income people would be able to earn is too large. So Mr. Ungar probably can relax on that point.

The second concern, though, is much harder to solve. The risk of a flat tax is that the system somehow will get compromised and degenerate back to the mess we have now. I like to think the American people, after finally being freed from today’s awful system, would vigorously fight to preserve the flat tax. But I also confess there are no guarantees. But here’s the deal. The worst thing that happens is that the current system re-emerges. That obviously would be a big disappointment, but that downside risk is rather tame compared to the downside risk of a national sales tax or value-added tax, which is that politicians would pull a bait and switch, never get rid of the income tax, and then we wind up with a French-style tax system (and the bloated government it finances).

Let’s close by considering a new argument for the flat tax.

Preston Cooper of E21 explains that a single rate protects people in expensive parts of the country from disproportionately harsh taxation.

…data from the Bureau of Economic Analysis (BEA) show that in states such as Arkansas and Mississippi, $100 can buy $115 worth of goods, while in New York and Hawaii, the same dollar value will only get you $86 worth. …This provides yet another argument for a flat tax. …areas with higher prices also tend to have higher incomes, because employers must compensate for their employees’ reduced purchasing power. Therefore, people earning $44,000 in West Virginia can afford the same standard of living as someone earning $58,000 in Hawaii, despite the gap in nominal income. But the federal government does not account for these regional price disparities when setting tax policy. The progressive federal income tax means that those who earn a higher income in nominal terms will pay a higher tax rate. However, the varying cost of living across the United States means that those who earn a higher nominal income may not actually be any richer, yet will still have to pay the taxes for it. This violates an important goal of tax policy known as horizontal equity: people with the same income ought to pay the same amount in taxes.

Using the example of a single adult, Cooper shows that people living in high-cost-of-living states can pay hundreds of dollars in extra tax compared to people with similar levels of purchasing power in low-cost-of-living states.

Looking at this data, I’m temped to say “serves them right” since the list is dominated by blue states that routinely elect politicians who support class-warfare tax policies and lots of redistribution.

But that knee-jerk reaction is misguided. A fundamental libertarian principle is that the law should treat everyone equally.

So how can this work?

A potential solution is to adjust federal tax brackets in different states for differences in purchasing power. But price disparities do not end at the state level: prices also differ by metropolitan area. People in New York City pay higher prices than people in Buffalo. This phenomenon exists even within cities, as anyone who has compared apartment prices in Manhattan and Queens can attest. There are far too many jurisdictions to effectively adjust tax brackets for cost-of-living differences. A better remedy is to apply a flat income tax at the federal level. Under such a tax everyone would pay the same proportion of their income to the federal government, eliminating the interregional redistribution that comes with progressive taxation.

This makes sense.

When I argue for the flat tax, I tend to focus on the economic benefits (low rate, no double taxation, and no loopholes) and the moral benefits (less corruption, more fairness, and better compliance).

Now I can augment that fairness argument because the government shouldn’t arbitrarily penalize people based on where they live.

So, yes, we should have a flat tax. Other nations shouldn’t have all the fun.

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I’m a big fan of the Baltic nations of Estonia, Latvia, and Lithuania.

These three countries emerged from the collapse of the Soviet Empire and they have taken advantage of their independence to become successful market-driven economies.

One key to their relative success is tax policy. All three nations have flat taxes. Estonia’s system is so good (particularly its approach to business taxation) that the Tax Foundation ranks it as the best in the OECD.

And the Baltic nations all deserve great praise for cutting the burden of government spending in response to the global financial crisis/great recession (an approach that produced much better results than the Keynesian policies and/or tax hikes that were imposed in many other countries).

But good policy in the past is no guarantee of good policy in the future, so it is with great dismay that I share some very worrisome news from two of the three Baltic countries.

First, we have a grim update from Estonia, which may be my favorite Baltic nation if for no other reason than the humiliation it caused for Paul Krugman. But now Estonia may cause sadness for me. The coalition government in Estonia has broken down and two of the political parties that want to lead a new government are hostile to the flat tax.

Estonia’s government collapsed Wednesday after Prime Minister Taavi Roivas lost a confidence vote in Parliament, following months of Cabinet squabbling mainly over economic policies. …Conflicting views over taxation and improving the state of Estonia’s economy, which the two junior coalition partners claim is stagnant, is the main cause for the breakup. …The core of those policies is a flat 20 percent tax on income. The Social Democrats say the wide income gaps separating Estonia’s different social groups would best be narrowed by introducing Nordic-style progressive taxation. The two parties said Wednesday that they will immediately start talks on forming a coalition with the Center Party, Estonia’s second-largest party, which is favored by the country’s sizable ethnic-Russian majority and supports a progressive income tax.

And Lithuanians just held an election and the outcome does not bode well for that nation’s flat tax.

After the weekend run-off vote, which followed a first round on October 9, the centrist Lithuanian Peasants and Green Union party LGPU) ended up with 54 seats in the 141-member parliament. …The conservative Homeland Union, which had been tipped to win, scored a distant second with 31 seats, while the governing Social Democrats were, as expected, relegated to the opposition, with just 17 seats. …The LPGU wants to change a controversial new labour code that makes it easier to hire and fire employees, impose a state monopoly on alcohol sales, cut bureaucracy, and above all boost economic growth to halt mass emigration. …Promises by Social Democratic Prime Minister Butkevicius of a further hike in the minimum wage and public sector salaries fell flat with voters.

The Social Democrats sound like they had some bad idea, but the new LGPU government has a more extreme agenda. It already has proposed to create a special 4-percentage point surtax on taxpayers earning more than €12,000 annually (the government also wants to expand double taxation, which also is contrary to the tax-income-only-once principle of a pure flat tax).

So the bad news is that the flat tax could soon disappear in Estonia and Lithuania.

But the good news, based on my discussions with people in these two nations, is that the battle isn’t lost. At least not yet.

In both cases, policy can’t be changed unless all parties in the coalition government agree. Fortunately, they haven’t reached that point.

And hopefully that point will never be reached if Estonia and Lithuania want long-run success.

All of the Baltic nations get reasonably good scores from Economic Freedom of the World. Ditching the flat tax will cause their scores to decline.

Given that fiscal policy is only 20 percent of a nation’s grade, adopting some bad tax policy may not seem like the end of the world.

But the flat tax isn’t just good policy. It also has symbolic value, telling both domestic entrepreneurs and global investors that a country has a commitment to a system that won’t impose extra punishment just because a person contributes more to national economic output.

By the way, the LPGU Party is very correct to worry about emigration. The Baltic nations (like most countries in Eastern Europe) face a very large demographic problem. And every time a young person leaves for better opportunities elsewhere (even if that better opportunity is a big welfare check), that makes the long-run outlook even more challenging.

But imposing a more punitive tax system is exactly the opposite of what should happen if the goal is faster growth so that people don’t leave the nation.

Let’s close with a famous quote from John Ramsay McCulloch, a Scottish economist from the 1800s.

To be sure, progressive taxation didn’t lead to total catastrophe, so McCulloch’s warning may seem overwrought by today’s standards.

But the so-called progressive income tax did lead to the modern welfare state. And the modern welfare state, when combined with demographic change, is threatening immense economic and societal damage in many nations.

So what he wrote in 1863 may turn out to be very prescient for historians in 2063 who wonder why the western world collapsed.

P.S. If Estonia and Lithuania move in the wrong direction, Latvia could be a big winner. That nation already has received some positive attention for being fiscally responsible, and it also has withstood pressure from the IMF to impose bad tax policy. So Latvia is well positioned to reap the benefits if Estonia and Lithuania shoot themselves in the foot.

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While the political world is consumed by the various scandals and baggage of the two main presidential candidates, let’s play a game of make-believe. Let’s pretend that politicians aren’t crooks and clowns and instead actually want to make America’s economy more vibrant and productive so the American people can enjoy higher living standards.

What would they do? What should they do?

Those are very big questions with lots of answers, so let’s focus just on the issue of tax policy. If the goal is more growth and prosperity, there are two obvious choices.

And if these two policies are desirable, there are three ways to make them happen.

  • Pass a stand-alone tax cut.
  • Finance a tax cut with concomitant reductions in federal spending (i.e., a spending-reducing and deficit-neutral tax cut).
  • Finance a tax cut by eliminating special tax preferences (i.e., a revenue-neutral, spending-neutral, and deficit-neutral tax reform).

Needless to say, a combination of the three also is possible.

My preference is for a spending-reducing/deficit-neutral tax cut for the simple reason that lower spending and better tax policy is a win-win situation that would make us more like Hong Kong. And I certainly don’t mind going with a pure, stand-alone tax cut since it’s generally a good idea to “starve the beast.”

In the current political environment, however, I suspect the final choice may be the most practical option. That’s because reasonable leftists may be willing to go along with better tax policy so long as they can be convinced that the burden of government spending won’t be reduced. And self-styled deficit hawks may be willing to go along with better tax policy so long as they can be convinced that red ink won’t increase.

But this also can be a win-win situation since there are many distortionary preferences in the tax code that lure people into making economically inefficient decisions solely because of tax considerations. So if those provisions are repealed and all the money is used to finance lower tax rates and less double taxation, we’ll have a tax system that is much less punitive.

Heck, this is the premise of the flat tax. Wipe out the 70,000-plus pages of the tax code and replace it with a simple and fair system that taxes income only one time at one low rate.

This means getting rid of preferences such as the healthcare exclusion, the municipal bond exemption, the charitable contributions deduction, and the state and local tax deduction.

Some people say eliminating tax preferences is too politically risky, however, akin to “touching the third rail.”

And it’s certainly true that the interest groups benefiting from a tilted playing field will fight to preserve their special preferences. But I’m not sure they would be able to scare voters into supporting their position.

The first thing to understand is that only 30.1 percent of taxpayers utilize itemized deductions. And those that do itemize on their tax returns tend to have higher-than-average incomes. And remember that these are the same people who will directly benefit from lower tax rates and less double taxation.

Interestingly, the Open Source Policy Center has an interactive site where you can see what happens to people in various income classes if selected itemized deductions are repealed.

Here are the results from repealing the state and local tax deduction. As you can see, rich people are the only ones who take a meaningful hit.

Yet are these upper-income taxpayers going to fight to preserve that deduction if they are offered a trade for lower tax rates and less double taxation?

I suppose it depends on the specific circumstances of each taxpayer, but I’m guessing a majority of them would prefer a friendlier and simpler tax code that didn’t punish wealth creation.

Moreover, if you look at where these people live, you find that they are highly concentrated in just a handful of states along with a few urban areas elsewhere in the country.

This suggests that policy makers from most states shouldn’t even care about itemized deductions. So there shouldn’t be any reason for them to oppose a tax reform plan that produces lower tax rates and less double taxation.

P.S. The hard-core left will not go along with revenue-neutral tax reform. They have such antipathy to success that some of them openly urge punitive taxes even if the economic damage is so severe that the government doesn’t collect any revenue.

P.P.S. With regards to the reasonable leftists and the deficit hawks, one can point out that good tax policy will generate better economic performance and therefore more taxable income (i.e., the Laffer Curve). But it’s only in rare (albeit sometimes very noteworthy) cases that the increase in taxable income is sufficiently large to offset the impact of lower tax rates, so revenues will still fall. And since these people don’t like tax cuts, even smaller-than-expected ones, they will still be opposed to pro-growth tax policy unless it is revenue-neutral.

P.P.P.S. The mortgage interest deduction is misguided, but isn’t technically a loophole since one of the goals of tax reform is to give business investment the same tax-income-only-one-time treatment now reserved for residential real estate.

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There’s no agreement on the most important variable for state tax competitiveness.

I’m sympathetic to the final option, in part because of my disdain for the income tax. And if an income tax is imposed, I prefer a simple and fair flat tax.

With that in mind, here’s a fascinating infographic I received via email. I don’t know if Reboot Illinois is left wing, right wing, or apolitical, but they did a very good job. I particularly like the map showing zero-income tax states (gray), flat tax states (red), and states with so-called progressive tax schemes (blue).

For what it’s worth, Illinois taxpayers should fight as hard as possible to preserve the state’s flat tax. If the politicians get the power to discriminate among income classes, it will just be a matter of time before all taxpayers are hit by higher rates.

Now let’s shift to the spending side of the fiscal ledger.

Like any good libertarian, I generally focus on the size of government. I compare France with Hong Kong and that tells me that big is bad and small is good.

But regardless of whether a government is large or small, it’s desirable if it spends money efficiently and generates some benefit. I shared, for instance, a fascinating study on “public sector efficiency” from the European Central Bank and was not surprised to see that nations with smaller public sectors got much more bang for the buck (with Singapore easily winning the prize for the most efficient government).

So I was very interested to see that WalletHub put together a report showing each state’s “return on investment” based on how effectively it uses tax monies to achieve desirable outcomes for education, health, safety, economy, and infrastructure, and pollution.

I’m not completely comfortable with the methodology (is it a state government’s fault if the population is more obese and therefore less healthy, for instance, and what about adjusting for demographic factors such as age and race?), but I nonetheless think the study is both useful and interesting.

Here are the best and worst states.

One thing that should stand out is that the best states are dominated by zero-income tax states and flat tax states.

The worst states, by contrast, tend to have punitive tax systems (Alaska is a bit of an outlier because it collects – and squanders – a lot of revenue from oil).

By the way, if you’re a Republican, you can probably give yourself a small pat on the back. The so-called red states do a bit better than the so-called blue states.

P.S. WalletHub put together some fascinating data on which cities get a good return on investment (i.e., bang for the back) for spending on police and education.

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I’m in Hong Kong for series of meeting and briefings on various economic and policy issues.

As you can imagine, I’m a huge fan of the jurisdiction’s simple 15 percent flat tax. It’s basically about as close to a pure flat tax as anyplace in the world. There is zero double taxation of income that is saved and invested.

That’s not an exaggeration. You don’t get double taxed on the interest you earn on your bank balances and other financial accounts. There’s no capital gains tax. There’s no death tax. And there’s no double taxation of dividends.

There are only a few deviations from a pure flat tax that even merit a mention. First, taxpayers with modest amounts of income don’t have to use the flat tax system. Instead, they can opt for a “progressive” tax system that has a top rate of 17 percent, but also has tax rates of 2 percent and 7 percent, and 12 percent.

Imagine, taxpayers getting to choose the system that works best for them, instead of the government forcing them into the system that requires the highest payment!

The other deviations are that businesses are not always allowed full expensing of business investment, and there also are a handful of deductions.

All things considered, though, Hong Kong gets almost everything right on tax policy, whereas the United States gets a majority of things wrong.

Oh, and I should mention that there are no payroll taxes in Hong Kong. Nor is there a value-added tax.

That’s all very impressive, but let’s actually focus on something that may be even more remarkable about Hong Kong.

It currently has a modest-sized government, with spending consuming less than 20 percent of economic output. That’s not as good as the United States 100 years ago, but it’s far better than where America is today.

That being said, Hong Kong has some major challenges. I’ve explained before that demographic changes will put pressure on fiscal policy in America, but demographic change is far more profound in Hong Kong.

As you can see from this data, it has the seventh-highest level of life expectancy in the world.

That’s good news, of course, but it does mean a lot of fiscal pressure, even for a jurisdiction that is justly famous for its very small welfare state.

But then you have to consider the fact that Hong Kong also has the fourth-lowest birthrate in the entire world.

In other words, Hong Kong faces a perfect storm of demographics. More and more non-working elderly over time, combined with fewer and fewer taxpayers to pull the wagon.

Given these unfriendly numbers, the Hong Kong government put together a working group to look at long-run fiscal issues.

In its recent report, the group presented a fiscal forecast that shows how the burden of government spending will slowly climb to nearly 24 percent of GDP over the next 25 years.

Here’s a chart showing actual data starting in the late 1990s and then projections until 2042.

To those of us from North America and Western Europe, where the overall burden of government spending, on average, consumes more than 40 percent of economic output, it seems like Hong Kong has a trivial problem.

But it’s still a problem and something has to change. Hong Kong could finance a bigger public sector by dipping into its large reserves (currently the jurisdiction has saved enough money to finance about two years of government spending) or by increasing the tax burden.

But hopefully Hong Kong will abide by Article 107 of its Basic Law (its constitution) and limit government spending so that it doesn’t grow faster than the private economy.

And there are some positive signs.

About 15 years ago, Hong Kong set up a system of private retirement accounts in order to create a self-funded source of retirement income.

Based on a recent government report on retirement income, here are some key features of this Mandatory Provident Fund (MPF) system.

The MPF System is an employment-based, privately-managed mandatory defined contribution system. …Employers are required under the Mandatory Provident Fund Schemes Ordinance (Cap. 485) to arrange for their employees aged 18 or above but under 65 to join… The MPF System has been implemented for 15 years only. …about 2.55 million employees are enrolled in MPF schemes, representing 100% of the employees required by law to join the schemes. This is a very high rate by international standards. In addition, another 210 000 self-employed persons are also scheme members. …An employer and an employee are each required to contribute 5% of the relevant employee’s income… As at end October 2015, MPF assets had increased to $594.2 billion, of which about $123.1 billion were investment returns.

Here’s a chart from the report, showing the cumulative growth of assets, based on both contributions and investment returns.

Keep in mind, though, that it takes 7.8 Hong Kong dollars to equal 1 U.S. dollar, so $594.2 billion is not nearly as large as it sounds.

In part, this is because the system isn’t yet mature. Workers have only been making contributions from 15 years, while a working lifetime is 40-45 years.

But there also are concerns that the level of mandatory saving is insufficient. Here’s additional language from the report, which cites the private retirement systems in Australia and Denmark.

There are views that the contribution rate or the maximum relevant income level should be raised to strengthen the retirement protection function of the MPF System. Take the privately-managed mandatory occupational contributory pension plans in Denmark and Australia as examples. In Denmark, employers and employees generally contribute a total of 9% to 17%. In Australia, only employers make contributions and the contribution rate will be raised progressively from 9% in 2013 to the present 9.5% and further to 12% in 2025.

I’m personally agnostic on the precise level of mandatory savings. My goal is simply to shrink tax-and-transfer entitlement programs, particularly before demographic changes lead to a larger burden of government spending.

And since I have great fondness for Hong Kong (how can you not get a thrill up your leg about a jurisdiction that routinely gets the highest score in Economic Freedom of the World?), I want it to remain a beacon for advocates of economic liberty.

P.S. Lest anyone think I’m being too fawning, Hong Kong has several policies that are misguided. Public housing is pervasive, there’s government-run healthcare, and one peculiar legacy of British rule is that only one piece of land is privately owned. Fixing these warts would make Hong Kong even more vibrant.

P.P.S. Another quirky feature of Hong Kong policy is that currency is issued by private banks. If you pull a $20 bill from your wallet, you’ll see that it was printed by HSBC, Standard Chartered, or Bank of China. Unfortunately, this isn’t because Hong Kong has a market-driven system of competing currencies. But it does have a currency board, which – by standards of government-controlled monetary systems – is one of the least-worst options. Of course, that means Hong Kong’s money is only as good as the currency to which it’s linked. And since the Hong Kong dollar is pegged to the U.S. dollar, that might be a cause for long-run concern.

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