So the Renua flat tax proposal continues to keep them in the headlines, as I guess was the idea. But do we have any actual evidence as to the effects of flat taxes? What do we know, as opposed to what can we assert?
Karl Whelan has already poured the equivalent of an arctic lake of cold water on the notion that 23% would be enough. See here for the takedown. TL:DR – 23% nowhere near enough and no, it wont lead to sufficient tax buoyancy to make up the difference.
What I want to do here is to look at the evidence on flat taxes. I used Scopus as the main source, searching for “flat tax” and sorting by citations, and then looking at papers that used some method of quantification to analyse the tax. We don’t have nearly enough evidence based policy in Ireland, and the gold standard for evidence still remains the double blind peer review. So, lets see what they say. One thing to note – in every one of the papers which I could see the assumption was of a revenue neutral tax, which is not at all what Renua are proposing. The conclusion is pretty stark – Flat taxes are great, if you’r rich. They don’t seem to induce people to work more, and there is little evidence they reduce tax evasion.
Altig et al AER 2001 looks at two flat tax approaches (with and without deductions), and finds that the biggest winners, by far, are those who are initially wealthy.
Ventura JECD 1999 do some simulations on the US system, and find “in all circumstances analyzed, the distributions of earnings, income and especially wealth become more concentrated” and “ mean labor hours are relatively constant across tax systems” AKA no inducement to work more emerges.
Ivanova EP 2005 look at the Russian flat tax and find, no, there isn’t a massive multiplier, supply (of labour) doesn’t really rise that much. They do find a reduction in tax evasion but note that this is perhaps less down to the flat tax than to the introduction of more robust enforcement at the same time.
Siemrod 2006 NTJ finds that support for a flat tax is related very strongly to the degree of perception of the existing tax system being regressive (which it is not..). In other words, less knowledge of how the system works = more desire to change.
Keen et al 2008 ITPP do a comprehensive review of the then state of knowledge. They state “there is no sign of Laffer-type behavioral responses generating revenue increases from the tax cut elements of these reform”. In plain language, no, there is no magic buoyancy.
Fuest et al 2008 simulate the reform of the German tax system to a flat tax, noting an important issue that is often overlooked – many flat tax reforms have taken place in enviromnets where the existing tax regime was collapsed. “We find that a flat rate tax with a low tax rate and a low basic allowance yields positive static welfare effects amounting to approximately 1.8% of income tax revenue but increases income inequality. The increase in income inequality can be avoided by combining a higher tax rate with a higher basic allowance. But in this case, the efficiency gains vanish. “ In other words there is an equity-efficiency tradeoff, which is further analysed in Paulus and Peichi JPM 2009.
An ex post analysis of the Slovenian reforms is given in Macjen et al EEE 2009 and they conclude “Our results suggest that choices other than the flat tax system are better suited to the country’s longterm economic development”
Dunbar et al 2008 NTJ conclude “our main conclusions appear to be quite robust. Switching to the proposed flat tax would increase the tax burdens of a majority of taxpayers and would significantly redistribute tax burdens, mainly from the top decile to other taxpayers. This pattern of redistribution persists, although the top decile’s gains are lessened, even if the flat tax is modified to make it more progressive”.
Looking again at simulations for Germany, Fossen 2009 FS concludes “The simulation results indicate that flatter tax systems do not encourage people to choose self-employment, but rather discourage them from doing so. This is explained by the reduction of entrepreneurs’ income risk through progressive taxation”
Voinea and Mihaescu 2009 looked at the Romanian experience “We conclude that the flat tax led to increased income inequality and it stimulated households consumption particularly among the wealthiest households.”
Altig, D., A. J. Auerbach, L. J. Kotlikoff, K. A. Smetters, and J. Walliser. 2001. “Simulating Fundamental Tax Reform in the United States.” American Economic Review 91 (3): 574-595.
Dunbar, A. and T. Pogue. 1998. “Estimating Flat Tax Incidence and Yield: A Sensitivity Analysis.” National Tax Journal 51 (2): 303-324.
Fossen, F. M. 2009. “Would a Flat-Rate Tax Stimulate Entrepreneurship in Germany? a Behavioural Microsimulation Analysis Allowing for Risk.” Fiscal Studies 30 (2): 179-218. doi:10.1111/j.1475-5890.2009.00093.x. .
Fuest, C., A. Peichl, and T. Schaefer. 2008. “Is a Flat Tax Reform Feasible in a Grown-Up Democracy of Western Europe? A Simulation Study for Germany.” International Tax and Public Finance 15 (5): 620-636. doi:10.1007/s10797-008-9071-2. .
Ivanova, A., M. Keen, and A. Klemm. 2005. “The Russian ‘Flat Tax’ Reform.” Economic Policy 20 (43): 397-444. doi:10.1111/j.1468-0327.2005.00143.x. .
Keen, M., Y. Kim, and R. Varsano. 2008. “The “Flat Tax(Es)”: Principles and Experience.” International Tax and Public Finance 15 (6): 712-751. doi:10.1007/s10797-007-9050-z. .
Majcen, B., M. Verbič, A. Bayar, and M. Čok. 2009. “The Income Tax Reform in Slovenia.” Eastern European Economics 47 (5): 5-24. doi:10.2753/EEE0012-8775470501. .
Paulus, A. and A. Peichl. 2009. “Effects of Flat Tax Reforms in Western Europe.” Journal of Policy Modeling 31 (5): 620-636. doi:10.1016/j.jpolmod.2009.06.001. .
Slemrod, J. 2006. “The Role of Misconceptions in Support for Regressive Tax Reform.” National Tax Journal 59 (1): 57-75. . Ventura, G. 1999. “Flat Tax Reform: A Quantitative Exploration.” Journal of Economic Dynamics and Control 23 (9-10): 1425-1458. .
Voinea, L. and F. Mihǎescu. 2009. “The Impact of the Flat Tax Reform on Inequality – the Case of Romania.” Romanian Journal of Economic Forecasting 12 (4): 19-41. .