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? 1997 NCPA
LOOK TO HONG KONG FOR FLAT TAX EVIDENCE
The flat tax is alive and well and living in Hong Kong. And the benefits for taxpayer and government alike are enormous.
On nearly every score, Hong Kong’s tax system eradicates or avoids distortions so common everywhere else:
· Although there are four levels of income tax — from two percent to 20 percent — the system is structured so that no one need pay more than 15 percent of income to the government.
· There is no tax on capital gains or interest.
· Corporate profits are taxed at a flat 16.5 percent.
· The form Hong Kong taxpayers fill out every year is four pages long — but that’s only because it’s printed in both English and Chinese.
Far from hurting the middle class, as flat tax critics in the U.S. keep warning, Hong Kong’s effective 15 percent flat tax does not even kick in until people’s incomes put them well into the middle class.
· More than half of Hong Kong’s citizens pay no tax at all.
· Almost all the rest pay only seven percent of their income to government.
· Nearly 75 percent of tax revenue comes from the wealthiest 10 percent of the population.
· Even at that, the colony consistently runs a budget surplus in the billions of dollars.
· Authorities estimate that by the time Hong Kong is handed over to China in mid-1997, the national coffers will hold more than $40 billion.
From its inception after World War II, Hong Kong’s tax system was never meant to be anything other than a source of revenue. Concepts like redistribution of income are absent. There aren’t any of those deductions and penalties that turn tax codes elsewhere into social engineering documents.
Source: Editorial, “An ‘Untested’ Flat Tax,” Wall Street Journal, February 9, 1996.
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? 1997 NCPA
a flat tax An argument for a flat tax system in the United States of America
(hint: it already is!)
by Matthew Dent, average citizen
Copyright ? Matthew Dent, 1996
Last Updated: 12/09/96
Please mail comments to: Me!
There has been controversy in recent years over a flat tax system. Even this year’s Republican nominee (Bob Dole) is advocating a “Flatter Tax” system which he says he will usher in beginning with a 15% across the board tax cut.
I don’t think there are many in America who believe that we are under taxed, and I know that there are many who believe we are over taxed.
It can and should be pointed out, however, we are one of the lowest taxed industrialized nation in the world. Many other countries including our northern neighbors in Canada, “enjoy” a much higer level of taxation than we do. Although it must be pointed out as well that they recieve services like a nationalized health care system which we do not. But many of these countries are being crushed under the high rate of taxation.
The world economy (not just our national economy) has been experiencing a time of sustained growth in recent years. In the United States, this has resulted in fewer people being as concerned as they used to be about job security and their financial well being. Whether this is truly the result of the nations economic well being or just the media’s lack of reporting on financial issues (including the U.S.’s sluggish growth in the past few years) will be taken up in another document, but nontheless, it is the case.
The following research was originally done for a project on scientific method. The research yeilded some interesting results the most startling of which I wish to share with you in the following paragraphs.
In doing this research, the following two facts seemed extremely inconguous:
· The lowest rate of taxation on personal income is currently 15% of Adjusted Gross Income.
· The national average rate of taxation on personal income has hovered around the 10% mark since 1943.
You may also now be remarking, “How can this be?”. The answers can be found in the tax code itself, however as everyone knows, the tax code is pretty complicated, so an entire enumeration of causes is impossible to create. However, there is one cause which is obvious… Adjusted Gross Income (AGI).
Adjusted Gross Income (AGI) is the money you are taxed on after you subtract the money which the government considered a good way to spend your money. For example, interest paid on a loan which was used to purchase your home (mortguage) is “deductable”. This means that you can subtract that from the amount of money you received as income before your income tax is calculated.
For expediency and ease of research, the standard deduction was used. The standard deduction is the amount the government allows you to subtract because they realize that it does cost something to sustain yourself with food, clothing, and shelter. Since there are different standard deductions depending upon wether you are married filing jointly, single, or a dependant child, it was decided that the deduction for a single person would be used. We knew this would skew the results as the deduction for two single persons is generally (but not always) more than the deduction for a married couple filing jointly and that the standard deduction for a dependant is almost always less than the deduction for a single person filing alone.
Even with this skew, our results didn’t come near the 10% value. The 10% value is actually just an approximation/average of the rate of taxation on personal income. It was calculated very simply by computing the percentage of personal income which went to the government and was reported as “Federal receipts from Personal Income [tax]“. These values were obtained from the National Income and Product Accounts (NIPA) put out by the Federal Government. A summary of each calculation is presented in the accompanying Table 1.
It was further noted that since 1943, except for the years 1977 through 1986, everybody except the bottom 20% of wage earners was being taxed at or above the “National Average” of 10%. The laws of mathematics indicate that with an average, approximately 50% of the population participating in that average will be below it, and approximately 50% of the population participating will be above it. However, as can be seen in Table 2 except for the years 1977-1986, 80% or more of the population was above the average (that is, if only the standard deduction was taken). Further discussion of this discrepancy can be found in the accompanying commentary on this research.
Methodology
What follows is the methodology used for the calculations which yeilded these results. This methodology was performed within the context of a class on scientific method taught at Concordia College, Ann Arbor, MI, 1993, taught by Neil Skov.
Data was obtained for the Number of Employees (part & full time) as well as income from Wages & Salaries from the National Income and Product Accounts (NIPA) information available through EconData.
Then, data was obtained about Percentage Distribution of Income by population fifths from a variety of sources (including several years of The World Almanac and Book of Facts and other such compilations of existing data). This data was not only split out by population fifths, but also included information about the top 5%, so this information was also used in comparison calculations. Further, this data was not available for all years. Missing years were approximated based on surrounding years. The years 1965-1985 most notably were missing from the data. We understood that the approximations certainly would not be 100% accurate, however, surrounding years did provide a basis for a trend and this trend was carried through the missing years.
We then calculated “Per Person Income” based on the Number of Employees, Income from Wages & Salaries, and the Percentage Distribution of Income by population fifths. This calculation was done by population fifths as this gave us a much better approximation of personal income in differing economic strata.
We then consulted the United States Tax Code as published for the standard personal exemption.
Then was calculated the Adjusted Gross Income of the population fifths computed earlier by subtracting the Personal Exemption from the Personal Income by Population Fifths. (The top 5% data and calculated data of the 15% below them was included as well).
Then by using the information obatined from the Tax Code, we calculated the tax bill for each of the population fifths.
Finally, we calculated the Tax Rate of each of the population fifths by dividing the tax bill by the personal income. This provided the basis for comparing government collections to approximate codified tax rates.
To complete the comparison, we took Personal Income and Federal Receipts from Personal Income Tax (both in nominal and real dollars) from the NIPA tables. We calculated the percentage of Personal Income which the government received and used this number as “Actual Average Tax Rate”, since it is the actual rate at which personal income was taxed and given to the federal government. We also calculated the Average Codified Tax Rates by averaging the tax rates of the population fifths. We also calculated this using the data which split the top 5% from the top fifth as a separate calculation for comparative purposes.
Because we already had the data regarding personal income, we constructed hypothetical “flat” tax systems at a rate of 15%, 11%, and 10%. 15% was chosen because it was pushed by the then independent candidate, Ross Perot in the 1992 election. We used 11% and 10% because those numbers were close to the actual average tax on personal income. These calculations are contained in Table 3.
RESULTS
Some of the results of this investigation were brought out in earlier paragraphs. In the following paragraphs I will attempt to analyze the results of the calculations in a more comprehensive manner.
The first interesting thing noticeable thing is that the personal exemption from 1929 to 1931 was substantially higher (in nominal dollars) than it was until 1987. From 1929 to 1931, the personal exemption was $1500. That’s 1500 1929, 1930, and 1931 dollars or $10,742, $11,110, $12,373, in 1987 dollars respectively. Compare this to $1,900 in 1987 (in 1987 dollars). Or even the all time low of $1040 in 1985 (1985 dollars) which is $1124 1987 dollars!
I prviously mentioned that since 1943, the national average tax rate has hovered around 10%. It is probably unlikely that anyone will argue the cause for this. In 1943, the United States entered the fray of World War II and the United States government was required to increase taxes in order to pay for the building of all of the armaments of war and to pay US Soldiers to defend us and push back aggressors in Europe.
It does seem somewhat disconcerting that since the biggest conflict in our nation’s history which was funded with federal funds, our national leaders have yet to ultimately bring down the burden on it’s citizens. It could be argued that since that time, there is a larger burden on more Americans today than there were then (See the accompanying commentary). The biggest basis for this arguments can be found in the lowering of the Personal Exemption causing the poorest of our citizenry to need to pay taxes. These are the members of our society which it is argued, would be most burdened by a flat tax system.
The final, and most interesting point, is that barring any changes in the economic develoment of our nation, including changes in personal income (which would likely have gone up), with a flat tax at 11% without personal exemptions, if it were instituted in 1943, the Federal Government would have made $786.5 billion more from personal income taxes in the period 1943-1987 (as calculated in real 1987 dollars). In that period, the Federal Government received $9166.7 billion (in real 1987 dollars), but would have received $9963.2 billion (in real 1987 dollars) with a flat tax of 11%.
I indicated that personal income would likely have gone up under a flat tax system. When you compare changes in personal income to changes in tax rates, there is a correlation between tax cuts and an increase in personal income. Some of the most notable examples can be found in Table 4. Conversely, large, abrupt hikes are followed by drops in personal income (Summarized in Table 5).
Summary
The Federal Tax System of the United States of America is a very large and complex body of law which oddly enough boils down to essentially a flat tax. The government, on average since 1943, has received approximately 10 cents on each dollar earned without incurring the fluctuations of the codified tax rates to any great extent. For example, if everyone took only the standard deduction in 1955, the average rate of taxation on personal income would have been around 17.2%, but the average rate of taxation on personal income was actually around 9.6%. In 1965, with the standard deduction, the rate would have been around 14.0%, but was actually aound 9.2%. In 1975, it would have been around 17.1%, but was around 9.2%. And in 1985, they come closer together with the rate with the standard deduction approximately 11.7% and the actual rate approximately 9.9% (Full details in Table 6).
This indicates that the standard rates codified in the tax codes are being avoided by some members of our society. The causes for this can be boiled down into only a couple of categories:
· Tax evasion.
· Tax Exemptions based on what is done with the money (eg. exemptions for mortguage interest, dependent children, or investments in certain areas of our economy).
Conclusion
From the research done, since 1943 the Federal system of taxation has effectively already been a flat tax system with an average tax rate of approximately 10%. This is lower, in the case of 80% of the population, than the tax that would be paid if only the standard deduction was taken by everybody. The only group who would be taxed at a higher rate would be the lowest 20% of our population, but even there, throughout this period, if the U.S. had a flat tax of only 11%, it would have been only marginally higher than the lowest 20% was already being taxed (eg. from 1952-1976, the lowest 20% was being taxed at between 6% and 10% and averaged around 8%).
From this, one wonders what all of the flap about a flat tax rate of 15% with a high enough deduction to shelter the majority of the bottom 20% is about.
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Copyright ? 1996, Matthew Dent, All Rights Reserved
Definitions
Adjusted Gross Income
The tax system has built into it a way to reduce your taxable income. If you put your money into certain investments, you are paying interest on a mortgage, or basically doing what the government wants you to do with your money, you can deduct that amount from the amount of money you have made as income before your taxes are calculated. The amount of money left after you deduct the money from your income, what you are left with is called you “Adjusted Gross Income”. Back
Nominal
When you are dealing with dollar amounts in calculations, there are two ways you can look at the data. Because of inflation, you cannot equitably compare dollar amounts between two years. This can be compensated for by using some sort of Index like the Consumer Price Index (CPI). If this compensation is not made, you are talking about nominal dollars. That is, when you talk about a dollar amount in a given year without compensating for the difference in the value of a dollar because of inflation. When you make the compensation, you are talking about real dollars.Back
Real
When you are dealing with dollar amount in calculations, there are two ways you can look at the data. Because of inflation, you cannot equitably compare dollar amounts between two years. It is possible to compensate for inflation by using some sort of index like the Consumer Price Index (CPI). When you make this compensation, you can compare the dollar amounts in constant dollars (ie. inflation is factored out). This constant dollar amount is also called real dollars.Back
Benefits of the Flat Tax
Would it increase economic growth and raise wages?
Absolutely. Over the past two years, many of the nation’s leading public finance economists were invited to testify before Congress on tax reform, and not a single one — Democrat or Republican — argued that a flat tax would have a zero or negative growth effect. Of those who mentioned the flat tax specifically, all agreed the flat tax would lead to greater economic growth.
In fact, Dr. Alan Auerbach, a professor of economics at the University of California at Berkeley, a former chief economist at the Joint Committee on Taxation, and a Democrat, released a study of the economic effects of a flat tax. Estimating the flat tax plan outlined in The Flat Tax by Hall and Rabushka (19 percent rate), he found the economy would be 5.7 percent larger after five years than it would be if current law were left in place. That translates into $522 billion in higher output, or more than $3,000 in higher income for the typical family of four.