This is an analysis of Rick Perry's flat tax and how it has all the problems of a flat tax (regressivity, not being able to take into account people's different life situations), but lacks the benefits of simplicity and being a quasi-consumption tax. Basically is not a good idea unless you're rich and want to pay less taxes.

Rick Perry’s flat tax isn’t very good at being a flat tax

Posted by Dylan Matthews at 09:41 AM ET, 10/25/2011

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As flagged in Wonkbook this morning, Rick Perry’s flat-tax plan, or at least a précis of it in the form of a Wall Street Journal op-ed, is finally out. It actually comes with a few surprises. The plan calls for a flat income tax of 20 percent, which is higher than past notable flat-tax proposals. Steve Forbes, for example, called for a 17 percent flat tax in his1996 and 2000 presidential runs, as did a proposal introduced in Congress in 1995 by then-House Majority Leader Dick Armey and Sen. Richard Shelby.

(Nati Harnik - AP)But more notably, Perry’s plan doesn’t actually replace the existing tax code. Taxpayers would instead get to choose between paying taxes under the current system and paying the flat tax. The flat tax thus serves as a kind of upside-down version of the Alternative Minimum Tax. As it stands, taxpayers have to pay either their regular income tax burden or their AMT burden, whichever’s higher. Under Perry’s system, taxpayers will get to pay their flat tax burden or their regular burden, whichever’s lower. What’s more, the flat tax would preserve major tax deductions that benefit the middle-class (like the mortgage-interest deduction) for people making under $500,000 a year, though credits that largely benefit the poor, like the Earned Income Tax Credit, are eliminated.

This is good for people who benefit from middle class-targeted tax breaks, and for those whose income mostly fall in the current 10 and 15 percent brackets, because they can just keep paying taxes normally. But this approach also eliminates two of the flat tax’s main selling points.

For one thing, flat tax advocates frequently point to the plan’s simplicity, that tax forms could “fit on a postcard.” Indeed, Perry uses just this talking point in his op-ed. But by making the flat tax optional, Perry’s plan actually complicates the tax code. It would force households to determine whether they should pay the flat tax or the regular income tax, making the process more time-consuming and expensive, not less. And keeping major deductions for the vast majority of taxpayers means that even those who opt for the flat tax won’t face a much simpler code. The main cause of tax complexity is the plethora of credits and deductions, not the number of brackets. Perry’s plan greatly reduces the latter, but doesn’t do nearly as much as most flat tax proposals to reduce the former.

The second big selling point of flat taxes is that they, as Len Burman explained in a post yesterday, are secretly consumption taxes. Indeed, it’s a lot like a value-added tax. A VAT taxes the difference between a business’s revenue and the cost of its inputs. The corporate side of the flat tax does this, but also lets companies deduct wages. Individual wages are then taxed, albeit with a standard deduction, but the overall effect is basically identical to that of a VAT.

Economists like consumption taxes, as they tend to encourage investment and discourage consumption-based bubbles like the one that led to the financial crisis. VATs, and thus flat taxes, are particularly regressive consumption taxes compared with some alternatives, but the focus on consumption is at least an advantage. But because he keeps the traditional income tax around, Perry negates this advantage somewhat. By offering the choice not to pay the flat tax, Perry’s plan results in a more limited shift toward taxing consumption.

About how governments can get a lot of revenue from taxing inelastic socially detrimental behaviors, or if the behavior proves more elastic than expected, that's good too because the detrimental behaviors go down.

Taxes And Inelastic Goods

By Matthew Yglesias on Oct 4, 2011 at 3:15 pm

There’s not a ton of evidence out there, but what evidence we do have suggests that a tax on fatty foods such as the one Denmark is about to implement is unlikely to drastically change behavior. That makes sense. One reason people get so upset when grocery prices go up is that people aren’t really inclined to radically alter their meal behavior in response to modest price changes. They just eat the losses and grumble.

Still, as tax policy, that’s not necessarily a terrible thing.

The thing about Denmark is that it’s a very high tax country. It’s just been governed for a decade by an anti-tax center-right coalition government, whose big achievement was to get total taxes down to 50 percent of GDP. In the United States, I think the Progressive Caucus would laugh at you if you suggested making taxes that high. And now the Social Democrats just won an election and are coming back in office. Higher spending and higher taxes are, naturally, on the agenda. When seeking new sources of tax revenue, something like a tax on unhealthy foods has a lot of appeal. On the one hand, most people probably won’t change their behavior much in response to a tax, which means it’ll raise plenty of revenue. On the other hand, if people do change their behavior, the social consequences will be beneficial. The Nordic countries have become the world leaders in combining high levels of public services with strong economic growth precisely by being pretty relentless at seeking out economically efficient ways to raise tax revenue.

Something relevant to the U.S. debate is that the basic logic of a Financial Transaction Tax is actually quite similar. Such a tax will hardly kill off financial markets speculation, but that’s precisely the point — people will pay the tax and it’ll raise a chunk of revenue. But on the flipside, if it does somewhat discourage certain kinds of rapid asset-flipping, it’s not some tragic loss for our living standards.

Interesting comparison of percentages of spending

1. Numerical percentages of spending:

A. National Defense: There are several answers to this question, as both what is counted as defense and what is counted as total spending have multiple answers.

This site, http://www.usgovernmentspending.com/us_military_spending_30.html, says that the federal government spent $964.8 billion total on defense in Fiscal Year 2011, out of 3,818.8 billion total, for a percentage of 25.26%. The Center for Budget and Policy Priorities said the U.S. in 2010 spent $705 billion, or about 20% of the budget, on “defense and security-related international activities,” using a budget total of $3.5 trillion.

Here is an enlightening article about the debate about how a percentage of defense spending is calculated and the political and ideological ramifications: http://thinkprogress.org/security/2011/07/28/281841/fpi-hides-massive-military-spending-growth-by-framing-dod-budget-as-percentage-of-gdp-total-federal-spending/

The article, on the website for the liberal Center for American Progress, criticizes attempts by Foreign Policy Hawks to say that defense spending is staying neutral. Meanwhile a more conservative website, newsobserver.com, has this op-ed by the CEO of a defense contractor, arguing “deficits don’t stem from defense”. This is his argument, in which he acknowledges his bias without admitting that it might color his judgment: “As CEO of an aerospace and defense parts manufacturer, I am deeply concerned by the prospect of significant cuts to our national defense. At 4.9 percent, defense spending as a percentage of Gross Domestic Product is already below the postwar average of 5.3 percent. The U.S. aerospace and defense industry employs more than 800,000 high-skilled workers, and indirectly supports another 2 million jobs.” He does not source his information on defense spending as 4.9% of GDP. The CIA World Factbook, which apparently has not updated its number since 2005, says that the U.S. spends 4.06% of its GDP on defense. Of course a key question is what officially is counted as defense.

B. Medicaid, federal vs. state: As of 2009, the combined cost of Medicaid was $380.1 billion, with the federal government paying about two-thirds (66%), and the state governments paying about one-third (34%), according to the National Health Policy Forum of February 2011

There are contrasting changes to this ratio due to health care reform and then the current deficit-cutting emphasis in Washington.

On the side of cuts to the federal role is that both Obama and the Republicans have proposed varying cuts to federal aid to states on Medicaid, so the states are banding together to resist these changes, cutting across party lines, as described in this article.

On the side that the federal government will increase its role, this 2010 report, Medicaid and the Uninsured by the Urban Institute addresses the changes to Medicaid as a result of health care reform; it is being expanded, and it finds that “the federal government will pay a very high share of new Medicaid costs in all states,” 95.4% of all new Medicaid spending, with the result that “increases in state spending are small compared to increases in coverage.”

C. Education, federal vs. state vs. local:

In Fiscal Year 2009, out of a total of $550 billion spent, state governments spent 47%, state governments 44%, and the federal government 10% of elementary and secondary education spending, according to this report by the moderate New America Foundation. See the pie chart on the link. The article says that until the 1970s local governments did most of the funding, with states only supporting, but then major changes in that decade saw states overtaking local governments.