With the Flat Tax, Common Sense is Better than an Economist

by Casey B. Mulligan

March 1, 1996

(A condensed version of this article appeared in the Chicago Sun-Times, May 4, 1996, "Government Gets Fat on the Flat Tax," page 14.)

A prominent economist recently asked me, "How could economics textbooks be changed so that more citizens would understand the desirability of a flat tax?" I was not surprised to hear the question because so many economists seem to agree on the efficiency of a flat tax - a tax with a single tax rate and no deductions. Some may worry about equity or fairness, but positions on the efficiency of flat taxes are pretty uniform across economists. At a recent meeting of economists from top universities, I witnessed a "debate" on the flat tax in which even the economist assigned to officially oppose it was willing to accept a flat tax if it encouraged education. Twelve famous economists recently contributed to a Wall Street Journal editorial that strongly favored a flat tax.

Common Sense and Historical Experience

I don't claim to have a monopoly on common sense, but I worry when noneconomists - including my wife, my parents, Howard Stern, and Rush Limbaugh - all seem to think harder about the potential problems with a flat tax than do most economists. The question raised by these five noneconomists and many others is "If we start with a 20% or so flat tax, won't revenue-hungry politicians raise the flat tax rate to the point where everybody is in a high tax bracket rather than just a few? It seems better for a few people to be paying taxes at a 50% rate than everybody paying 50%." This is a wise question to ask in light of U.S. historical experience. Back in the days when the Federal Government relied heavily on import tariffs - taxes which most economists today view as very inefficient relative to an income or consumption tax - government spent (and wasted) very little money. With the permanent introduction of an income tax in 1913, we begin to see the growth of the size of the federal government. With the introduction of fairly "flat" taxes such as your Social Security "contributions" and Medicare taxes since 1937, we have seen the Federal Government grow to many times its 19th century size. The flat Social Security tax began at a 1% rate in 1937 and no politician at the time would have admitted that it would be increased almost 20 times to the 18.4% (the sum of employer and employee old age, Medicare, and other social security contributions) that it is today! The social security revenue machine now brings in almost as much as the Individual Income Tax.

Does a transition to more "efficient" tax revenue machines foster the growth of a wasteful government? Our historical experience is suggestive.

The flat tax wouldn't be the first time when a majority of economists lined up against common sense and lost. At the end of World War II, many Americans (according to the stock market and one of the few polls that were taken at the time) were confident about the postwar economy. 54 prominent economists - including one who went on to sell a massive number of textbooks and win a Nobel prize - disagreed and published a letter in the New York Times warning of another great depression that would follow the War and advocated the continuation of price controls. Price controls were not continued yet the unemployment rate never surpassed 4% in the 3 years that followed. Economists appeared unaware of some of the important social forces that affected the wartime and postwar economies.

Why are Political Forces Ignored?

Economists talk a lot about "distortions" and "incentives" but very little about politics. Paradoxically, economics can explain why so many economists ignore the political effects of a flat tax that could lead to further growth in our already massive government. The story is no different than why the post office might advocate use of U.S. mail for your communication even when facsimile or email might be better or why a dairy farmer might suggest butter rather than margarine. People tend to advocate their product rather than the product of a competitor. It should be no surprise when an economist emphasizes economic issues and deemphasizes political issues even when the latter are important for the problem at hand.

A solution to dubious salesmanship is to allow each salesman to sell both competing products. If the dairy farmer produced both butter and margarine, he would be less likely to overexaggerate the virtues of butter. A similar merger of economics and politics has been initiated by Nobel Laureate James Buchanan. He has argued that the full impact of public policies cannot be understood without understanding the behavior of politicians and he uses the tools of economics to understand that behavior. A conclusion of his analysis, which you can read about in the book The Power to Tax (with Geoffrey Brennan), is that it is efficient to constitutionally prohibit flat taxes in order to control the scope of government.

Even though so many economists advocate a flat tax, America would have benefitted on the whole by following the various recommendations that have come from the profession over the past 50 years, including their defense of free international trade and opposition to minimum wages. Traditional economics has produced several wise policy recommendations, but have missed the mark on a few issues where political and social forces are important. When the merger of traditional economics with politics and sociology is complete, you can expect reliable advice from economists on a broader range of issues. Until then, rely on your common sense when it comes to the flat tax.

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