Income Taxes Do Their Best Flat Tax Impression

Martin Sullivan at Tax.com crunches the latest IRS data to show that the effective personal income tax rate for millionaires has steadily declined since 1996. That in and of itself is interesting enough, and he makes a persuasive argument that this trend will probably reverse itself soon.

Meanwhile, since my last post was on progressivity, I used the same data Sullivan cited to come up a snapshot of personal income tax burden across different levels of AGI, purely out of curiosity. The resulting curve — the blue on at the left — gradually rises asymptotically from almost zero percent to twenty-five percent. This behavior looked familiar, so I set up a hypothetical flat tax, set the rate at twenty-five percent, and played around with the exemption (a flat tax with any exemption is not really a “flat tax”, since you’ve in essence created two brackets, but in reality most modern flat tax proposals only apply above some level of income). As you can see from the red curve, a flat tax of twenty-five percent that kicks in at $30,000 of income or greater mimics the actual 2007 federal tax burden quite well up to $1 million. Beyond $1 million, our effective income tax burden starts to decrease slightly, so the flat tax model is less predictive.

To be clear, this isn’t some sort of profound insight: yes, our current system’s progressivity is similar to that of a flat tax (to a point), but flat tax advocates would rightly point out that the status quo achieves this through a labyrinthine system of deductions, credits, and loopholes that are regressive in nature. The ideal flat tax would jettison all or most of these write-offs. On the other hand, I was genuinely surprised by how closely our current system’s burden paralleled that of a hypthetical flat tax. Maybe that’s an argument for the flat tax, maybe an argument against it, but I found it interesting nonetheless.