Flat tax solves best – fair tax code, economic growth, and higher incomes prove

To many Americans, consumption taxes are those collected at the cash register- such as the state sales tax--or value-added taxes like those they might encounter on a trip to Europe. Few Americans consider the flat tax a consumption tax because it would be levied on personal income. Economists and public finance experts, however, do consider the flat tax a consumption tax. The confusion revolves around the current tax code's policy of imposing greater penalties on income that is saved and invested than on income that is consumed. A tax code that does not discriminate against savings and investment is considered a consumption-based tax system, regardless of whether taxes are collected at the paycheck or at the cash register. In this respect, the flat tax is a version of a consumption tax.

Both the flat tax and a national sales tax also could be considered examples of an income tax, but one in which "income" is properly defined. The current tax system, by contrast, should not be referred to as an income tax; rather, it is an excessively complicated amalgamation of income and wealth taxation.

Charts 3 and 4 illustrate the ways in which the flat tax and sales tax are so similar and yet have so little in common with the current income tax structure.

What are the Benefits of a Single-Rate Tax System?

Regardless of which option is chosen, both the flat tax and sales tax would yield immense benefits for Americans. Specifically, these benefits would include:

Fairness. Most Americans believe the tax code is riddled with discrimination. They are right. The government either imposes tax penalties or grants tax preferences depending on the source, use, or level of income. All of these special provisions violate the principle that all citizens should be treated equally by the law. The flat tax and a sales tax would restore fairness in the system by ensuring that all taxpayers, all income, and all products are treated the same.[9]

Economic growth. Both the flat tax and a sales tax would minimize the tax rate imposed on productive behavior and eliminate the myriad forms of double taxation in the current code. Consequently, either one would boost the economy's potential growth rate and cause permanent increases in economic output. How much the economy would benefit is not easy to predict, but many economists project that, within 10 years, the economy would be 5 percent to 10 percent larger than it would be under the current tax structure. Faster growth and a bigger economy also translate into higher standards of living.[10]

Higher incomes. Tax reform increases income in two ways. Simply stated, when people get to keep more of what they earn, they want to earn more. A low tax rate increases the incentives to work and the desire to work longer hours. The second, and far more important, reason tax reform causes income to rise is that workers become more productive. Because the flat tax and a national sales tax would eliminate the bias against savings and investment, companies would be willing to invest in upgrading their production capabilities, giving their employees better machinery, tools, equipment, and technology with which to work more efficiently and hence become more productive.[11] As Chart 6 illustrates, this capital-driven increase in productivity is tied closely to higher wages. It is impossible to make exact predictions about how much workers' incomes will rise, but it is worth noting that even a 0.1 percent increase in the growth rate, sustained over 10 years, will mean an additional $5,000 in annual income for an average family of four.