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The theory of incentives provides the basis for the concept of a flat-rate tax, which is so-called because a single tax rate applies equally to all sources of income and does not change as a result of the taxpayer’s volume of income. Any exemptions, deductions, differential rates or progressivity would preclude the name flat rate. They also represent a deviation from the principles of efficient taxation. Such exceptions to the even application of a single tax narrow the tax base, lead to a higher tax rate, make for greater complexity and increase tax avoidance.
Incentives can be either positive or negative. They are alternatively described as carrots and sticks or pleasure and pain. Whatever their form, people seek positive and avoid negative incentives. If a dog is beaten, for example, the animal’s whereabouts will not be known, but the dog is certain not to be where the beating took place. If, however, a dog is fed, we know exactly where the dog will be. The principle is simple enough: If an activity should be shunned, a negative incentive is appropriate and vice versa.
In the realm of economics, taxes are negative incentives and government subsidies are positive incentives, subject to all the subtleties and intricacies of the general theory of incentives. People attempt to avoid taxed activities—the higher the tax, the greater their attempt to avoid. As with all negative incentives, no one can be sure how the avoidance will be carried out.
In the case of taxable income, people try to shift income from higher-taxed categories to lower-taxed categories. They purchase tax shelters and, in the extreme, they may even earn less income or literally evade the strictures of the IRS at considerable personal risk. Because taxation in some form is necessary to sustain government spending, one canon of taxation has always been to have the largest possible tax base coupled with the lowest possible tax rate. By so doing, people are provided the least opportunity to avoid paying taxes and the lowest incentive to do so. In the words of Henry George: A good tax should “bear as lightly as possible on production—so as least to check the increase of the general fund from which taxes must be paid and the community maintained.” He also went on to say that a tax should “be easily and cheaply collected … so as to take from the people as little as possible in addition to what it yields government.”
Under a flat rate tax, average tax rates will remain approximately constant for a given level of income or output. However, the rewards for incremental work by labor, the employment of additional capital and the more efficient combination of the two will all be higher with the flat tax. As a result, more employment, output and production is expected. Economic growth will accelerate as these effects are incorporated into the workings of the economy.
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