Dr. Alvin Rabushka is the David and Joan Traitel Senior Fellow at the Hoover Institution and an expert on tax policy in the United States and abroad. He is the author of The Flat Tax with Robert Hall. Editor-in-Chief of The Stanford Review, Benjamin Guthrie, interviewed Dr. Rabushka about the flat tax.

SR: What is the flat tax and why do you support it?

AR: The flat tax is a tax with one rate – uniform for everyone. Why I support it requires my giving you a little bit of history of how I came to it. It’s a combination of several factors. One was having lived and studied in Hong Kong and having seen its tax system at work. A second was serving on Ronald Reagan’s tax policy task force in 1980. I participated in giving a set of recommendations that were hundreds of pages long and then discovered when I filed my own taxes that even Reagan’s recommendations weren’t going to simplify the system. Bringing to bear my experience of Hong Kong on what I thought an ideal tax system was about, I got together with Robert Hall and decided to revamp the entire U.S. tax code. We came up with a tax system based on two postcards – one for wages and salaries and one for business enterprises. And we’ve been supporting it since 1981.

SR: What about the poor? Is the flat tax really fair? Would instituting a flat tax system be one giant tax cut for the rich and a tax hike for the poor?

AR: I have to ask the question you didn’t ask, which precedes your question – what is the purpose of a tax system? And the answer is to collect revenue. A good tax system collects money with minimal distortion of the economy. Thus it results in the efficient use of resources, investment, growth, job creation. If there is concern about helping poor people, that should be done through the expenditure side of the budget. The purpose of the tax code is to collect money, not to undertake social policy.

Having said that, one can ask: what would constitute a fair tax system? For that I would answer, for thousands of years, taxing everybody equally. For example, the tithe of the ancient Church was not to distinguish rich and poor. If we all pay the same rate, let’s say 20%, and I make ten times as much as you, I pay ten times as much as you. Why should I pay twenty times as much as you? The notion that you have to have graduated rates as consonant with fairness, I think is inappropriate. And in fact until the mid-twentieth century, fairness was generally seen as treating all people equally.

Moreover, there is a constitutional question about fairness. Richard Epstein wrote a book some years ago called Takings, and his view was that only the flat tax was a constitutionally acceptable tax because it treated everybody equally under the due process clause of the Constitution.

Every proposal for the flat tax exempts a certain basic level of income. This arose with the establishment of income tax regimes, where it was assumed that individuals should have sufficient income to consume the basic necessities of life, without subjecting that income to tax. For example, let’s assume that a family of four would need so many thousand dollars to consume food, shelter, clothing, and medical care – to maintain the basic minimum level of consumption at or above the poverty line. Let’s say we were to exempt the first $30,000 dollars of income on a family of four. A family making $30,000 would pay zero income tax under the flat tax. Assuming a 20% tax rate, a family making $60,000 would pay 20% of the next thirty but not 20% of the whole sixty. You would have a gradual rise in the average tax burden. As a matter of fact, a flat tax with an exemption provides a measure of fairness in the tax code. And most flat tax proposals, whether it’s the one Bob Hall and I did or the one proposed by Steve Forbes or the one proposed by other members of Congress, would exempt a considerable part of the American population – almost up to half – from paying any income taxes at all. Low income households would pay virtually no tax. Lower middle income households would pay very small income tax, and your fairness would be achieved through that exemption.

SR: Doesn’t the law of diminishing returns suggest that high-income individuals would lose less utility if they were taxed at a higher rate than low-income individuals?

AR: We live here in this fabulously wealthy mid-peninsula area, and I see all kinds of Mercedes-Benz convertibles, Ferraris, Maseratis, and BMWs. It doesn’t seem to me that high-income individuals lose utility for the next dollar. I also see people paying two, three, four, and five million dollars for homes, taking fancy vacations, flying first class, buying boats, and so forth. I think this notion of diminishing marginal utility is just plain wrong. It appears to me that wealthy people don’t lose any interest or ambition in acquiring additional wealth. It may turn out that they do things with that wealth that is somewhat different than other people, for example form charitable foundations or direct the money towards social causes they think are important….

SR: How would the flat tax help the economy?

AR: The flat tax as Bob Hall and I have constructed it provides 100% first year write-off of all investment spending. In effect, we take the investment out of the tax base in the year it’s made. That compares with the current system whereby we slowly depreciate investment. By getting a tax write-off for all your investment rather than just part of it, you basically have more money to invest. Also, in our system, we tax income only once, which would mean there would be no tax on capital gains and no tax on dividends because corporations already pay tax on their business income. If you reduce the tax rate on capital, you are likely to have more of it. You’ll get more investment. More investment means more growth, more jobs, higher salaries for people using more capital goods. Basically, reducing the tax treatment of capital to zero has a very constructive impact on economic growth.SR: Would you support a consumption tax or national sales tax?AR: The Hall-Rabushka flat tax is designed to look like an income tax; it has two postcard size tax forms. But in fact it’s a consumption-based tax. Now why is that? Gross Domestic Product consists of investment plus consumption. If you allow 100% first-year write-off of all investment spending, what you’re left with is consumption. The actual base of the tax turns out to be consumption. The Hall-Rabushka tax is a consumption-based tax. It’s similar in economic terms to a value added tax, but it’s designed to have the look and feel of an income tax, which makes it easier to administer. We already have the apparatus in place; we have the experience; people are comfortable filing forms. If we scrubbed it and went to a European-style value added tax, we’d have to generate a whole new collection mechanism, a whole new system of training. It probably wouldn’t be worth doing. We can achieve the same economic objective. A national retail sales tax has shown itself to be very unstable. About thirty to forty years ago, almost all European countries had a retail sales tax. None of them do today; they’ve all been transformed into a value added tax. And the reason is that it’s very easy to cheat on the retail sales tax; you can strike a deal with somebody at the point of purchase. But with the income tax, we have a system of bookkeeping and records so that you can take a credit for your deductions, you declare your income, and you pay tax on the difference.

SR: Some people argue that the structural question of the tax system is less important than simply having lower tax rates. How would you respond to that characterization of priorities?

AR: The attraction of lower marginal rates is that you get higher after-tax rates of return, and presumably that encourages work, savings, and investment. The real question between the choice of simply lowering the marginal tax rate and going to a flat tax is the issue of simplicity. About ten years ago I went to the law school library, and I took a yard stick and measured shelf space devoted to the federal income tax – thirty-three feet was my measure. And it’s because of all the complexity that arises out of the code. Each year when the Congress passes a tax bill, to the extent there are new measures in it, the average length is somewhere between 700 and 1,000 pages. They don’t know what’s in it. The IRS doesn’t know what’s in it. H&R Block doesn’t know what’s in it. People can’t understand what they should do, what’s legitimate, what’s illegitimate. We’re constantly having IRS suits about illegal shelters, evasion, avoidance, pushing the envelope too far. There’s something to be said about getting rid of complexity. Estimates are that we spend $100 billion per year complying with the tax code, that it causes misallocation of resources by several hundred billion dollars. We’ve got tens of thousands of lawyers and accountants who are doing less than productive work. They’re not creating goods and services; they’re just taking care of other people’s tax obligations. The flat tax brings real simplification. Simply lowering marginal rates doesn’t. And we’ve had a lot of experience over the last 50 years lowering rates – for example, Reagan took the tax code and got the rate down from 70% to 28%, Bush-41 got it back to 31%, Clinton got it back to 39.6%, and Bush-43 got it back to 35%. It’s like an accordion; it just goes up and down. If you were to look at the IRS tax code today and compare it to when Bush-41 took office, it’s probably another 4,000 pages longer. We’re never going to get to simplification and remove all these overhead costs from the economy until we get to one rate.

SR: How would The Stanford Review, as a 501(c)3, be affected by a flat tax system without donors being able to deduct charitable contributions?

AR: You can keep, in a flat tax, as many particular exemptions as you would like. Our view is you shouldn’t have any because there are at least four hundred interest groups, each of which believes their preferential treatment is as important as the other 399. Once you go down the road of having home mortgage interest and charitable contributions, you lead to deductions for state and local taxes. How about tax exemptions for municipal bonds? How about tax exemptions for restoring historic property? How about tax exemptions for sending your children to college? And you can go on and on. Before you know it you’re back to 50% tax rates because you’ve exempted so much of the national income from taxes that what you have at the end of the day is a very small tax base and you need a very high rate, which would defeat the purpose of having a serious low flat tax.There are two kinds of giving. There’s the kind where people pay attention to the tax code; and there’s the kind where they don’t. For example, if somebody donates $60 million to Stanford to build a building and was donating out of wealth, if they don’t have any income, then there’s nothing to shelter. They don’t get a tax break out of giving $60 million – like the Bio-X Center from Jim Clark. Really big donors give out of considerations of merit, rather than out of considerations for the tax code.

You do get people in certain ranges that take a tax deduction for their giving, but there has been a pretty good statistical correlation between increases in real income and giving. During the ‘80s when Reagan cut the top rate from 70% to 28%, annual giving increased at a faster rate than it did in the ‘70s when the rate was 70%. And the reason is due to economic growth and stock market gains and people’s real income and wealth rose more rapidly so they gave more. Income and wealth are better determinants of giving than the tax subsidy component of giving. My sense is that if you got the charitable contribution deduction to zero – it disappeared – but you had a really good tax system and you got 4-5% annual economic growth instead of 3-4% and the stock market gained 20-30%, you would have a significant increase in giving even though there was no tax break for the giving. The Stanford Review would be much better off with a healthier, wealthier economy. Besides The Stanford Review has merit, and people give on the basis of merit.

SR: Is the flat tax a practical proposal in the United States or the rest of the world today?

AR: The following countries have adopted the flat tax: Latvia, Ukraine, Russia, Estonia, Slovakia, Georgia, Romania, Serbia, Iraq, Hong Kong, and Guernsey. Poland and the Czech Republic are discussing it. Even in Germany and Spain they’re beginning to talk about it. It’s certainly been successful in the post-communist world. The reason there, of course, is that they had to start from scratch. They had to find a way to collect revenue when they dismantled communism. They needed something simple and easy to administer, and the flat tax appealed to them.In this country it’s certainly doable. It’s only a question of political will and whether or not this nexus of special interest groups and committees can be broken. I never want to be too pessimistic on this, but we have not seen much success in the last twenty-four years in this country breaking that nexus. My hope is that if another 10-15 countries in the world were to adopt a flat tax, the United States would find itself under enormous competitive pressure to improve its tax system. My best guess is that it would take countries like Germany, Italy, China, and other big countries to follow these former Central and Eastern European communist countries. If that happened, then I think you would have members of Congress urging us to do something to maintain a competitive investment and work environment.