By Neil Brooks

The idea that income tax rate brackets should be flattened has gained some support in Canada--especially in Alberta. Those propounding the idea argue that flattening the rate structure would simplify the tax system and reduce tax avoidance and evasion. Most importantly, they argue that it would usher in an era of increased economic prosperity by encouraging talented Canadians to work harder, save and invest more, and remain in Canada.

On its face, the political attraction of the idea of flat taxes is somewhat of a mystery, since there is no question that flattening the income tax rates would increase the taxes paid by the middle class. If a flat tax reduces the rates paid by the rich, and exempts the very poor (as most flat tax proposals do), the relative percentage of taxes paid by the middle class must go up, even if taxes are reduced. This is elementary mathematics.

Flat taxes have political appeal only because flat-taxers misleadingly conflate the case for flat taxes with the case for broadening the tax base, reducing taxes, simplifying the tax system, and closing loopholes ostensibly so that the rich pay at least some tax. In all these respects, the rhetorical appeal of flat taxes is misleading.

In selling flat taxes as if it were a populist idea that deserves the support of the middle-class, and in attempting to capitalize on populist discontent with the tax system, flat- taxers are being deceitful.

They make a number of beguiling claims. First, they argue that a flat tax rate will greatly simplify the income tax by making it easier to understand, more convenient to comply with, and less expensive to administer. They also argue that a flat tax rate will substantially reduce tax avoidance and evasion. Second, in addition to administrative advantages, a flat tax rate will allegedly have significant economic benefits. It will increase the living standards of all Canadians by encouraging tax-payers, particularly the rich, to work harder, save more, and undertake more entrepreneurial activities and risky investments. It will also, we are told, encourage talented Canadians to remain in Canada and not migrate to more tax-hospitable climates. Third, the flat-taxers contend that a flat tax will increase the transparency of the tax system by reducing the futility and hypocrisy of high rates, make abolishing tax loopholes politically easier by reducing their value to high-income taxpayers, and constrain high government expenditures by ensuring that all voters share the costs of such expenditures in the same proportion.

Finally, proponents make a fairness argument for flat taxes; namely, that only a tax system in which everyone pays the same proportion of their income in tax can make a claim of treating everyone equally.

All of these arguments are dead wrong. Their logic is faulty, their factual premises are not supported by the weight of empirical evidence, and their normative judgments are perverse. The only significant effect of a flat tax rate will be to shift even more wealth and power to the already wealthy and powerful. Moreover, a flat tax is contrary to the basic principles of an equitable tax system and the social goals of Canadians.

The myth of simplicity
Perhaps the most appealing feature of a flat tax is the claim that it will simplify the tax system. The idea that the income tax system could be made easy to understand, convenient to comply with, and straightforward to apply, has an obvious attraction. So much so that everyone with a tax design tries to trade on the virtues of simplicity. It is the one issue upon which even tax lawyers can speak publicly and sound like statespersons while attempting to achieve special tax breaks for their clients. The need for simplicity is thus often used as a slogan to obscure a hidden agenda.

In spite of the apparent urgency of simplifying the tax system, however, the proposition that flattening the tax rates will do so is patent nonsense. None of the difficulties of understanding the Act, the mistakes that professionals make in filing returns, the wrong answers that Revenue Canada agents give in answering taxpayer's questions over the telephone, or the headaches involved in filling out a tax return, has to do with applying the tax rates.

The section in the Act that sets out the tax rates is one of the most straightforward: it is scarcely a dozen lines. It has not been the subject of any court cases or interpretive problems, so far as I am aware. No one has trouble applying this section. Furthermore, once someone's taxable income is calculated on their tax return, a Grade 3 student can calculate the tax owing, no matter how many rates there are.

Whether the tax structure has two or 102 rates, once taxable income is determined, the calculation of tax owing requires only two lines on the return. The tax system's rate structure has almost nothing do to with its complexity. The major sources of the complexity, uncertainty, and compliance costs of the income tax arise because of the need to measure taxable income on an annual basis, and from the felt political need to use the tax system to pursue social and economic goals through the enactment of tax expenditures.

Also, to be brutally frank, in spite of the mileage that flat-taxers get out of arguing for a simpler tax system, for most people filing a tax return is simple. The great bulk of the population who live on a wage or salary either pay no personal income tax at all, or already pay tax at a flat rate on their earnings.

Moreover, to the extent that claiming a tax credit for charitable donations, for example, complicates filling out their tax return, it is likely that taxpayers would be even more unhappy if the credit were eliminated on the grounds that this would make life simpler for them.

Further, all the talk about letting people file their return on a postcard looks a little silly these days when an increasing number of taxpayers file over the telephone or by computer.

The myth of reduced tax evasion
A claim frequently made to justify flat tax rates is that lowering income tax rates will lead to less tax evasion. This argument is particularly popular in the business press. In the heady days of supply-side economics, it was often suggested that cutting marginal tax rates could be revenue neutral, partly because lower marginal rates would lead to greater reporting of income.

The argument has a particularly peculiar ring to it when it is made by the rich themselves or their representatives. It hints of political blackmail. In effect, they are arguing that their taxes should be reduced because, if they are required to pay the amount the democratic majority deem to be their fair share, they will subvert the political will by engaging in criminal activity. In any event, even accepting that the argument is made in good faith, the claim that evasion can be reduced by flattening the tax rate is clearly fallacious.

Those who make the argument presumably reason that, as tax rates are lowered, the benefits of evasion are reduced and therefore taxpayers are less likely to cheat. If, for example, the tax rate is reduced from 50% to 30%, the benefits of not reporting $100 of earned income slips from $50 to only $30. Since the benefits of cheating are reduced when marginal tax rates are lowered, evasion should be reduced as well.

On the contrary, however, although higher tax rates increase the benefits of cheating, they also increase the costs, and the costs increase faster than the benefits, so tax cheating should be reduced, rather than increased, with higher rates.

Theories of human behaviour suggest that, at best, tax rates are likely to have a minor effect on compliance. Certainly, it is difficult to postulate a serious theory that would suggest that reducing tax rates would increase compliance.

Even within the Canadian tax system itself, there is no evidence that those taxes with the lowest or flattest rates tend to have the least amount of evasion. What evidence is available suggests the opposite. The GST, for example, is a flat 7% tax, yet there was a substantial increase in the underground economy in the early 1990s that has been attributed almost exclusively by some researchers to the introduction of the GST.

The myth of increased economic prosperity
Every ill the economy has suffered over the past two decades has been attributed by neoconservatives to high tax rates on rich individuals. Their most persistent refrain has been that the present progressive tax system has stifled the economy and productivity growth. Flattening tax rates, they argue, would usher in a new era of unconstrained prosperity.

The flat-taxers apparently assume that, given lower marginal tax rates, the rich will work more hours per week, more weeks per year, and more years per lifetime, since the amount they can earn after tax from working will have increased.

It is further assumed that they will save more because the government will be taking less of the interest, dividends and capital gains they can earn on their savings, and consequently, that rich and talented Canadians will be more likely to remain in Canada and contribute to its economy instead of emigrating to more tax-hospitable countries.

These arguments are derived from the familiar "trickle-down" theory of economics: a tax cut will cause rich people to work harder, save and invest more, and thus make everyone better off in the long run.

There are many versions of supply-side economics, and even the most modest version should be discounted. It is worth noting, however, that almost no one believes the version that the flat- taxers often put forward: that, by reducing tax rates, tax revenues would significantly increase as individuals work harder, save more and take more risks.

John Kenneth Galbraith called it "a relatively sophisticated form of fraud." Walter H. Heller likened it to laetrile, and James Tobin, Nobel Laureate in economics, termed it "snake oil." During the campaign for the Republican nomination in 1980, when Ronald Reagan popularized this variant of supply-side theory, George Bush referred to it as "voodoo economics."

No one doubts the existence of the kind of incentive effects flat-taxers postulate. Incentive effects of this kind are the stuff of Economics 101, as economists are fond of endlessly reminding us. The question is how important the incentive effects are within a range of reasonable tax rates, and what they add up to in relation to the potential GDP.

Although it seems to be almost an article of faith among the converted that high taxes have significant adverse effects on economic growth, this proposition is not supported by the weight of empirical evidence.

Looking first at changes in marginal tax rates in Canada over the past 50 years, the fact that reductions in the top marginal tax rate have been accompanied by lower rates of economic growth must at least be a troubling coincidence to those who argue that reducing the top marginal tax rate is the key to spurring economic growth.

In the late 1940s and early 1950s, the top marginal tax rate was in excess of 90%, yet in real terms the gross domestic product (GDP) was increasing at an annual rate of 6.2%. In the 1950s and 1960s, when the top marginal tax rate was in excess of 80%, the average annual growth rate was 5.1%. From 1972 to 1981, the top marginal tax rate was reduced to about 60%, while the growth rate slipped to 4.2%. Since 1981, the top marginal tax rate has been around 50%, and the growth rate has averaged only 2.4%.

This time-series correlation between marginal tax rates and growth rates points unambiguously to a negative, not a positive relationship. Of course, these simple time-series correlations are subject to all sorts of confounding variables, and, in spite of the correlation between high marginal rates and high rates of economic growth in recent history in Canada, no one would suggest this correlation implies causation--in other words, that high marginal tax rates on the rich cause economic growth.

For that reason, no one takes these one-time coincidences of economic history too seriously. However, they are part of the historical record and at the very least suggest that high tax rates do not appear to have the adverse effects often attributed to them, and that they can coexist with high rates of economic growth.

Neil Brooks teaches tax law and policy at Osgoode Hall Law School in Toronto. This is Part I of an excerpt from the annual Horace Read Lecture that he was asked to deliver. Part II will appear in our September issue.) Taken from The CCPA Monitor, July/August 1999.