Word: flatness
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Dates: during 1990-1999
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Like all economic models, however, the beneficial effects of the flat tax rest upon the ceteris paribus assumption, i.e., that all other things held constant. Yet under Forbes' proposal, ceteris paribus does not hold. This is because his flat tax, which amounts to a massive tax cut especially for the wealthy, would substantially increase the federal budget deficit and overheat the economy. Both of these consequences of the flat tax would serve to undermine and even undo the beneficial effects of having a single tax rate that exempts investment income...
Despite Forbes' claims to the contrary, his flat tax proposal would increase the budget deficit. Even he admits that his proposal could cost the government as much as $200 billion a year in revenues. Given such a sum and prior experience with the Reagan era tax cuts, Forbes' claim that economic growth would more than compensate for the lost revenue cannot be taken seriously. The Reagan-era tax cuts generated only enough additional revenue through the supply-side to offset a third of the lost revenues. Forbes' proposal is unlikely to do three times as well...
...result, the budget deficit would no doubt balloon under his flat tax. This would then drive up interest rates since the government would need to borrow more money to finance the deficit and to do this would have to offer higher interest rates to lenders. These higher interest rates would then lower investment, which depends primarily upon the interest rate, and undermine the supply-side effects of the flat tax. The end result, of course, would depend on the size of the deficit, but in all likelihood investment would decrease and economic growth actually fall...
This problematic outcome would be further compounded by the demand-side consequences of Forbes' flat tax. Historically, supply-side tax cuts that produce budget deficits, like the Reagan tax cuts, tend to have a far greater effect on the demand-side of the economy than on the supply-side. In other words, Forbes' massive tax cut would substantially increase aggregate demand while only marginally increasing aggregate supply. The result, of course, is inflation. This higher inflation would then require the Federal Reserve to contract the money supply by raising interest rates which would also lower investment and hence long-term...
...only way out of this conundrum is the implementation of a flat tax that would not produce a budget deficit. Yet such a flat tax would require a rate of around 25 percent. Once the various deductions currently allowed are taken into account, such a flat tax would result in higher taxes for the middle class and lower ones for the wealthy. This flat tax would admittedly increase long-run economic growth, but it would also engender even greater economic inequality by undermining the middle class. This would return us to the familiar world of the efficiency-equity trade...