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The flat tax and housing

  • Economics


FRBSF January 25, 1985 WEEKLY LETTER The Flat Tax And Housing The United States Treasury recently presented sug- gestions for reforming the Federal individual and corporate income tax systems. Its proposal, identi- fied as a "modified flat tax," was the latest in a numberof proposals generically refered to as "flat tax" systems. Many of these flat tax systems alter the tax treatment of housing sign ificantly. The pur- pose of this Letter is to discuss briefly the rationale behind a flat tax system and the implications of such a system for the housing market. In its most general sense, a flattax system is simply one that imposes a tax on income, profits, wages or some other base at a rate that is independent of that base. Thus, most of the sales, property and excise taxes levied in the United States today are flat taxes. A sales tax, for example, applies a flat rate to the volume of retail sales. The present flat tax reform movement applies the flat rate principle to the Federal income tax system in which individual income tax rates rise progres- sively with income. Rationale The rationale for replacing a progressive tax sys- tem with a flat tax system lies in the effects of taxation in distorting economic behavior. Taxa- tion of wage income, for example, is believed to reduce labor supply and, hence, to depress na- tional income. Under a progressive rate scheme, the highest marginal tax rates - and, hence, the greatest disincentives to additional work - are imposed on those who earn the highest wage, who usually are considered the most productive work- ers. Thus, although a progressive tax rate system may have desirable consequences for equity, namely, by placing most of the tax burden on those best able to pay, it may have a more than offsetting deleterious effect on the performance of the economy. The economist Edgar Browning, for example, has demonstrated that when the tax burden is shifted from the lowest income taxpayers to the highest income taxpayers by progressive taxation, the l

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