Flat Taxes and Distributional Justice

Income tax reform has become a hot topic in both the United States and Canada. Over the past few years, a variety of proposals have been advanced for the replacement of the current income tax system and most proposals involve a compression of the multi-rate structure into a single rate and a shift to some form of consumption tax base. Flat taxes are advocated on the belief that they will provide a strong stimulus to investment, employment and output. Their supporters are convinced that the economic benefits are sufficiently large to make everyone better off, therefore there is no need to be concerned about the distributional effects of flat taxes. However, the claims about potentially large efficiency gains from flat taxes are not supported by research. Evaluating the effects of a consumption-base flat tax of the type proposed by Hall and Rabushka is one of the main purposes of the paper. Using a microdata set for Canada, which allows identifying taxpayers by both income level and family type, we show that flat taxes not only increase income inequality but also have important horizontal equity implications. We argue that a full debate on income tax reform requires a detailed evaluation of both polar alternatives to the current hybrid income tax: a move to a consumption base and a move to a comprehensive income tax. Toward that end, we have performed a simulation which estimates the distributional effects of a comprehensive income base with across the board rate reductions in order to maintain revenue-neutrality. We show that this option has advantages over the consumption-base flat tax in terms of both vertical and horizontal equity.