WILLisms.com: Tax Reform: Flat Tax Or Fair Tax?

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Tax Reform: Flat Tax Or Fair Tax?

The Democratic Party derives electoral and financial support from a piecemeal coalition of African-Americans, unions, gays, Jews, trade protectionists, anti-Semites, environmentalists, abortion-rights advocates (mostly single women), college professors, the media establishment, artistic urban hipsters, socialists, and peaceniks. Often the categories of support overlap, but, just as often, the interests contradict each other.

That's where the GOP has a decided advantage. The Republican Party has disparate and distinct groups represented under its tent, to be sure (and we could brainstorm and identify a commensurate number of interests), but generally the modern Republican coalition boils down to three 'T's, TERROR, TRADITION, and TAXES.

Terror is a no-brainer. It's why many Democrats, libertarians, and fence-sitters became Bush Republicans after 9/11. The War On Terror has a way of making people more Republican, with or without intentional politicization of the issue.

Tradition is a little more complicated. It's both vague and specific, all at once. It is the "morals and values" that garnered so much attention in the 2004 election. But it could mean anything from opposition to gay marriage, to being tough on crime, to being pro-life on abortion, to a general sense that our culture is moving forward too rapidly-- and not always for the better.

Taxes, meanwhile, are a crucial part of the GOP triumvirate. In 1998, President George H.W. Bush (41) told a roaring crowd of partisans that they could read his lips, "no new taxes," and they rewarded him with a landslide victory over Michael Dukakis. Then, in an unfortunate political (as well as policy) move, Bush the elder succumbed to pressure from a Democratic Congress to break his now-infamous pledge and raise taxes. He lost-- decidedly-- in 1992.

President Bush has pledged to fundamentally reform the tax code. He, and others charged with the task, if they care about the political legacy they will leave in their wake, ought to consider the (Steve) Forbes Flat Tax proposal:

My flat tax plan has one simple rate, on the federal level: 17% on personal income and 17% on corporate profits. There would be generous exemptions for individuals: $13,200 for each adult; $4,000 for each child or dependent, and a refundable tax credit of $1,000 per child 16 or younger. A family of four would pay no federal income tax on its first $46,165 of income. Exemptions for a family of six--mom, dad, four kids--would be $65,930. No anti-risk-taking capital gains levy; the capital gains tax would go to zero. The abusive Alternative Minimum (really maximum) Tax would be abolished. No more death tax: You'd leave the world unmolested by the IRS. No taxation without respiration!
Corporate profits would be taxed at a rate of 17%. Companies could expense all investments at once: no more depreciation schedules. If these instant write-offs produce a loss, that could be carried forward to use against future profits for as many years as necessary to use it up. And businesses would be taxed only on income made in the U.S.

Steve Forbes, a nerd, does not and could not really inspire the "Terror Warrior" image Republican primary voters now demand. He's not really believable as a Commander-In-Chief. Strike one. Not a Terror Republican.

Meanwhile, Forbes does not really seem like someone who has a genuinely-held position, one way or another, on values issues. He is not a Tradition Republican.

But he did raise millions of dollars in both 1996 and 2000, garnering relatively broad grassroots and electoral support for a candidate running on essentially a single issue, the flat tax. He is a Taxes Republican. And his flat tax idea remains popular with the GOP rank-and-file.

Some left-wingers mock the idea as yesterday's news, but no idea as meaningful as a flat tax moves from conception to implementation overnight. In the past 10 years, the global economy has changed in a dramatic way. In the past 10 years, the American political landscape has changed in a dramatic way. And over the past decade, people have had time to think about the flat tax, if only in the very back of their minds. It's no longer some radical proposal by some rich dude; the flat tax is a system that has been tried internationally, with great success:

Other countries are getting the message, even if we have yet to. Hong Kong has successfully had a variation of the flat tax for 60 years. Lithuania, Latvia and Estonia enacted flat taxes in the 1990s that have been hugely successful. Russia put in a flat tax four years ago, and revenues have more than doubled in real terms. Ukraine, Slovakia, Romania, Georgia and Serbia have also successfully enacted flat taxes. How ironic that onetime Communist nations have been reaping the benefits of a flat tax before that bastion of free enterprise, the U.S.

And, by every indication, a flat tax would be a boon to the American economy, especially as our workers and our businesses compete directly against flat tax nations in the global marketplace:

Experience demonstrates time and time again--the Harding-Coolidge tax cuts of the 1920s, the Kennedy cuts of the '60s, the Reagan cuts of the '80s and the Bush reductions of 2003--that lower tax rates lead to more economic activity, which leads to more government revenue. Fiscal Associates of Alexandria, Va., an economic consulting firm, did an analysis of the flat tax. Its findings: Between 2005 and 2015, the Forbes Flat Tax Plan would generate $56 billion more in new government revenue than the current income tax. More important, an estimated $6 trillion in additional assets would be created, an immense boost to our nation's balance sheet. This study also predicts that that flat tax would lead to nearly 3.5 million new jobs by 2011--jobs that otherwise would not exist.

Indeed, as we've seen in recent months, the Laffer Curve lives. Lower taxes can actually produce higher revenues for the government. It's not hairbrained to believe that a flat tax could end up supercharging the American economy.

The history of tax tinkering bears out the idea that lower taxes typically lead to more robust economic growth. It's not brain surgery. It is common sense. And it gets to the nature of our economy. Are we empowering the free enterprise system, the greatest engine for economic growth in the history of the world, to work at full capacity? Or even close to it? Or are we resigned to antiquated Marxist ideas about a "heavy" and "progressive" income tax around our necks, holding us back?

Tax cuts work, and tax simplification is a political winner. It's just good policy. A flat tax makes sense on so many levels, and it makes perfect sense to the average apolitical American.

But, unfortunately, the debate will become politicized by the still-eminent establishment media and status-quo worshipping socialist Democrats in Congress. It will become a "tax cut for the rich," a giveaway to Bush's rich buddies. It will "cost" "us" x billion dollars over x years. It will "bankrupt" the government.

And the flat tax will compete with the fair tax (essentially a national sales tax, and an idea certainly worth considering) for political turf on the right. Conservatives and libertarians, who agree that taxes ought to be lower, will derail serious tax reform by fighting over nuances, rather than uniting behind a single proposal.

Ideally, we could have some sort of caucus/primary process, where the fair tax and the flat tax battle it out for supremacy. The losing side would agree to get behind the winner, in the spirit of unity. Then, we could all go to battle together against the forces of higher taxes. And win. Handily.

In about a week, I am going to pick up a copy of Neal Boortz' The Fair Tax Book at an upcoming book signing in Houston. Right now, I tend to favor a flat tax to a national sales tax, but I am going into it with an open mind.

I would hope that other conservatives would do the same.

And when President Bush's Tax Reform Commission reports back, I hope the fiscal conservative movement behaves like the majoritarian force that it is and rallies behind fundamental tax reform, one way or another.

Posted by Will Franklin · 21 August 2005 01:52 AM

Comments

This is all well and good, but it conveniently omits a basic rule of arithmetic: income tax reform cannot simultaneously be revenue-neutral and result in lower taxes for everyone.

If some people will face higher tax burdens, then let's disclose that. And we know exactly who they'll be:

--Not the poor: They'll fall within the "generous" flat-tax exemptions (and the lower 50% of households pay no income tax already, so it's a wash for them).

--Not the rich, who are essentially flat-taxed already due to progressive reductions in deductions and exemptions, not to mention the AMT.

No, it will be upper middle-class homeowners living in high-tax states, which -- for better or worse -- tend to be "blue states."

Meanwhile, if tax reform is not revenue-neutral, then why bother? Just lower tax rates and be done with it. Take care of oppressively high taxes and "tax simplification" will take care of itself.

As for a national sales tax: no way in hell. If you go from an income tax today to a sales tax tomorrow, then you will only end up with both the day after tomorrow. Oh, and that national sales tax could be as high as 82% to be revenue-neutral. That's another thing they don't tell you.

Posted by: KipEsquire at August 21, 2005 07:15 AM

You may be right about the upper middle class, but I think it would be a fairly narrow window that would actually have higher taxes, considering where the current jump to 35% takes place. The question is really whether it's revenue neutral.
Plus, that group, the UMC, would have the advantage of knowing that if they worked overtime or took a better job they wouldn't be penalized at a higher rate on the additional dollars earned.
Then there's the simplicity. Imagine the additional money that can be poured back into the economy that otherwise gets directed toward tax compliance.
On top of that is fairness. Progressives like to think of fairness as the government deciding how much each group gets to keep. But fairness is really equal treatment under the law. The current tax code is not equal treatment. If you're just barely above the level for the EITC then you're penalized. Then at each level you move up you're further penalized in the interest of "income equality." Until, eventually, you're in Senator & Mrs. Kerry's tax bracket, in which case you pay 5% or so due to all your non-taxable investments. Remember, Forbes' flat tax proposal wants to tax all income - including interest from muni bonds and dividends - as income.

Posted by: Giacomo at August 21, 2005 08:46 AM

Oh, by the way, Will, thanks for taking an idea I had for a post and doing a better job on it than I would have. Rats.

Posted by: Giacomo at August 21, 2005 08:51 AM

A flat tax would make alot of people's life much easier!...

Posted by: Zsa Zsa at August 21, 2005 09:13 AM

My husband I have talked about a flat tax for years. We're that "upper middle class" you're talking about.

We'd like the simplicity of a flat tax. And we're also drawn to the idea of fairness.

Question:

Will the deduction on housing remain? I've heard this question answered both ways. In some ways this seems like the biggest tax cut for the rich, and despite being in an expensive housing area I'm not sure how I feel about it. It does help prop up the housing industry, thats for sure...and I believe that ownership is a good thing...but...

Posted by: Carolynn at August 21, 2005 10:56 AM

The mortgage deduction would be one of the most significant pivot points for debate.

And there would be some who might see their tax burden go up under a flat tax.

Forbes wants to allow people the choice of filling out a simple postcard and being done with it, or doing their taxes the way we do today (which would mean they could use the housing exemption). I wonder exactly how that would go. Would the IRS still shrink? Would people spend even more time figuring out under which plan to pay? Would it invite more loopholes and such?

I don't know.

Posted by: Will Franklin at August 21, 2005 11:09 AM

I'm against a national sales tax. It would destroy the market for NEW homes, NEW automobiles, and NEW luxury items like boats. Also it would spawn a black (cash only/barter) market to avoid sales taxes.

The best thing is to work gradually toward Steve Forbes ideas by implementing them over a five/ten year period. Phase out such popular deductions as home loan interest and charity over a number of years so people can adjust their financial plans to the new realities.

Work toward the flat tax in increments. It is a worthy goal and would, in my opinion, resultn in much higher tax revenues due to increased economic activity.

Posted by: Jim at August 21, 2005 11:30 PM

While a sales tax will hurt consumption, it does reward savings and work, unlike the present system.

However, tax dodging would be rife.

A Value Added Tax is better and also helps exports as it is refundable for exports (and imports have to pay it first thing.)

Posted by: Aaron at August 22, 2005 12:46 AM

A flat tax doesn't necessarily simplify tax preparation. Think about the last 1040. Most of it has to do with what part of your income is taxable. Once you figure that out, all you do is flip to the back of the book to see how much you owe based on that number.

There are ways of implementing a flat tax that simplify tax preparation, but only if you get rid of deductions for dependents, home mortgage credit, etc. The deductions are the the biggest part of the tax code. The "you pay x % if you make this much, and y % if you make this much" part is pretty straightforward.

Posted by: Les Jones at August 22, 2005 04:13 PM

We need a flat tax. If a flat tax was adopted we could save money by getting rid of a lot of the IRS and there would be a lot more money in the federal coffers.

Posted by: LaVern Crews at September 28, 2005 01:10 PM