Flat Taxes and Fair Taxes
IT'S been clear for months that tax reform would be an issue in this year's Republican presidential contest. Sen. Arlen Specter of Pennsylvania, who has suspended his campaign, spent months waving his proposed postcard-sized tax form around New Hampshire. Sen. Richard Lugar of Indiana has stumped for a national retail-sales tax to replace the income tax. Other candidates have also floated proposals.
So it must seem ironic to these men that candidate-come-lately Steve Forbes has rocketed himself into second place in the polls, and the flat tax onto the national agenda, using his personal fortune as the fuel. Mr. Forbes has already spent millions of dollars on TV and radio advertising in Iowa and New Hampshire pushing his particular flat-tax idea. So much for retail politics.
The issue got further impetus last week when a Republican commission led by former Housing Secretary Jack Kemp endorsed a single-rate tax, without specifying a figure, and proposed guidelines for tax reform.
It's high time the nation began a serious discussion about our national taxation system and some of the assumptions behind it. The current tax code is such a mess even the IRS won't guarantee that it's giving the correct answers to taxpayer inquiries. Its high-handed approach to dealing with honest disputes has earned it widespread enmity.
Existing tax rates are supposed to be progressive, meaning that wealthy taxpayers pay a higher percentage of their income in taxes than the middle class and the poor. But that's more illusion than reality - those who have big money are certain to find and use the legal loopholes available to shelter their assets. That shifts more of the burden back onto the average citizen.
The current system not only doesn't prevent the wealthy from becoming wealthier (not that it should) - it works to encourage consumption, discourage savings, and prevent the middle class from building wealth - a factor even more relevant in light of next century's strain on Social Security revenues. The capital-gains tax is a perfect example: Taking one-third of a middle- or lower-income taxpayer's earnings on the sale of a modest house is not just "making the rich pay."
As the tax debate heats up, however, it's important to remember that there is no single flat-tax proposal. There are many, and their various provisions could have radically different consequences.
Members of both parties, including Democrats Jerry Brown of California and Rep. Richard Gephardt of Iowa, have proposed flat taxes in recent years. The basic goals of a flat tax are to simplify the tax system, encourage honest filing and payment of taxes, and boost economic growth. In its "purest" form, that proposed by Forbes, it would not tax interest and dividend income, using the argument that such income is now taxed twice - once when the corporation pays its taxes, and again when the investor or saver pays his or hers. That means, however, that an individual living off a multimillion dollar trust fund - like Forbes - would pay no taxes at all, while all others would pay the full 17 percent rate. Forbes's proposal would also eliminate the home-mortgage and charitable-contribution deductions.
Texas Sen. Phil Gramm proposes a 16 percent rate, but would preserve the home-mortgage and charitable-contribution deductions and make up the difference through spending cuts. Senator Specter calls for a 20 percent rate, with similar deductions, to prevent increasing the deficit.
We are not yet ready to endorse any new tax plan, although we strongly believe that a revision should emerge from the current national discussion. Lawmakers must keep in mind, of course, that the jolt to the economy of changing the tax system would be significant, so any transition would need careful thought and planning.
To ensure fairness and to maximize public acceptance, a reformed tax system should:
*Establish a lower and flatter tax rate, which past experience shows (as in the much-cited Kennedy tax cut) actually increases government revenues and encourages the rich to pay more.
*Preserve the home-mortgage and charitable-contribution deductions, but eliminate most others.
*Allow individuals to deduct payroll taxes such as Social Security and Medicare, which would primarily help taxpayers earning less than $62,700.
*Ensure that lower-income families - say, those making less than $30,000 - pay no tax.
*Encourage savings instead of consumption.
*Substantially reduce capital-gains and estate taxes, thereby aiding farm families and small businesses and allowing the middle class to create and build more wealth.
*Significantly simplify filing.
*Reduce the power of the IRS to examine financial records without a warrant or seize property without a judicial finding of wrongdoing.
Above all, tax reform should not increase the deficit. If it results in lower revenues, the president and Congress must agree on appropriate peacetime spending cuts to balance the budget.