Postcard-Size or Not, America Needs a New Tax Plan

TWO approaches to tax reform are building up steam in Washington. In the House, the flat tax advocated by majority leader Dick Armey (R) of Texas has been gaining support. In the Senate, the USA Tax Plan (a form of progressive consumption tax) has been developed by Sens. Sam Nunn (D) of Georgia and Pete Domenici (R) of New Mexico and is attracting adherents in both parties.

Virtually all the discussion to date has focused on the differences between the Armey and Nunn-Domenici proposals -- and they are significant. However, their overlooked similarities are basic and transcend the differences. Moreover, if the two approaches are not ultimately reconciled, the likelihood of Congress passing significant legislation in this field will greatly diminish.

Essentially, Mr. Armey would tax employee wages and salaries at a flat 19 percent and eliminate a host of complicating provisions, such as the deductions for mortgage interest, charitable contributions, and state and local taxes. His proposal contains a more generous set of personal allowances and dependent exemptions than the present law provides. For many low-income families, the tax burden would decline. For all taxpayers, today's complicated federal return would be boiled down to the size of a postcard.

In contrast, Senators Nunn and Domenici start with the existing federal tax return and make several key adjustments. The most important is a deduction for all the saving that the taxpayer has done during the year. The current and very limited Individual Retirement Account would be converted into an Unlimited Savings Allowance (hence the label for the plan -- USA).

In addition, a full credit is given for the Social Security and Medicare taxes withheld from the employee's wages. The generous personal allowances and exemptions provided are not quite as high as in the Armey proposal. Rather than a single flat tax, a graduated schedule ranges from a bottom rate of 19 percent to a top rate of 40 percent.

On the surface, the differences between the two plans seem very large. However, when we step back from the details, we find that both are variations on the same set of themes. Both proposals promote economic growth by putting more of the tax burden on consumption and lightening it on saving and investment. Both simplify the tax system substantially. Although not down to a postcard-size return, Nunn-Domenici eliminates approximately 80 percent of the federal income law. Today's several thousand pages of the Internal Revenue Code are boiled down to about 300.

Although the USA Tax Plan does not result in a truly flat tax, it does continue the steady move to a flatter tax structure. Since 1980, when the top rate was five times as high as the bottom rate, changes in the federal tax structure have steadily narrowed that differential. By 1994, the top rate was only 2.6 times the bottom rate. Under Nunn-Domenici, a modest further reduction is made -- to 2.1.

The Armey and Nunn-Domenici plans are similar in what they avoid. Neither requires setting up an additional record-keeping apparatus or collection system because neither creates a new tax. By not adopting the form of a sales tax or value-added tax (VAT), each is neither regressive nor inflationary. In contrast, because sales taxes and the VAT are included in the price of goods and services, their introduction registers an upward movement in the measures of inflation. Moreover, because people's consumption rises more slowly than their incomes, proportional-rate sales taxes and VATs are regressive.

Either the Nunn-Domenici USA Tax Plan or the Armey flat tax would be substantially better than the status quo or other alternatives. Nunn-Domenici is more attractive. It continues the progressive tradition of federal taxation and more directly encourages saving and investment, the keys to faster economic growth and rising living standards.

Adding one bracket to Armey and flattening Nunn-Domenici's rate structure a bit would help bridge the gap between the two. The spirit of Voltaire is needed: ''The best is the enemy of the good.''