Flat, Flatter, Flattest: Singing From the Same Tax 'Hymnal'
Alternatives to the current revenue code are all the rage
TAX reform has become the latest rage in Washington. Presidential aspirants and congressional leaders are stumbling over one another to propose new tax systems to capture the hearts, not to mention the votes, of the public. While we have heard the siren song of ''reform'' before -- every two years Congress tinkers with arcane sections of our overgrown tax code -- these proposals represent fundamental change in the way we tax ourselves.
Tax reform is also generating interest outside of Washington. The ''flat tax'' has entered the popular lexicon as a result of the attention House majority leader Dick Armey's proposal has received. Sen. Arlen Specter (R) of Pennsylvania has introduced his own flat tax, House minority leader Dick Gephardt has proposed a ''flatter'' tax, and Senate majority leader Bob Dole and House Speaker Newt Gingrich have formed a commission on tax reform chaired by Jack Kemp, a vocal flat-tax supporter.
Sen. Richard Lugar (R) of Indiana has made his proposed national sales tax, which he says would replace all existing taxes and eliminate the need for the IRS, a centerpiece of his presidential campaign. House Ways and Means Committee chairman Bill Archer supports a broad-based consumption tax. Former Ways and Means Committee chairman Sam Gibbons has advocated a European-style value-added tax.
The latest proposal to gain attention is the USA (for Unlimited Savings Allowance) Tax Act of 1995, introduced recently by Senate Budget Committee chairman Pete Domenici and Sen. Sam Nunn (D) of Georgia. Actually, however, the Domenici-Nunn proposal predates many of these other plans, having evolved from the 1992 recommendations of the Strengthening of America Commission that the senators chaired for the Center for Strategic and International Studies. It is perhaps the best positioned alternative, since it is the only one so far with strong bipartisan support.
The hype surrounding these proposals might lead one to conclude that they represent fundamentally different, and mutually exclusive, visions of our tax future. In fact, it is remarkable how much these seemingly disparate proposals have in common. To wit, each is intended to:
* Simplify the tax code;
* Eliminate the current tax code's bias against saving and investment;
* Better integrate business and individual taxes (the sales tax would do away with both);
* Tax what one takes out of the economy, rather than what one puts into it;
* And rationalize the tax system with those of our principal trading partners.
Moreover, the differences among the competing tax plans are much overblown. For example, while the proposals have markedly different rate structures, the differences are superficial.
This becomes clear when one looks at the effective rate of tax that will be paid by taxpayers, not just the marginal rate (although the marginal rate has the greatest impact on behavior). Congressman Armey's flat tax of 17 percent would be somewhat progressive for all taxpayers because of the large family allowance and personal deductions, with families at the low end of the income scale having zero percent effective and marginal tax rates. Those with incomes at the top will have effective tax rates almost equal to the full 17 percent marginal rate.
Somewhat surprisingly, this is quite similar to effective tax rates under current law. The top marginal tax rate is nearly 40 percent. However, according to data compiled by Jonathan Gruber of the Massachusetts Institute of Technology, recently published in a Progressive Policy Institute report, the effective rate paid by the top 5 percent income group was just 17.4 percent, because these taxpayers can avail themselves of numerous tax-avoidance strategies.
Although the Domenici-Nunn USA Tax plan also employs a graduated rate structure and the continuation of the mortgage interest and charitable deductions, as well as the deduction for net new savings and a new payroll tax credit, it will result in effective tax rates much lower than the advertised marginal rates.
Most important, tax reform proponents are unanimous on the issue of greatest significance -- the need to replace the tax code, which is byzantine, costly, and inefficient. There is complete agreement that the current code imposes billions of dollars of dead-weight loss on society, is biased against saving, and discourages investment, risk-taking, and competition. There is complete agreement that the tax code imperils our ability to achieve real productivity and wage gains and improve our standard of living.
No action the administration and Congress could take would do more to put the country on the path to sustained prosperity. Let's hope the proponents of tax reform continue to sing from the same hymnal and emphasize their common goals, rather than their differences, which are much less important in the long run. Perhaps then the taxpaying public will join in the chorus, and the prospects for a tax system that will benefit all Americans will be markedly enhanced.