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Real tax reform: flat-tax simplicity with a progressive twist

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Nati Harnik/AP/File

(Read caption) Republican presidential candidate and businessman Herman Cain speaks in Des Moines, Iowa, last month. Mr. Cain ignited interest in the flat tax with his 9-9-9 plan. But to make headway politically, flat-tax proponents have to find a way to make their plans more progressive.

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Tax reform has emerged as a key issue for GOP presidential hopefuls. Texas Gov. Rick Perry wants to scrap our current system and replace it with a 20 percent flat tax on individual and corporate incomes. Former Speaker of the House Newt Gingrich wants to do the same, but with even lower rates.

Then there's pizza magnate Herman Cain. His "9-9-9" plan would replace today's income and payroll taxes with a trio of levies: a 9 percent flat tax on individuals, another on businesses, and a 9 percent retail sales tax. But Mr. Cain's ultimate vision is to eliminate anything remotely resembling today's tax system in favor of a national retail sales tax, which proponents call the FairTax.

These three plans have much in common. Catchy names, for one. More important, they all focus on taxing consumption – what people spend – rather than income.

The flat tax is most famous, of course, for applying a single rate to all corporate earnings and to all individual earnings above some exemption. It's also famous for allowing taxpayers to file their returns on a postcard by eliminating all the special deductions, credits, and other rules that complicate today's tax code. (It also proved too radical for Governor Perry and Mr. Gingrich; their modified flat taxes keep some select deductions, including for charity and mortgage interest, and they also allow individuals to choose to remain in the current system.)

Equally important, however, is the way the flat tax handles investment income. Individuals would pay taxes on their labor income but not on capital gains, dividends, or interest.

That doesn't mean capital income would escape taxation. Instead, the taxes would be collected at the business level. Businesses would pay taxes on all their income, regardless of whether it's paid out as dividends or interest. They would also be allowed to write off the entire cost of new investments when they are made.

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