All over the world, from Estonia, to Albania, to Russia to Hong Kong, flat taxes are in vogue. The flat tax is being instituted to enhance economic growth, increase tax revenues and make tax codes fairer. Why not in the U.S.
After all, isn’t the world topsy-turvy when Moscow, the onetime center of socialism, has a 13 percent top income tax rate compared to 35 percent in America, the land of the free?
Former Sens. Connie Mack of Florida and John Breaux of Louisiana are trying to grapple with the issue of how to make tax reform politically palatable, as they enter their final stage of deliberations as chairmen of President Bush’s federal tax reform panel. I would suggest one politically viable way to overcome the special interest opposition to tax reform is adoption of a Freedom to Choose Flat Tax.
The potential economic gains are gigantic for American workers and firms if the tax panel adopts this approach. For example, if the $200 billion a year compliance costs attributable to the tax code could be cut in half, the financial windfall to the nation would be larger than the value of all goods and services produced by every worker and business in the states of Maine, Vermont and New Hampshire combined. On top of that, Harvard University economist Dale Jorgenson estimated several years ago that if replacing the U.S. tax code with some kind of flat and simple consumption tax would increase economic growth by about 10 percent.
The idea behind the Freedom to Choose Flat tax is an optional postcard flat tax, offered to tax filers as an alternative to, rather than a replacement of, the current tax code. What I propose is an Alternative Maximum Tax of 20 percent. The current tax laws require millions of Americans to fill out their tax forms then compute the Alternative Minimum Tax and pay the greater of the two. Under this Freedom to Choose Flat Tax, the filer would be allowed to pay the lesser of the two tax liabilities. In fact, this idea simultaneously solves the middle-class AMT problem by simply lowering the tax rate to 20 percent on all income and letting Americans opt into that system if they so wish.
Wage and business income would be taxed at a maximum 20 percent. The corporate tax rate would fall to 20 percent, but all tax credits would end. Business capital purchases would be expensed, thus eliminating complicated depreciation schedules. Capital income — from capital gains, dividends, and estates — would also be taxed at 20 percent.
This plan would accomplish each major goal of tax reform. It would be: (1) sweeping, (2) dramatically simpler than the current tax code, (3) an enormous boost to U.S. economic growth, (4) fair and (5) politically feasible. The last point is the most significant: This plan would allow tax reformers to avoid the grueling task of dredging the Internal Revenue Service’s tax code swamp. The plan also would avoid the kind of ferocious opposition from deep-pocket special-interest groups that inevitably leads to a political collision in which reform advocates suffer the most casualties.
The advantages are obvious. First, there are no winners and losers as with conventional tax-reform plans. Under this optional flat tax, no one is forced into a losing position because every filer could stick with the current tax system. So the conventional complaint about a flat tax, that it would raise taxes on the middle class, is rendered null and void.
Second, the plan does not force people to give up “sacred cow deductions” for homeowners, or charitable givers or municipal bonds owners. If tax filers want the homeowners deduction, they can take advantage of it by staying in the current system.
Third, the plan does not require writing horrendously complicated rules to get from one system to the other.
Recently, economist Bruce Bartlett attacked this plan as a gimmick. But he fails to realize this is precisely how the Hong Kong tax system works. Hong Kong has a complicated system and a simple flat tax, and filers choose between the two. Also, both Dick Armey and Steve Forbes, flat tax champions, have adopted a similar glide path in their respective plans. Steve Forbes would give every tax filer five years to choose between the flat tax and the current 1040 forms and then after the end of the transition period, the flat tax would be the law of the land.
Under the Freedom to Choose Flat Tax, every tax filer would be grandfathered into the old tax code as long as they wished. But once they migrated into the flat tax, they would be there for good. All new workers would go immediately into the flat tax. Hence, in time, the old tax code would essentially phase out.
In testimony earlier this month, I told Sens. Mack and Breaux that fundamentally overhauling the tax system doesn’t require a single change in a paragraph, word or comma of the Internal Revenue Code. Just a one-page supplement is needed to the current tax laws, providing workers and businesses the option of bypassing the first 13,000 pages of legal gobbledy-gook and complying with a postcard return with one flat rate for all. That is: A flat tax can be achieved before this president leaves office, if only Congress gives taxpayers the freedom to choose.
Stephen Moore is president of the Free Enterprise Fund and a senior fellow in economics at the Cato Institute.