Time to flatten those taxes?

By Aussiegirl

Bruce Bartlett, writing in National Review Online shares his thoughts on possible tax reforms being considered by the Bush adminstration. As I'm no tax expert, (except so far as to complain mightily like a good red-blood American every time tax day rolls around) I have no idea how all this is going to work. What is clear is that the present system is completely broken. What's also clear is that no matter what system is offered or considered, someone or some group is going to cry foul once it is proposed, and given the complete lack of courage on display in the Congress, it's doubtful whether any meaningful reform stands a chance. Those lobbyists are just not going to leave those congressmen alone long enough to make real fundamental changes even though that is probably what is needed.

I have a few questions about how this would all work -- either a flat tax (I better not end up paying more under a flat tax system, that's all I have to say), or a national retail tax. My question, as a layperson and complete economic ignoramus is this -- how do we take care of the seeming inequity involved in say, a national sales tax, when people who are living on modest incomes and who spend their entire paychecks just to survive will wind up paying taxes on their entire incomes, while -- dare I use the term "rich people"? -- who spend only a small fraction of their incomes annually will get off relatively easily. Now I know all about how it's rich people that make the world go round, and invest in business, and all that good stuff, and believe me, I love and esteem them for doing that, nevertheless, it does seem a tad unfair to those of us laboring down here in the great vast unwashed lands of America, those of us who spend most of what we earn, to think that the rich are going to pay less, while we pay more. How is that going to work? The last proposal I saw was for a national sales tax of 28%!! Now, I don't pay 28% of my income for taxes now -- and I'd be horrified to have to do it. Furthermore, wouldn't that impinge on the retail and buying part of our economy? Let's face it, if I had to pay nearly a third more for any high-ticket item like a car or an appliance, etc. -- I'd postpone it as long as I could. I think any new tax proposal is going to have to consider the psychological factor. Right now we have a lousy system but everyone is used to it. You get your paycheck and there's stuff deducted, but still what you have left over is yours to spend. Then comes tax time and with a lump in your stomach out come all those endless forms, referring to paragraph this and table that, and as you get to the bottom line you wonder if the tax jackpot is going to come up all cherries -- i.e. you actually get something "back" (I know this illusory - -but nevertheless, this is the psychology of those of us down here in the hinterlands) -- or -- horrors!! -- you miscalculated your withholding -- or you came into some unexpected money during the year and you owe more money! Ouch -- that always hurts. And even though we understand that it is our money we are getting back -- still -- we feel briefly that we have come into a little windfall if we are due a tax refund. I can't imagine having everything suddenly turned upside down. Frankly, the prospects of suddenly facing something completely different is scary. How do all these experts know everything that will happen? People are notoriously clever in avoiding taxes no matter how they are imposed. If goods are taxed, I can see a barter economy coming about to avoid the taxes. I offer these completely ill-tutored thoughts just as a reminder to those up there making these reforms how these changes are liable to be seen by the average person.

Whatever the commission brings forth we can probably assume that it's dead on arrival. Bush has no mandate at this point. He spent all his political capital on the Social Security reform road show, and has precious little to show for it. Frankly, as Bruce Bartlett has written elsewhere, if the Bush administration hadn't pushed through the feel-good prescription benefit for seniors, Social Security wouldn't presently be in danger of going bankrupt. Further, in a time of war, in a time of terror, in a time of high taxes and high gas prices, it's hard to concern one's self with how Social Security may fare in a future which seems far removed given the current political uncertainties. It almost seems foolish to worry about something so remote when we could be engaged in what amounts to this war on terror for the forseeable future. In a nutshell, it's hard to see what the goals are of this administration, which started with such optimism after a bruising election, promised much, and so far has delivered what looks like a lack of interest in pursuing the war on terror, and a lackluster show of initiative on the domestic front.

President Bush says he wants to reform the tax system and has appointed a tax-reform commission that will issue a report in September. It was originally supposed to have reported by July 31, but the White House asked the commission to delay its report so that it would not interfere with the Social Security-reform effort, which needs a few more months before it can be declared legally dead.

I've long thought that the White House had made a very serious error in attempting to do both Social Security reform and tax reform at the same time. The issues were too big and it would be lucky if it could do one or the other. Trying to do both ran the risk of accomplishing neither. The delay in the tax-reform report shows that the White House has finally started to figure this out.

We still don't know what the commission will recommend. The assumption has been that it would endorse one or more comprehensive reform options, such as the flat tax or national retail-sales tax. However, indications now are that the commission's report may be more targeted and less comprehensive.

The other week, the tax commission's cochairmen, former senators Connie Mack (R., Fla.) and John Breaux (D., La.), said that abolition of the Alternative Minimum Tax would definitely be one recommendation sent to the Treasury department. (Technically, the commission reports to the secretary of the Treasury, who will then decide what recommendations to forward to the president.)

The AMT unquestionably is a very bad part of the tax system and ought to be abolished. But by making this isolated recommendation, it suggests that the commission's report will be less comprehensive than previously thought. After all, if the commission were to recommend, say, a flat-tax system, then there would be no need to make abolition of the AMT a separate recommendation. It would be abolished automatically.

Therefore, I think we may be more likely to get a laundry list of specific recommendations for improving the tax system than a master plan for complete overhaul. The problem with this is that there are any number of reports that have already detailed specific failings of the tax system from the point of view of fairness, efficiency and administrability. They are all gathering dust on library shelves.

Secondly, trying to do tax reform this way means that the commission must necessarily come up with a list of tax increases to pay for the reforms. The commission is under a mandate to makes its recommendations "revenue-neutral." This means that the package must raise the same revenue as currently projected by the current tax system-no more, no less.

It is certain, therefore, that the vast bulk of the public attention will be on the revenue raisers. For example, people are already assuming that the AMT repeal will be paid for by abolishing the deduction for state and local taxes. Naturally, this has high-tax states like New York and California up in arms. In 1986, then-New York Governor Mario Cuomo, a Democrat, virtually killed this idea single-handedly. This time it could be California Governor Arnold Schwarzenegger, a Republican.

The high tax states like the federal deduction because it lowers their tax burden by the amount of one's federal tax bracket. If one itemizes and is in the 33-percent federal tax bracket, then this is like getting a one-third discount on your state and local taxes. Elimination of the deduction, therefore, would constitute a significant tax increase for many people even if they no longer have to pay the AMT.

In my opinion, these kinds of trade-offs are politically impossible. People will fight much harder to keep a current tax benefit than those who would benefit from a new one will fight for that. Consequently, the only way you can even hope to eliminate "sacred cow" deductions like that for state and local taxes is in a complete overhaul of the tax code. Trying to do it incrementally, as it appears the tax commission is suggesting, is simply doomed to failure.

Unfortunately, President Bush has never articulated a vision of tax reform, which explains why he is supporting a long list of new tax gimmicks — I mean incentives — for energy production and conservation, none of which have any place in a properly designed tax system, from either a liberal or conservative point of view. They just clutter up the tax code and make reform all the more difficult, because they create new constituencies in support of the status quo.

In his new book, Flat Tax Revolution, magazine publisher Steve Forbes again explains the virtues of fundamental tax reform. I hope someone at the tax commission is reading it.

— Bruce Bartlett is senior fellow for the National Center for Policy Analysis.