The Magazine

Bush's Stealth Flat Tax

He's more of a tax reformer than people realize.

Sep 13, 2004, Vol. 10, No. 01 • By STEPHEN MOORE
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OF ALL THE policy recommendations in the president's acceptance speech last week, none got more applause than his promise to revamp our antiquated and antigrowth IRS tax code. But even a mild cynic has to wonder whether this call for a "simpler, fairer, pro-growth tax code" was just a flirtation with voters. After all, every president since Jimmy Carter, who once called the American income tax system "a disgrace to the human race," has promised tax reform. We're still waiting--in fact, we've regressed: The pages of the tax code have nearly doubled in the last 30 years.

There are signs that tax reform isn't just a passing fancy for Bush, however. He's clearly intrigued with the possibilities of making history here. In early August, when he was asked what he thought of the concept of a national consumption tax, he replied: "It's an interesting idea that we ought to explore seriously." Right on cue, John Kerry protested that Bush had another bundle of tax cuts planned for Bill Gates, Warren Buffet, and his rich friends at Halliburton. Kerry uttered the non sequitur that if Bush had his way, "families already squeezed by rising health costs and higher gas prices and college costs would have to carry a whole new tax burden." He left out the inconvenient fact that these families would no longer have to pay an income tax.

One advantage Bush has in this debate is that Americans don't need to be educated about the evils of our income tax system; these are well established. Americans spend more than six billion hours a year complying with the tax code, just figuring out how much they owe. That is more man hours than are used to build every car, van, truck, and airplane manufactured in America. Harvard economist Dale Jorgenson has estimated that shifting from our current graduated tax system with its multiple layers of taxes on saving and investment to a flat-rate tax on consumption would permanently increase national income by about 5-10 percent. Those are massive economic gains that would raise average family incomes in the United States by several thousand dollars a year.

One reason to think that Bush may succeed where flat-tax advocates like Dick Armey and Steve Forbes failed is that there's been great success with flat-tax systems elsewhere. Hong Kong has long had a 15 percent flat tax and has enjoyed perhaps the highest growth rate of any nation on the globe over the past 40 years. There was worry that the flat tax would be swallowed up by the Chinese tax system when Hong Kong was given back to the mainland. Just the opposite has occurred. The capitalistic impulse of the Chinese has led the mainland to move toward Hong Kong's system, through tax-rate reductions and saving and investment incentives.

And of course, Russia under Putin famously installed a 13 percent flat tax that has helped launch an epidemic of entrepreneurial activity and growth. Incidentally, for those skeptics who believe that the flat tax is economic fool's gold, consider that despite its well-known gangster and crony afflictions, the Russian economy has nonetheless grown at an average rate of 8 percent since the flat tax was adopted, and the Wall Street Journal reports that Russia now collects more tax revenues with a 13 percent rate than it did when the rates reached 70 percent.

But here's the other reason to think that Bush is committed to a radical simplification and overhaul of the tax system. There's been a rhyme and reason behind the three tax cuts that the Bush administration has already implemented. With each incremental change to the tax code that President Bush has put in place, or has proposed, we take another leap toward a flat-rate consumption tax system. I call this Bush's stealth flat-tax plan.

Consider the four goals of tax reform: (1) to flatten tax rates so that disincentives on productive and wealth-enhancing activities are minimized; (2) to eliminate double taxation of saving and investment so as to get more of both; (3) to simplify tax compliance to reduce the dead weight loss of the tax system; and (4) to get the intrusive IRS out of our lives to the fullest extent possible.

Now consider the actions Bush has already taken. First, he has chopped tax rates, thus moving toward a single flat-rate system. Second, he reduced the death tax, which is probably the most antigrowth tax of all, because it is levied entirely on accumulated savings and encourages seniors with wealth to spend it down to zero. Bush has also dramatically lowered the tax rate on capital gains and dividends to 15 percent. Under a flat-consumption tax, there would be no direct tax on dividends and capital gains. Any proceeds from stocks would be taxed when the money earned was spent.