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.

Bush's latest plan is perhaps the biggest leap of all toward a flat tax. The White House has proposed a dramatic expansion of tax-free IRA-type retirement accounts. This means that large pools of savings by American households would no longer be double taxed. Now imagine that we allowed all savings that Americans stashed away into an IRA account to be sheltered from the IRS. Under that model we would tax income, but savings would be deducted. All that leaves to be taxed is what people consume out of their income (because income minus savings equals consumption). Now the picture starts to come into focus. George W. Bush and his economics team are quietly moving toward a flat-rate consumption tax system without anyone much noticing.

Now for the bad news. The hard part is still left to be done. What many Americans want most from tax reform is clarity and simplicity: They want the postcard tax return, or, better yet, no tax return at all. What forever trips up every politician when it comes to tax reform is the grand compromise: to get a low flat-rate tax requires a broadening of the tax base. This means sweeping away the reams of special interest tax loopholes that pollute the tax code. These tax carve-outs--for everything from housing to child-care expenses to investment in bull sperm and tobacco farming--leave in place a Swiss cheese tax system wherein two families with equal incomes can have vastly different tax payments. A few years ago an exotic dancer gained notoriety for taking a tax deduction for the cost of her breast enlargements, because this was a business write-off. That was no more absurd than Bill Clinton's taking a charitable deduction for underwear and other old clothes he donated to Goodwill.

Economists have calculated that if all these absurd loopholes were closed the federal tax rate could be chopped to about 18 percent and the same amount of revenues would be raised. To protect poor people from paying higher taxes, the first $10,000 to $15,000 of income would not be taxed.

To be sure, there are mountainous political forces aligned to preserve and protect the current tax policy with all its special favors to gold-cufflinked K Street corporate lobbyists. For example, when Steve Forbes campaigned on the flat tax in his 1996 presidential bid, the housing industry spent millions of dollars on a scurrilous campaign full of half truths to discredit the flat tax. Whether George Bush has the spine to combat this murderers' row of influential Washington interest groups is anyone's guess. The flat tax is the ultimate fight of the general interest versus the special interest, or, to put it differently, Washington versus America. Alas, Washington usually prevails in these fights.

But if George W. Bush wants a grand and lasting domestic legacy, other than being the biggest-spending president since FDR, this may be his opportunity to make the history books. He can campaign and win on the idea of creating a 21st-century tax system designed to allow America to compete and win in the global economy. Imagine a flat tax of 18 percent with no double tax on savings, no capital gains tax, no dividends tax, no death tax, a postcard return that takes 30 minutes to fill out, and legions of tax lawyers and accountants out of our lives. This would be rocket fuel for the U.S. economy. And there is no reason it can't be accomplished with Democratic votes. Prominent flat-tax advocates in recent memory include Democrats like Jerry Brown, who nearly won the Democratic nomination for president in 1992 with a flat-tax agenda, and Leon Panetta, Bill Clinton's chief of staff.

On the back wall of my office is a copy of an old Peanuts cartoon. Snoopy sits atop his doghouse and taps out a letter on his typewriter: "Dear IRS: Please take me off your mailing list." That's the way tens of millions of Americans feel. If Bush can fix our Byzantine tax system, and prevail where so many others before him have failed, there is almost no enemy--foreign or domestic--he can't conquer.

Stephen Moore is president of the Club for Growth and a senior fellow in economics at the Cato Institute.