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April 14, 2005

A Flat-Out Case for Tax Reform

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If anything's likely to boost support for the flat tax, it's the annual nightmare of tax season.

Imagine junking all the paperwork the current system requires and replacing it with two simple postcard-sized forms that tax income only once and at one low rate. Imagine a simple and fair tax system that required all Americans to play by the same rules, regardless of how many lawyers and accountants they had on the payroll. And imagine politicians having no ability to put loopholes in the tax code in exchange for campaign cash.

These are all strong arguments for the flat tax. But there's an even bigger reason to support it: It would be good for the economy.

Globalization has dramatically increased the importance of good economic policy. Investment funds now have almost unlimited ability to cross national borders. Jobs and capital are fleeing high-tax welfare states for low-tax jurisdictions.

This means the rewards for good economic policy are greater than ever. By the same token, though, the penalties for misguided class-warfare policies are greater than ever. In other words, international competition has made tax policy much more important. Nations have to compete with each other if they want faster growth and better jobs.

Other countries certainly seem to realize the importance of "tax competition." Eight nations in Eastern Europe have adopted flat taxes, for instance, including a 13 percent flat tax in Russia. Two of the countries, Romania and Georgia, adopted the flat tax this January, and Poland just announced that it will be hopping on the flat-tax bandwagon.

All of these former Soviet-Bloc countries recognized that it was very difficult to overcome the legacy of communism while burdened with high tax rates and discriminatory taxes on saving and investment. Leaders from these nations understand that a flat tax draws job-creating capital. They understand that a low tax rate rewards productive activity.

Other nations have cut tax rates deeply. Ireland doesn't have a flat tax, but it has slashed its corporate tax rate from 50 percent to 12.5 percent. Combined with other tax cuts, this helped turn the "Sick Man of Europe" into the "Celtic Tiger." Unemployment has dropped from 17 percent to 5 percent, and Ireland is now the second-richest nation in the European Union.

Tax competition has forced other European nations to cut their corporate tax rates. Indeed, there has been so much progress that every nation in Europe now has a lower corporate tax rate than America -- even socialist countries such as France and Sweden!

America needs to regain its status as a major contender in the tax-competition battle. If we want to remain the world's strongest economy, we can't rest on our laurels. Yes, the Reagan tax cuts resuscitated the U.S. economy in the 1980s. And yes, the Bush tax cuts are helping America grow faster and create more jobs than most other industrialized nations.

But growing faster than France and Germany is nothing to brag about. And besides, America needs to watch developing nations such as China and India. These countries are shifting toward free-market policies and are attracting jobs and investment. It's even rumored that China may adopt a flat tax. If that happens, America will face even more vigorous competition. Hong Kong has enjoyed incredible prosperity with a flat tax, so just imagine if the rest of China gets the same simple, pro-growth tax system!

President Bush has appointed a Tax Reform Advisory Panel, which has been holding hearings and learning how the tax system undermines U.S. competitiveness. Members are expected to issue a report on July 31 and almost certainly will recommend that America move in the direction of a flat tax. Hopefully, they will be bold and suggest that the entire tax code be junked.

Tax competition is causing a global shift toward better tax policy. Fifteen years ago, people would have called you crazy if you predicted the Soviet Union would disappear and that a bunch of communist countries would have a flat tax. Twenty years ago, people would have laughed if you said that Ireland would have a 12.5 percent flat tax and be the fastest-growing economy in Europe.

More and more nations understand the critical importance of good tax policy, and the United States should join them. A flat tax would improve America's economy dramatically and serve as an example for the rest of the world. Not bad -- especially for a reform that would make our lives easier.

Daniel J. Mitchell is McKenna senior fellow in political economy at The Heritage Foundation.

Distributed nationally on the Knight-Rider Tribune wire

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