May 1, 2015

May 1, 2015 | Commentary on Taxes, Flat Tax

Remember the Flat Tax?

Almost exactly 20 years ago, a gawky conservative renegade magazine publisher named Steve Forbes threw his hat in the ring for the 1996 GOP presidential nomination. Forbes’s run was first seen as a joke. But he wound up rocking the Republican establishment by injecting fresh and bold reform ideas into a party that had become crusty and tired.

Term limits. Medical savings accounts. Tax limitation. Personal savings accounts for Social Security. And the issue that electrified conservatives across the country: Blow up the tax system and install a low-rate flat tax. When the New Hampshire primary rolled around, the GOP politicos, the housing lobbyists, and the municipal bond traders were in a state of terror. Steve Forbes had somehow caught on. He might—God forbid—even win. The empire fought back and successfully derailed him; their man Bob Dole then got crushed in the general election.

Two decades later, the flat tax is again the rage in a presidential primary. A number of GOP candidates, including Rand Paul, Rick Perry, Ted Cruz, and Scott Walker, are looking to go flat with a radically simplified postcard tax return. Mike Huckabee wants a low flat-rate tax too, but he would use a sales tax, not an income tax—i.e., no tax return at all.

“I’ve been for the flat tax since Steve Forbes first started talking about the idea,” Cruz tells me over dinner. “It’s one of the three most important reforms to fix the economy and take power away from Washington.”

Rand Paul (who I have been informally advising on tax policy) says, “I want a flat tax that pushes the rate down as low as we can get it.” His plan could have a rate of 15 percent.

Perry knows firsthand that low tax rates are important, because Texas, of course, has no income tax at all. “It’s our great comparative advantage,” he insists, “and it helps explain why for five years we created more jobs in the Lone Star State than the rest of the nation combined. If Washington wants to create jobs for America, it should adopt the Texas tax model.”

Ripping up the 70,000-page tax code has visceral appeal to voters. I always remind this year’s crop of White House aspirants: What is the one thing—maybe the only thing—voters remember about 2012’s dismal presidential primary race? Herman Cain’s 9-9-9 plan. “The simplicity of the concept is what sprung Herman into the lead,” recalls Ohio-based economic consultant Rich Lowrie, who helped devise the plan. “People were absolutely captivated that we could really make the tax code that easy to understand—and that pro-growth.”

The new Republican party has been baptized in the iron logic of the Laffer Curve. High tax rates stifle innovation, work, investment, and American competitiveness. Our absurdly high corporate tax rate (40 percent on average) is incontrovertibly sending jobs and corporations abroad, where rates are typically half as high. Just ask Burger King, one of the latest iconic American companies to flee to a lower-tax competitor.

Laffer has been hard at it, selling this message in meetings in his Nashville office with nearly all the A-list candidates, from Jeb Bush to Ted Cruz. In his usual theatrical style, he explains that “if you raise tax rates in location A,” lifting up his left fist, “and cut tax rates in location B,” lowering his right fist, “don’t be surprised if people and businesses move from A to B.” Think of New York as A and Texas as B.

When Reagan reduced the top marginal tax rate from 70 percent to 28 percent in the 1980s, the Laffer Curve effect was indisputable. The economy exploded, tax revenues nearly doubled over the decade, and the share of income taxes paid by the rich soared from 19 to 26 percent.

Lowering tax rates has the added virtue of increasing the overall simplicity and efficiency of the tax code. We don’t want investment or spending decisions to be distorted by tax preferences. Lower rates reduce the value of inefficient loopholes, credits and deductions for everything from investing in windmills, to race horses, to bull sperm, to empty apartment buildings. Under an ideal tax code, there are no deductions whatsoever.

It’s worked before. One of the most underappreciated laws of the last half-century is the bipartisan Tax Reform Act of 1986. This public policy miracle consolidated tax rates down to two—15 and 28 percent—while clearing out hundreds of loopholes.

“No one thought it could possibly be done, given the K Street lobbyists’ ferocious opposition,” recalls Oregon senator Bob Packwood, who, along with Democrat Dan Rostenkowski in the House, designed the bill. “It was all based on the simple economic principle that people in both parties bought into: a broad base with a low rate.” Amazingly, the bill with a top rate of 28 percent passed the Senate with more than 90 votes; even iconic liberals like Ted Kennedy and Howard Metzenbaum voted yea. A study by Dale Jorgenson, then head of Harvard’s economics department, estimated long-term efficiency benefits of more than $1 trillion.

A few years later, in 1992, Jerry Brown finished a surprising second to Bill Clinton in the Democratic primary by running on a 13 percent flat tax. In the 1980s and ’90s, influential pro-growth Democratic thought leaders like Bill Bradley, Dick Gephardt, and John Breaux teamed with Republicans like Jack Kemp on tax policy.

Today, any Democrat would be tossed out of the party for such an act of treason. The next Democratic leader in the Senate, Chuck Schumer of New York, has alerted Republicans that the 1986 tax reform consensus is gone. He wants to get rid of tax loopholes for the rich, not to pay for lower rates, but to raise money for more government spending.

So if Republicans are going to reinvent the tax code, they won’t get help from the party dominated by Elizabeth Warren class warriors. The GOP is going to have to win a resounding electoral mandate to do it.

It’s not going to be easy. At the Heritage Foundation, we’ve done extensive polling on how Americans feel about tax reform. “Flat tax” as a concept does not poll very well. What polls off the charts and what Americans want overwhelmingly from tax policy is “fairness.”

The challenge for Republicans is to convince voters that abandoning the Rocky Mountain high of multiple tax rates for a flat tax is “fair.” Democrats will scream “tax cuts for millionaires and billionaires.” The key, as Forbes explains, is to “convince Americans that the current progressive rate system is unfair, because the people who get hurt the most from tax rates that chase jobs out of America are the poor and the middle class.”

The way to sell the flat tax is as the ultimate Washington versus America issue. The only people who benefit from a complicated, barnacle-encrusted 70,000-page tax code are tax attorneys, accountants, lobbyists, IRS agents, and politicians who use the tax code as a way to buy and sell favors. The belly of the beast of corruption in American politics is the IRS tax code. The left keeps saying it wants to end the corrupting influence of big money in politics. Fine. By far the best way to do that is enact a flat tax and D.C. becomes the Sahara Desert.

Loopholes mostly benefit the wealthy and the politically well-connected. Well over half of the revenue lost from them comes from the top 1 percent. Want to make Warren Buffett pay his “fair share” of taxes? Get rid of the charitable deduction, which Laffer calls “by leap years the biggest tax dodge for rich people.” Laffer says Buffett and Bill Gates escape income tax on billions of dollars in earnings by diverting the money into the Gates Foundation to support dubious “charities” like the Sierra Club and Harvard. The flat tax, in short, is fair because it makes everyone play by the same rules, no matter how many lobbyists they hire in Washington.

Not every leading Republican candidate has bought into the flatter tax solution. Many GOP political operatives argue that the flat tax keeps getting rejected by voters. A new group of thought leaders called Reformacons want to ditch the supply-siders’ obsession with lowering tax rates and load up the middle class with tax credits. The usually sensible Marco Rubio has endorsed this concept; his tax plan offers an additional $2,500 credit per child. This would only reduce the top rate to 35 percent, and some tax filers without children would see tax rates go up.

“This is one of the dumbest ideas I’ve heard in a long time,” says Larry Kudlow of CNBC. “It costs $2 trillion for those credits over the next 10 years, with no growth effects whatsoever.” It also misunderstands the middle-class squeeze that is killing families’ finances. The problem isn’t so much that the middle class pays too much income tax—though they do. It is that real wages haven’t risen over the last decade. A tax giveaway isn’t going to solve that problem. By depleting the Treasury of revenues, it will boost the left’s case for raising tax rates down the line.

So can the flat tax catch the populist tide of voter rage and angst over an economy that has squeezed the middle class for nearly a decade? Who knows? What seems certain is Democrats will run a class warfare campaign of raising tax rates on the rich. But envy isn’t an economic revival policy. Republicans can win this debate by going on the offensive and reminding voters that the best way to grow the economy, create jobs, and increase tax payments by the rich is to flatten the code. Flat is the new fair.

 - Stephen Moore is a Distinguished Visiting Fellow at the Heritage Foundation.

About the Author

Stephen Moore Distinguished Visiting Fellow
Project for Economic Growth

Originally appeared in The Weekly Standard