The new year arrives with solemn prayers for peace on Earth and good will toward all, but also with memories of Christmas bills to pay and the first wisps of worry over the annual irritation of filing income taxes. One hesitates to mention tax filing in this season of good cheer. But this is also the season of hope, and there is good cause for hope that relief from the Internal Revenue Service tax code may finally be at hand.
Hope for tax reform arrives in two messages. In the first are words including “momentum,”“need,” “jobs” and “China.” Not much hope there individually, I grant you, but put the words together and for the first time in many years tax reform is really, truly on the national agenda. Not because the tax code is so complex or frustrating, though it is both of these things. As the last 25 years have demonstrated, popular displeasure is not enough to force Washington to act, except around the edges of the tax code.
No, the prospects for tax reform are rising because policymakers of all political stripes finally accept that the current code slows wage growth and it makes it harder to compete with tough new players like China and India. Interesting, is it not, how a long period of very high unemployment can focus a politician’s mind on the real tasks at hand?
The second message outlines a truly new tax reform plan called the New Flat Tax. Released in outline last May, this proposal is described in detail in a paper just out at the Heritage Foundation called “The New Flat Tax - Easy as One, Two, Three.”
As the name suggests, the New Flat Tax harkens back to the traditional flat tax, but goes far further toward comprehensive reform and simplification, much as the new Apple iPhone 4S builds on - but is light years beyond - the old rotary dial telephone.
Traditional tax reform proposals replace the individual and corporate income taxes but leave the rest of the tax system untouched. The New Flat Tax replaces nearly every tax Uncle Sam levies, including the payroll tax, the death tax and most excises. One tax is better than many.
The New Flat Tax also has a single tax rate. While the traditional flat tax had one rate at about 20 percent, it left taxpayers subject to a variety of payroll tax rates (all the way up to 15.3 percent). Many taxpayers, then, would pay a marginal rate of more than 35 percent under the traditional flat tax. The New Flat Tax has one tax with one rate so it’s even flatter and simpler than the traditional flat tax, and its 28 percent rate is lower overall.
The basic principle of the New Flat Tax is as commonsensical as it is sounds - you’re taxed on what you spend. If you save it, the federal government won’t tax it. So you get an immediate deduction for all saving, and savings remain tax free until they are spent.
The system is equally simple for businesses. All businesses would be taxed alike, at a single rate, on their domestic net cash flow, a figure already calculated by even the smallest business.
The New Flat Tax really is as easy as one, two, three. It has one rate. It has two credits - the current-law Earned Income Credit for the working poor and a non-refundable credit for health insurance - which are unfortunately necessary for non-tax reasons. And it has three deductions - for charitable contributions, higher education and an optional deduction for home mortgages - all of which are necessary to preserve tax neutrality. That’s it. No other deductions, exemptions, or credits whatsoever.
At 28 percent, the New Flat Tax is estimated to be revenue neutral; it raises and is capped at the traditional 18.5 percent of the economy. It is far more transparent than current law, so taxpayers have a better appreciation for the burden the federal government imposes. It doesn’t expand the ranks of the untaxed as does the traditional flat tax. And, unlike many such proposals, the New Flat Tax appears to leave the tax distribution roughly unchanged.
So, as we enter a new year, be of good cheer fellow tax-filing sufferers and tax-tortured entrepreneurs. Be of good cheer all who have seen little hope for better wages in recent years and all ye who must compete on the world stage. There are grounds for hope. There is a better solution, and Washington’s reluctant reformers may finally be waking to the need to junk the tax code to allow our economy to flourish, our wages to climb, our businesses to compete with China and India, and looks like it was designed with a purpose.
J.D. Foster is the Norman B. Ture Senior Fellow in the Economics of Fiscal Policy at the Heritage Foundation.
First appeared in The Washington Times