Two Choices for Tax Reform


Two Choices for Tax Reform

Aug 10th, 2004 3 min read

Even people who disagree about tax cuts usually agree that our tax system is a mess. It should be repealed and replaced with a system that treats all taxpayers fairly and equally.

Now that the speaker of the House of Representatives has announced he wants to dismantle the IRS, perhaps we have the chance to do just that.

Two great ideas for achieving this goal are on the table - the flat tax and the national sales tax. They may seem different, but the flat tax and the sales tax are different sides of the same coin: The flat tax takes a small slice of your income as it's earned; the sales tax takes a small slice of your income as it's spent. Both proposals share the following attractive characteristics:

  • A single flat rate. Economic activity is taxed at one low rate, ensuring that government treats taxpayers equally. It also would promote faster economic growth by minimizing tax penalties on work, risk-taking and entrepreneurship.
  • No bias against savings and investment. Both the flat tax and a national sales tax would ensure that no income is taxed more than once. Eliminating the double taxation of saving and investment would boost long-term growth.
  • Equality. Adoption of the flat tax or a national sales tax also would end the discriminatory treatment caused by a tax code that grants preferences or imposes penalties on certain behaviors and activities. Either reform would change the code so that all taxpayers - and all income - are treated the same. Rich people would have to pay their fair share no matter how many lawyers, lobbyists and accountants they had on the payroll. But the tax code would be stripped of the punitive "soak-the-rich" provisions that make it hard for other Americans to become rich.
  • Simplicity. With hundreds of forms and thousands of pages of incomprehensible instructions, the IRS system is a nightmare of complexity. Under the flat tax, individuals and businesses would fill out one simple postcard-sized form every year. With a national sales tax, wage earners wouldn't have to report their income, and businesses simply would send the government a postcard-sized form every month.
  • Competitiveness. In today's global economy, it's easy for jobs and investment to cross national borders. This is why many nations, such as Russia, Slovakia, Hong Kong and Estonia, have adopted flat taxes. It's also why jurisdictions that rely on consumption taxes, such as the Cayman Islands, are so prosperous. Tax reform will help America remain a rich and powerful nation.
  • Honesty. A flat tax or a national sales tax would end a corrupt system that allows politicians to trade tax loopholes for political support. This would be bad news for tax lobbyists in Washington but great news for honest government.

Ideally, both President Bush and Congress will launch a national debate on which tax reform plan would be best for America - which shouldn't be too difficult, as President Bush already has publicly praised the 13 percent flat tax in Russia, and Speaker Dennis Hastert is just one of many tax-reform advocates on Capitol Hill.

To be meaningful, this debate should include potential pitfalls. For instance, if we adopt a flat tax, how can we ensure that politicians don't create new loopholes? And if we adopt a sales tax, how do we make sure the politicians don't pull a bait-and-switch, implementing a sales tax but then conveniently "forgetting" to repeal the income tax? Many European nations have adopted a form of national sales tax, but none have eliminated their income-tax systems. As a result, national sales taxes have been used to finance a big expansion in the size of government - which helps to explain why so many European nations are economically stagnant.

There's no question tax reform will prove an uphill battle. Special-interest groups will fight to protect the loopholes and shelters they have placed in the current system.

But this doesn't mean the battle can't be won. Nobody thought President Reagan would be able to cut America's top tax rate from 70 percent to 28 percent. Nobody predicted 15 years ago that the Soviet Union would disappear and be replaced by a more democratic Russia with a 13 percent flat tax. If the American people demand a fair and simple tax system, the politicians will have no choice but to comply.

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

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