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Perry seeks to cash in on flat tax's enduring appeal

The flat tax, an idea that seems to offer simplicity and efficiency in place of the current tax code, gets a revival Tuesday as Rick Perry unveils his single-rate tax proposal.

The flat tax, an idea that seems to offer simplicity and efficiency in place of the complications of the current tax code, will enjoy a revival Tuesday when Texas Gov. Rick Perry unveils his single-rate tax proposal.

Perry has witnessed the success, at least in terms of publicity and in some polls, that businessman Herman Cain has had with his "9-9-9" plan—which calls for a 9 percent tax on personal income, combined with a 9 percent sales tax and a 9 percent corporate income tax.

His speech tomorrow in South Carolina is an attempt to give his campaign a vivid and defining idea. It is in particular an effort by Perry to draw contrasts between himself and Mitt Romney, the former Massachusetts governor with whom Perry has sparred on the campaign trail.

Where Romney's 59-point economic plan, released on Sept 1, seeks adjustments to the current tax code and does indeed call for "lower, flatter rates on a broader base," Perry's speech seems designed to capitalize on fervor within the GOP to scrap the tax system and start over with something new.

For three decades, the flat tax concept has had an enduring appeal, touted by politicians as diverse as Democrat Jerry Brown, who ran for the 1992 Democratic presidential nomination on the idea and Republican Steve Forbes, who ran for the 1996 GOP nomination on it.

Forbes endorsed Perry's candidacy Monday.

Both Brown and Forbes indicted the tax code as a cesspool of favoritism and influence peddling. "We have a 4,000-page tax morass that feeds on the corruption of selling loopholes for campaign contributions," Brown said in 1992. "None of those pages are for you and me. They're for people with high-priced lawyers that buy those loopholes."

But despite three presidential bids based at least in part on the flat tax, those of Brown, Forbes, and, in 1988, Rep. Jack Kemp, R-N.Y., the idea has yet to be put to the test in a general election.

Brown, Forbes and were each somewhat idiosyncratic candidates, not seen from the outset of their campaigns as men who'd likely win their party's nomination.

The challenge facing Perry, whose star has faded somewhat since entering the campaign to a great deal of fanfare, is to prove that he's not another one of those candidates, and that he has a credible plan to rejuvenate the economy in an election where jobs are the No. 1 issue.

Debut of flat tax idea
The flat tax was introduced on Dec. 10, 1981 by two scholars, political scientist Alvin Rabushka and economist Robert Hall, on the editorial page of the Wall Street Journal.

“Our system was so simple that an individual or business could file a federal income tax return on a postcard-sized form,” Rabushka said in the 2007 foreword to a new edition of their 1985 book The Flat Tax.

Rabushka said Friday that he has had a discussion with one of Perry’s economic advisers about the flat tax.

In their 1995 update of their proposal, Rabushka and Hall called for a 19 percent tax, exempting the first $25,500 of income for a family of four, with that tax-free allowance growing to keep pace with inflation.

Kemp took up the crusade with a bill in 1984 to impose a flat 25 percent income tax. Kemp helped influence the 1986 tax reform legislation that replaced multiple tax rates with only two, 15 and 28 percent.

Yet within four years, Congress began reverting to its habit of adding complexity to the tax code, a process that has gone on ever since.

As recently as last December, Obama and Congress reaffirmed that complexity, with more than 50 tax preferences built into the $857 billion tax cut bill he signed into law a few days before Christmas.

But calls for a simpler tax system have been growing, coming from everyone from Obama to House Speaker John Boehner to the Bowles-Simpson fiscal commission.

Cain modifies 9-9-9 plan
In recent weeks Cain has captured the imagination of some voters with his catchy 9-9-9 idea. He modified that plan last week by saying that people “at or below the poverty level” wouldn’t have to pay the 9 percent tax on income under his plan. The federal poverty level for a family of four is $22,350 of income in 2011.

In the run-up to Perry’s speech Tuesday, his campaign’s communications director, Ray Sullivan, would reveal few details of the plan, telling that “our plan is a single flat tax rate for individuals and businesses. We will broadly simplify the tax code and reduce the number of exemptions.”

He said the plan “would phase out some tax breaks and subsidies as part of the jobs/energy policy we put out last week.”

Sullivan said that Forbes “is helping develop the Perry plan. However, the plan is significantly different and we are not using the 17 percent rate” that Forbes proposed in 1996.

Sullivan would also not say if the current tax rates on capital gains and dividend income will remain the same as in current law.

In assessing Perry’s plan, economist Joel Slemrod, the director of the Office of Tax Policy Research at the University of Michigan, said, “I would look for: how big an exemption is there? Most of the flat rate plans do have an exemption so that tax liability doesn’t start until (the individual or family earns) a certain amount of income.”

As the original Hall-Rabushka flat tax did, and as Cain's plan does, Perry would exempt some earned income from taxation, so the effective tax rate for a low-income people would be lower than for high-income people. That means that the flat tax won't really be flat; it will have different effective tax rates for different income levels.

For example, if the first $30,000 of earned income were exempt and the remaining income were taxed at a nominal 15 percent rate, a household earning $40,000 would pay $1,500 in taxes, for an effective tax rate of 3.75 percent, while a household earning $400,000 would pay $55,500 in taxes, for an effective tax rate of 13.87 percent.

But the emphasis on the distinctive feature of the flat tax — its single rate — tends to divert attention from the essential issue: the debate is more about what deductions, credits and other tax preferences should be eliminated or limited, than it is about the tax rate.

Why the tax code is so complex
As Yale tax law professor Michael Graetz told the Senate Finance Committee 16 years ago when it was considering a flat tax, the reason the tax code is complex is not that there are different rates of tax.

Instead, he said, “the principal sources of complexity in the income tax can be found in the provisions that define the tax base. What is included in income subject to tax? What deductions and credits are allowable and what conditions must be satisfied to obtain them?”

The Tax Policy Center notes that despite the complexity for some people, nearly two-thirds of tax filers use the standard deduction and don't itemize.

Slemrod said that among economists, “the general view is that a broader base and lower rates is more efficient — it’s better for the economy than one that has a Swiss-cheese base and therefore needs higher rates.”

In assessing Perry’s plan, Slemrod said, a crucial factor will be which, if any, deductions he would retain and which he’d curtail.

But if the Perry plan is going to raise the same amount of revenue as current tax code but be simpler, the Texas governor will need to eliminate deductions and other preferences.

That tradeoff between lower rates and fewer preferences will affect different taxpayers in disparate ways: for example, if you have a large home mortgage and three children under age 17, you benefit from current tax code’s mortgage interest deduction and child tax credit — and even with a lower tax rate, you might be worse off if they were eliminated.

How is non-wage income taxed?
Another question to be assessed once Perry's plan is unveiled, Slemrod said, is whether all forms of income — wages, capital gains, dividends, and interest payments — are taxed the same. “The Forbes flat tax taxed labor income but not capital income and that’s going to raise a lot of objections,” he noted.

The Hall-Rabushka flat tax didn't apply to capital gains, dividend, and interest income that individuals received, but that income had already been taxed by their plan's business tax.

Whatever one might think of the flat tax, its durability is proven by candidates for president still advocating it three decades after it was introduced.

“It’s a fascinating idea that addresses problems with the current tax system that most people think are important,” Slemrod said. “It’s certainly simpler than what we’ve got.”

But he added a caution, "The flat rate sounds very appealing until you dig into what that flat rate would have to be to raise the same amount of revenue — and until you understand that going from multiple rates to a flat rate almost always shifts the tax burden away from very high income people who are subject to the higher rates now, to the middle class and lower-income people.”

It will be up to Perry to make the case that this reform is finally, after 30 years, worth doing.