Flat Tax Revolution: Using a postcard to abolish the IRS, Steve Forbes, Regnery Publishing (2005) – Tax law complexity is a serious problem (probably worse now than in 2005), and the idea of radically simplifying the system is appealing.  But there are several problems, in our opinion, with this flat tax proposal:

• Individual income taxes: Flat tax rate of 17%, most tax deductions eliminated, personal exemptions increased to $13,200 per adult ($17,160 for an unmarried head of household), $4,000 per child or dependent, eliminate tax on fringe benefits from employers, dividends, interest and capital gains.  Abolish the Alternative Minimum Tax.  Retain the refundable Earned Income Tax and Child Tax credits.  Taxpayers who do not owe tax need not file returns (although presumably they would still file if they had refundable tax credits coming) – taking some 50% of the population off the income tax rolls.  Filing a flat tax return would be an option; taxpayers who wished to do so could file a traditional tax return under the current law.

Comments: (1) Maintaining a traditional tax return option would seemingly undercut the goal of tax law simplification unless done on a transitional basis only.  (2) If the purpose of the tax law is to raise revenue in a fair and efficient manner versus serving social policy ends, refundable tax credits should be eliminated.  (3) Tax exemption for “fringe benefits” seems questionable (no coherent rationale is provided).  (4) A sharply reduced number of income taxpayers is not necessarily a plus; non-payers would be inclined (as is already evident with the current tax system) to favor expanding government programs someone else is paying for.

• Corporate income taxes: Flat tax rate of 17%, capital expenditures currently deductible (in lieu of taking depreciation), no deduction for interest expense or employee fringe benefits, tax deductions & credits (scores if not hundreds of them) eliminated, no tax on capital gains or interest income, no Alternative Minimum Tax, dividends from foreign subsidiaries not taxable (in lieu of allowing foreign tax credit).

Comments: Certainly simpler than the current system, and most corporations and businesses would be better off with these ground rules.  However, the changes would inevitably be labeled a giveaway to business.  A more modest package of changes plus a rate cut might be an easier sell.

• Payroll taxes, state and local taxes: No change.

Since 2005, the alternative “national retail sales tax” proposal (intended to replace all income, corporate income, and payroll taxes), aka “FairTax,” has gained support while enthusiasm for a flat tax waned.  But as discussed in chapter 5, the FairTax proposal has serious flaws.  Among them: (1) Repeal of the 16th Amendment (to ensure the U.S. would not wind up with both a federal sales tax and income tax) is remote.  (2) A sales tax rate well in excess of 10% (Forbes refers to a 30% rate, perhaps meant to include state and local sales taxes; the current FairTax estimate is 23%) would spark rampant tax evasion.  (3) A huge bureaucracy would be needed to administer a monthly rebate program for lower income Americans.  (4) There would be a devastating impact on new home construction.  (5) A decision would be required as to whether sales to the government would be taxed (raising the cost of government) or exempted (creating a bias for consumption of government services). Fans of the FairTax should read chapter 5, if only as a check on what they have read or heard elsewhere. 

Conclusion: Tax simplification would be great, but it is unclear that either the flat tax or FairTax is ready for show time.  It would be nice if a hybrid proposal could be developed that all of the would-be reformers supported.