Grading Perry’s Flat Tax: Some Missing Homework, but a Solid B+
Governor Rick Perry of Texas has announced a plan, which he outlines in the Wall Street Journal, to replace the corrupt and inefficient internal revenue code with a flat tax. Let’s review his proposal, using the principles of good tax policy as a benchmark.
1. Does the plan have a low, flat rate to minimize penalties on productive behavior?
Governor Perry is proposing an optional 20 percent tax rate. Combined with a very generous allowance (it appears that a family of four would not pay tax on the first $50,000 of income), this means the income tax will be only a modest burden for households. Most important, at least from an economic perspective, the 20-percent marginal tax rate will be much more conducive to entrepreneurship and hard work, giving people more incentive to create jobs and wealth.
2. Does the plan eliminate double taxation so there is no longer a tax bias against saving and investment?
The Perry flat tax gets rid of the death tax, the capital gains tax, and the double tax on dividends. This would significantly reduce the discriminatory and punitive treatment of income that is saved and invested (see this chart to understand why this is a serious problem in the current tax code). Since all economic theories – even socialism and Marxism – agree that capital formation is key for long-run growth and higher living standards, addressing the tax bias against saving and investment is one of the best features of Perry’s plan.
3. Does the plan get rid of deductions, preferences, exemptions, preferences, deductions, loopholes, credits, shelters, and other provisions that distort economic behavior?
A pure flat tax does not include any preferences or penalties. The goal is to leave people alone so they make decisions based on what makes economic sense rather than what reduces their tax liability. Unfortunately, this is one area where the Perry flat tax falls a bit short. His plan gets rid of lots of special favors in the tax code, but it would retain deductions (for those earning less than $500,000 yearly) for charitable contributions, home mortgage interest, and state and local taxes.
As a long-time advocate of a pure flat tax, I’m not happy that Perry has deviated from the ideal approach. But the perfect should not be the enemy of the very good. If implemented, his plan would dramatically boost economic performance and improve competitiveness.
That being said, there are some questions that need to be answered before giving a final grade to the plan. Based on Perry’s Wall Street Journal column and material from the campaign, here are some unknowns.
1. Is the double tax on interest eliminated?
A flat tax should get rid of all forms of double taxation. For all intents and purposes, a pure flat tax includes an unlimited and unrestricted IRA. You pay tax when you first earn your income, but the IRS shouldn’t get another bite of the apple simply because you save and invest your after-tax income. It’s not clear, though, whether the Perry plan eliminates the double tax on interest. Also, the Perry plan eliminates the double taxation of “qualified dividends,” but it’s not clear what that means.
2. Is the special tax preference for fringe benefits eliminated?
One of the best features of the flat tax is that it gets rid of the business deduction for fringe benefits such as health insurance. This special tax break has helped create a very inefficient healthcare system and a third-party payer crisis. It is unclear, though, whether this pernicious tax distortion is eliminated with the Perry flat tax.
3. How will the optional flat tax operate?
The Perry plan copies the Hong Kong system in that it allows people to choose whether to participate in the flat tax. This is attractive since it ensures that nobody can be disadvantaged, but how will it work? Can people switch back and forth every year? Is the optional system also available to all the small businesses that use the 1040 individual tax system to file their returns?
4. Will businesses be allowed to “expense” investment expenditures?
The current tax code penalizes new business investment by forcing companies to pretend that a substantial share of current-year investment outlays take place in the future. The government imposes this perverse policy in order to get more short-run revenue since companies are forced to artificially overstate current-year profits. A pure flat tax allows a business to “expense” the cost of business investments (just as they “expense” workers wages) for the simple reason that taxable income should be defined as total revenue minus total costs.
Depending on the answers to these questions, the grade for Perry’s flat tax could be as high as A- or as low as B. Regardless, it will be a radical improvement compared to the current tax system, which gets a D- (and that’s a very kind grade).
Here’s a brief video for those who want more information about the flat tax.
Last but not least, I’ve already received several requests to comment on how Perry’s flat tax compares to Cain’s 9-9-9 plan.
At a conceptual level, the plans are quite similar. They both replace the discriminatory rate structure of the current system with a low rate. They both get rid of double taxation. And they both dramatically reduce corrupt loopholes and distortions when compared to the current tax code.
All things considered, though, I prefer the flat tax. The 9-9-9 plan combines a 9 percent flat tax with a 9 percent VAT and a 9 percent national sales tax, and I don’t trust that politicians will keep the rates at 9 percent.
The worst thing that can happen with a flat tax is that we degenerate back to the current system. The worst thing that happens with the 9-9-9 plan, as I explain in this video, is that politicians pull a bait-and-switch and America becomes Greece or France.
The NYT‘s Weak Defense of Homeland Security Grants
Last week, the House passed a homeland security appropriations bill slashing funding for grants to states and localities. The New York Times has now noticed and unleashed an indignant editorial:
House Republicans talk tough on terrorism. So we can find no explanation — other than irresponsibility — for their vote to slash financing for eight antiterrorist programs. Unless the Senate repairs the damage, New York City and other high-risk localities will find it far harder to protect mass transit, ports and other potential targets.
The programs received $2.5 billion last year in separate allocations. The House has cut that back to a single block grant of $752 million, an extraordinary two-thirds reduction. The results for high-risk areas would be so damaging — with port and mass transit security financing likely cut by more than half — that the chairman of the House Homeland Security Committee, Peter King of New York, voted against the bill as “an invitation to an attack.”
Only a few months ago, Times editorials accused King of trying to “hype” and “stoke” fear of homegrown Muslim terrorism. It’s sort of touching to see them get behind his fearmongering when the beneficiaries are local firefighters, police, and other local interests.
But the editorial has trouble worse than hypocrisy. For starters, it’s light on facts. Its accounting seems to omit over $320 million in funds for local firefighters that a floor amendment put in the bill. It also fails to mention that the bill eliminates a formula that ensures that homeland security funds are distributed to every state. Because it means that counterterrorism spending is highest per-capita in rural areas where the threat from terrorism is lowest, homeland security watchers have long attacked that minimum funding provision. So while this bill would indeed cut homeland security funds going to New York, it would also mean that New York gets more of the remaining funds.
Is the FAIR Tax a Political Liability?
In the past 15 years, I’ve debated in favor of a national sales tax, testified before Congress on the merits of a national sales tax, gone on TV to advocate for a national sales tax, and spoken with dozens of reporters to explain why a national sales tax is a good idea. Even though I prefer a flat tax, I’ve been an ardent defender of sales tax proposals such as the FAIR tax because it would be a great idea to replace the current system with any low-rate system that gets rid of the tax bias against saving and investment. I even narrated this video explaining that a national sales tax and flat tax are different sides of the same coin — and therefore either tax reform proposal would significantly improve prosperity and competitiveness.
I will continue to defend the FAIR tax and other national sales tax proposals that replace the income tax, but I wonder whether this is a losing battle. Every election cycle, candidates that endorse (or even say nice things about) the FAIR tax wind up getting attacked and put on the defensive. Their opponents are being dishonest, and their TV ads are grossly misleading, but they are using this approach because the anti-FAIR tax message is politically effective. Many pro-tax-reform candidates have lost elections in favorable states and districts, largely because their opponents were able to successfully demagogue against a national sales tax.
What Gets You Most Upset about the TARP Bailout, the Lying, the Corruption, or the Economic Damage?
As an economist, I should probably be most agitated about the economic consequences of TARP, such as moral hazard and capital malinvestment. But when I read stories about how political insiders (both in government and on Wall Street) manipulate the system for personal advantage, I get even more upset.
Yes, TARP was economically misguided. But the bailout also was fundamentally corrupt, featuring special favors for the well-heeled. I don’t like it when lower-income people use the political system to take money from upper-income people, but it is downright nauseating and disgusting when upper-income people use the coercive power of government to steal money from lower-income people.
Now, to add insult to injury, we’re being fed an unsavory gruel of deception as the political class tries to cover its tracks. Here’s a story from Bloomberg about the Treasury Department’s refusal to obey the law and comply with a FOIA request. A Bloomberg reporter wanted to know about an insider deal to put taxpayers on the line to guarantee a bunch of Citigroup-held securities, but the government thinks that people don’t have a right to know how their money is being funneled to politically-powerful and well-connected insiders.
The late Bloomberg News reporter Mark Pittman asked the U.S. Treasury in January 2009 to identify $301 billion of securities owned by Citigroup Inc. that the government had agreed to guarantee. He made the request on the grounds that taxpayers ought to know how their money was being used. More than 20 months later, after saying at least five times that a response was imminent, Treasury officials responded with 560 pages of printed-out e-mails — none of which Pittman requested. They were so heavily redacted that most of what’s left are everyday messages such as “Did you just try to call me?” and “Monday will be a busy day!” None of the documents answers Pittman’s request for “records sufficient to show the names of the relevant securities” or the dates and terms of the guarantees.
Here’s another reprehensible example. The Treasury Department, for all intents and purposes, prevaricated when it recently claimed that the AIG bailout would cost “only” $5 billion. This has triggered some pushback from Capitol Hill GOPers, as reported by the New York Times, but it is highly unlikely that anyone will suffer any consequences for this deception. To paraphrase Glenn Reynolds, “laws, honesty, and integrity, like taxes, are for the little people.”
The United States Treasury concealed $40 billion in likely taxpayer losses on the bailout of the American International Group earlier this month, when it abandoned its usual method for valuing investments, according to a report by the special inspector general for the Troubled Asset Relief Program. …“The American people have a right for full and complete disclosure about their investment in A.I.G.,” Mr. Barofsky said, “and the U.S. government has an obligation, when they’re describing potential losses, to give complete information.” …“If a private company filed information with the government that was just as misleading and disingenuous as what Treasury has done here, you’d better believe there would be calls for an investigation from the S.E.C. and others,” said Representative Darrell Issa, the senior Republican on the House Committee on Oversight and Government Reform. He called the Treasury’s October report on A.I.G. “blatant manipulation.” Senator Charles E. Grassley of Iowa, the senior Republican on the Finance Committee, said he thought “administration officials are trying so hard to put a positive spin on program losses that they played fast and loose with the numbers.” He said it reminded him of “misleading” claims that General Motors had paid back its rescue loans with interest ahead of schedule.
P.S. Allow me to preempt some emails from people who will argue that TARP was a necessary evil. Even for those who think the financial system had to be recapitalized, there was no need to bail out specific companies. The government could have taken the approach used during the S&L bailout about 20 years ago, which was to shut down the insolvent institutions. Depositors were bailed out, often by using taxpayer money to bribe a solvent institution to take over the failed savings & loan, but management and shareholders were wiped out, thus preventing at least one form of moral hazard.
Rhee-buffeted?
We don’t know for certain that controversial DC Schools Chancellor Michelle Rhee will depart DC when her boss’s term ends — and it will end soon — but it seems very likely. Assuming she does leave, there is a big education lesson to be learned from Adrian Fenty’s re-election loss: Relying on crusading politicians to successfully and permanently reform a government schooling monopoly is a recipe for crushed hopes. Politics is simply too volatile — and enacting tough reforms too politically risky — for even good reforms to be sustained. It’s just another reason that the key to truly sustainable reform is school choice, in which parents control education funds, educators have to compete and perform for business, and children are no longer buffeted back and forth by the ever-changing winds of politics.
“Either the Most Honest Politician in the World or the Most Opportunistic”
Paul Waldie at Toronto’s Globe and Mail reports on the case of Mike Reilly, who (unsuccessfully so far) has sought to write off as tax expenses the costs of campaigning for local office in a suburb of Vancouver. Reilly told a tax court that there was nothing idealistic about his quest for government office: he wanted “to earn a good salary and promote his business,” raising the visibility of his development company. Lawyers for the Canada Revenue Agency insisted that Reilly wouldn’t have gone to the trouble of running unless he had cared about at least some public issues, but he disputed that:
“You know, I don’t recall being passionate about any issues other than seizing an opportunity to step in and develop a better profile for myself,” Mr. Reilly replied. “No. It was strictly business for me.”
The tax judge ruled against Reilly based on accounting issues but accepted his general contention that he “was not passionate about any issue except increasing his own profile and earning the salary of mayor,” noting that the candidate “did not listen to the citizens of Delta and did not appear to have much interest in their concerns.” If all politicians had to tell the truth, how many similar confessions might we hear?
More on Justin Amash
I wrote yesterday about a candidate for the House of Representatives who offered an interesting and critical look at his experience as a state legislator in Michigan. This candidate, Justin Amash, both reads the bills he votes on and posts explanations for his votes on his Facebook page. Here are two of his explanations:
Justin Amash just voted no on HBs 6038 and 6226, which impose stiff penalties and prison sentences on individuals who possess or use two synthetic drugs: one that mimics the effects of ecstasy and another that mimics the effects of marijuana. I have never possessed or used illicit drugs, nor should anyone. But this legislation is more about sensationalism than actual public protection. HB 6038 passed 105-1. HB 6226 passed 104-1.
Justin Amash just voted no on HR 294, which “recognize[s] the perfect game pitched by Armando Galarraga of the Detroit Tigers on June 2, 2010, against the Cleveland Indians.” Congrats to Mr. Galarraga for his outstanding performance and achievement, but I’m not the commissioner of Major League Baseball, and this resolution is not an appropriate legislative matter. It passed 101-5.
If he keeps this up, I may stop being cynical about politics which would be a problem because I don’t know any other way to be, having living in DC for 18 years. But I’m willing to give it a try.
You can have a look at his other explanations for his votes here. (Make sure you go down to the older posts on his wall to get his explanations).
Joe Biden Is No Friend of Tech, So Tech Should Give to Joe Biden
Politics and extortion share a similar logic: Give to the one who can hurt you the most.
Sestak: Business as Usual
I haven’t taken much interest in the growing story about the possibility that Rep. Joe Sestak (D-PA) was offered a job to entice him out of the primary race against incumbent senator Arlen Specter. If true, this apparently is illegal.
But does anyone think horse-trading like this does not happen in politics all the time? Perhaps someone was gauche enough to name the price of the horse, and perhaps someone didn’t know enough to keep his mouth shut about it. But it’s pretty much a law of physics that an entrenched group of politicians at a remote level of government is going to divvy up the emoluments the public has ceded to them. A law to the contrary may aspire to some ideal of good government, but its effect is only to hide what is going on.
Only if you pretend that politicians are selfless do you find horse-trading around the Pennsylvania Senate race unusual.
How the World of Campaign Finance Is Changing
Journalists are looking closely at the DISCLOSE bill, Congress’ response to Citizens United. CQ says DISCLOSE will loosen independent spending by the parties on their candidates.
Why is Congress liberalizing party spending? CQ explains:
According to one GOP attorney, opponents of the Supreme Court’s decision are realizing that they will have a difficult time challenging the constitutional right of outside groups to spend money, so this bill is a response to free up the parties to compete.
Mark that. Citizens United has altered the incentives regarding speech. In the past, Congress tried to suppress speech to win elections. Now leaders must liberalize in order to compete for votes.
Don’t Give Up on the American People…at Least not Yet
Gloominess and despair are not uncommon traits among supporters of limited government — and with good reason. Government has grown rapidly in recent years and it is expected to get much bigger in the future. To make matters worse, it seems that the deck is stacked against reforms to restrain government. One problem is that 47 percent of Americans are exempt from paying income taxes, which presumably means they no longer have any incentive to resist big government. Mark Steyn recently wrote a very depressing column for National Review Online about this phenomenon, noting that, “By 2012, America could be holding the first federal election in which a majority of the population will be able to vote themselves more government lollipops paid for by the ever shrinking minority of the population still dumb enough to be net contributors to the federal treasury.” Walter Williams, meanwhile, has a new column speculating on whether this cripples the battle for freedom:
According to the Tax Policy Center, a Washington, D.C., research organization, nearly half of U.S. households will pay no federal income taxes for 2009…because their incomes are too low or they have higher income but credits, deductions and exemptions that relieve them of tax liability. This lack of income tax liability stands in stark contrast to the top 10 percent of earners, those households earning an average of $366,400 in 2006, who paid about 73 percent of federal income taxes. …Let’s not dwell on the fairness of such an arrangement for financing the activities of the federal government. Instead, let’s ask what kind of incentives and results such an arrangement produces and ask ourselves whether these results are good for our country. …Having 121 million Americans completely outside the federal income tax system, it’s like throwing chum to political sharks. These Americans become a natural spending constituency for big-spending politicians. After all, if you have no income tax liability, how much do you care about deficits, how much Congress spends and the level of taxation?
Steyn and Williams are right to worry, but the situation is not as grim as it seems for the simple reason that a good portion of the American people know the difference between right and wrong. Consider some of the recent polling data from Rasmussen, which found that “Sixty-six percent (66%) believe that America is overtaxed. Only 25% disagree. Lower income voters are more likely than others to believe the nation is overtaxed” and “75% of voters nationwide say the average American should pay no more than 20% of their income in taxes.” These numbers contradict the hypothesis that 47 percent of Americans (those that don’t pay income tax) are automatic supporters of class-warfare policy.
So why are the supposed free-riders not signing on to the Obama-Reid-Pelosi agenda? There are probably several reasons, including the fact that many Americans believe in upward mobility, so even if their incomes currently are too low to pay income tax, they aspire to earn more in the future and don’t want higher tax rates on the rich to serve as a barrier. I’m not a polling expert, but I also suspect there’s a moral component to these numbers. There’s no way to prove this assertion, but I am quite sure that the vast majority of hard-working Americans with modest incomes would never even contemplate breaking into a rich neighbor’s house and stealing the family jewelry. So it is perfectly logical that they wouldn’t support using the IRS as a middleman to do the same thing.
A few final tax observations:
The hostility to taxation also represents opposition to big government (at least in theory). Rasumssen also recently found that, “Just 23% of U.S. voters say they prefer a more active government with more services and higher taxes over one with fewer services and lower taxes. …Two-thirds (66%) of voters prefer a government with fewer services and lower taxes.”
There is a giant divide between the political elite and ordinary Americans. Rasmussen’s polling revealed that, “Eighty-one percent (81%) of Mainstream American voters believe the nation is overtaxed, while 74% of those in the Political Class disagree.”
Voters do not want a value-added tax or any other form of national sales tax. They are not against the idea as a theoretical concept, but they wisely recognize the politicians are greedy and untrustworthy. Rasumussen found that “just 26% of all voters think that it is even somewhat likely the government would cut income taxes after implementing a sales tax. Sixty-six percent (66%) believe it’s unlikely to happen.”
Fiscal restraint is a necessary precondition for any pro-growth tax reform. If given a choice between a flat tax, national sales tax, value-added tax, or the current system, many Americans want reform, but it is very difficult to have a good tax system if the burden of government spending is rising. Likewise, it would be very easy to have a good tax system if we had a federal government that was limited to the duties outlined in Article I, Section VIII, of the Constitution.
Republicans should never acquiesce to higher taxes. All these good numbers and optimistic findings are dependent on voters facing a clear choice between higher taxes and bigger government vs lower taxes and limited government. If Republicans inside the beltway get seduced into a “budget summit” where taxes are “on the table,” that creates a very unhealthy dynamic where voters instinctively try to protect themselves by supporting taxes on somebody else — and the so-called rich are the easiest target.
Last but not least, I can’t resist pointing out that I am part of a debate for U.S. News & World Report on the flat tax vs. the current system. For those of you who have an opinion on this matter, don’t hesitate to cast a vote.
Just Give Us the Data! Transparency and Change
Yesterday my government transparency site WashingtonWatch.com rolled out a transparency campaign (along with many collaborators) called “Just Give Us the Earmark Data!”
Visitors to Earmarkdata.org are encouraged there to sign a petition asking Congress to publish data about earmarks in formats that are useful for public oversight. Developers can also participate in perfecting the data schema that will capture the “earmarks ecosystem” in the best possible way.
After a surprisingly successful effort at “crowdsourcing” earmark data last summer, the push for earmark transparency gained steam in January, when President Obama spoke about it in his State of the Union speech. A White House “fact sheet” issued the same day called for a “bipartisan, state-of-the-art disclosure database that allows Americans to examine the details of every proposed earmark.”
(We were going to ask for good earmark data anyway, but this gave the idea currency in a lot of quarters.)
The focus on earmarks and transparency got the political calculators whirring on Capitol Hill. “Is earmarking worth doing considering the political heat it is going to draw?”
One set of actors came up with their answer last week. House Democrats announced that they would restrict their earmarking only to non-profits. They want for-profit businesses seeking taxpayer money to go through conventional channels like competitive bidding.
The next day, House Republicans came back over the top of Democrats’ political bet. They announced that they would forgo earmarking entirely.
That’s House Democrats and House Republicans. Don’t assume that earmarking is going to go away. A good-government bidding war is on, though—spurred by the political challenge of transparency.
A couple of observations, least important first:
- If it wasn’t obvious before, this illustrates that politicians are very capable political risk balancers. Indeed, surfing political waves is arguably the primary task of elected officials, most especially at the national level, and without this skill, they are goners. (That’s why looking for a wellspring of principle in an elected official usually gets you swamped in disappointment.)
I’ve had a number of friendly cynics suggest that politicians wouldn’t mind earmark transparency—bringing home the bacon brings in the votes! This appears in general not to be true. There may still be earmarking from a hard core group who do perceive overall political benefits from it, but they’ll have to buck their parties, who do not.
(Alas, I can’t say “I told you so!” because I tended to just grin and say “Maybe you’re right!” For future reference, I agree with the tendency, but doubt the direct outcome described in the adage attributed to Benjamin Franklin, “When the people find that they can vote themselves money, that will herald the end of the republic.” Thankfully, it’s more complicated than that.)
- Notable: Elected officials’ political tuning is not just reactive. The anticipation of earmark transparency is what started this bidding war.This is especially worth noting with respect to President Obama’s “Sunlight Before Signing” promise, which I most recently reported on here. Skeptics have said that President Obama’s promise to post bills he receives from Congress online for five days before making them law wouldn’t make any difference because a bill that Congress has sent down Pennsylvania Avenue is already final. But a parochial amendment hanging out there for five days threatens to draw political discredit on its author and supporters—and their party. Sunlight Before Signing was a meaningful promise.
(SBS has two advantages over the creditable “Read the Bill” proposal to hold bills 72 hours before a vote in Congress: 1) SBS takes advantage of interbranch rivalry, and 2) it was a campaign promise of the president!)
- Broadly, this episode illustrates how transparency can bring welcome change. It’s correct to observe that earmarks represent only a tiny part of overall spending. But applying parallel transparency efforts to other parts of the legislative and regulatory processes are likely to elicit similar good behavior from government officials. There are manifold directions to go with government transparency. Each in its way stands to create political dynamics more congenial to good government and—more importantly—to liberty.
Cato on Facebook
Cato on Twitter
Cato on Google+
Cato on YouTube
