Rewriting the Code

A roundtable on tax reform

Bruce Bartlett, Edward H. Crane, Daniel J. Pilla & Grover Norquist from the July 1995 issue

(Page 5 of 10)

This excessively heavy taxation of capital, combined with widely different tax rates on different forms of income, has created enormous inefficiency and is, I believe, at the root of our economic malaise. We are collecting less revenue for the government at a far higher cost than necessary. The compliance cost of the income tax runs into the tens of billions of dollars a year.

However, the compliance cost is only a small part of the cost we pay for our current tax system. A much larger cost is what economists call the "excess burden" of the tax system. The excess burden is the cost to the economy of reduced work, saving, and investment that is over and above the amount of tax collected. Estimates of the excess burden run into the hundreds of billions of dollars per year.

At first glance, it appears that there is no way the Hall-Rabushka tax system could possibly raise the same $740 billion that the federal government expects to raise in individual and corporate income taxes in 1995. It also appears to be an enormous giveaway to the rich, who now pay rates as high as 39.6 percent on all of their income except capital gains, which are taxed at a maximum of 28 percent.

In fact, the numbers in the Hall-Rabushka plan do add up. And it is not quite the giveaway to the rich that it appears. In return for gaining the ability to expense capital investment, businesses would lose the ability to deduct the cost of fringe benefits and interest. Hall-Rabushka would also sweep away a long list of business tax incentives currently in law. On the individual side, taxpayers would lose the ability to deduct mortgage interest, charitable contributions, and state and local taxes, among other things. Also, keep in mind that while interest and capital gains are not taxable for individuals under the plan, they are taxable at the business level.

The result of all this is to roughly triple current federal revenue from taxing businesses, while halving individual income tax revenue. Since business income largely accrues to the wealthy, the effect of the Hall-Rabushka plan is to raise the actual amount of taxes paid by rich people even as their tax rate falls. And this result does not in any way depend on any "supply-side" effects on economic behavior, although it is clear that there will be a significant impact on saving, investment, and work effort. Economist Dale Jorgenson of Harvard, for example, recently estimated that if something like the Hall-Rabushka plan were enacted by Congress it would lead to an immediate $1-trillion increase in national wealth, which was $19 trillion in 1993 (the most recent year for which data are available).

Unlike the Tax Reform Act of 1986, however, the Hall-Rabushka plan is not a simple trade-off between higher corporate taxes and lower individual taxes. Rather, Hall-Rabushka must be viewed as a fully integrated tax system, of which the business tax and the wage tax are simply two sides of the same coin.

And Hall-Rabushka is by definition a pure consumption tax, because capital investment is fully expensed and because individuals pay no taxes on their investment income. Thus it is unnecessary to institute any sort of specialized saving incentive, such as that proposed by Sens. Sam Nunn (D-Ga.) and Pete Domenici (R-N.M.). Their plan, in effect, would force people
to save before they received any tax benefit, whereas Hall-Rabushka simply abolishes taxes on saving altogether.

As noted earlier, the Hall-Rabushka plan is not the pure flat- rate tax it appears to be. That would require a single rate on gross income, with no deductions at all. The effect of a large personal and family allowance is to create effective progressivity. Under Hall-Rabushka the effective tax rate on wage, salary, and pension income would rise from zero on low-income families, to a rate between 3 percent and 12 percent on moderate-income families, to 16 percent on a family earning $200,000. Rates continue to rise as income rises, although no one would ever pay more than 19 percent.

While there are many other comprehensive reform ideas out there--such as the Cato Institute's sales tax proposal--I believe that the Hall-Rabushka plan is the best one that has been put forward in terms of fairness and simplicity. And it is not a new proposal, but one that has been around for almost 15 years.

It has been the subject of previous hearings in the Senate Finance Committee, the House Ways and Means Committee, and the Joint Economic Committee, and has been discussed in numerous studies and articles. Consequently, it is a plan that is familiar and well vetted. Thus, rather than reinvent the wheel and try to come up with an entirely new reform proposal, I recommend that the Congress simply adopt the Hall-Rabushka plan.

Bruce Bartlett is a senior fellow with the National Center for Policy Analysis. He was previously deputy assistant secretary of the Treasury for economic policy. As deputy director of the Joint Economic Committee, he organized the first congressional hearing on the flat tax in 1982.

Taxes We Can See

By Grover Norquist

It spoke volumes about the revolutionary expectations of the American people and the Republican Congress that only days after the Republicans won a majority in the House and Senate on November 8, public debate shot past the already ambitious Contract with America to plans for radically restructuring the federal income tax.

Public cynicism might well have dwelled on the difficulty of moving a balanced budget amendment, line-item veto, tort reform, and term limits through the House, much less the U.S. Senate. Yet as unlikely a Jacobin as Texas's Bill Archer, slated to head the newly Republican House Ways and Means Committee, fast forwarded the political agenda by announcing his desire to abolish the federal income tax, root out the Internal Revenue Service, and replace the present tax structure with a national consumption tax: a sales or value-added tax. Archer's fellow Texan, House Majority leader Dick Armey, has weighed in with his own reform agenda: a flat tax of 20 percent on personal and corporate income for 2 years, to be reduced to 17 percent thereafter.

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