Tax reform as easy as 1, 2, 3
posted at 2:41 pm on August 10, 2012 by Rob Bluey
Republicans have promised to finally overhaul America’s tax code next year. Reform is long overdue. Now it’s a matter of what direction lawmakers should take.
While some of the GOP’s pragmatists have already balked at being bold, now is exactly the time to take that message to the American people. They’re looking for solutions, not excuses. And there’s one plan that stands out: the New Flat Tax. It features one rate, two credits, three deductions. It’s that simple.
The plan is part of The Heritage Foundation’s comprehensive solution for fixing America’s debt problem and restoring prosperity. As a Heritage employee, I’m naturally biased. But my personal preference for the flat tax predates my tenure at the think tank. It was 16 years ago, as Steve Forbes pursued the presidency, when the flat tax first appeared on many people’s radar, including my own.
There are few chances to fundamentally transform policy in Washington. The last major tax reform came in 1986 under President Ronald Reagan. So if Republicans are serious about tackling the tax code, they need to start preparing Americans now. (Lest we forget about the botched attempt at Social Security reform in 2005.)
Before we get into the details of the New Flat Tax, it’s important to first understand why tax reform is necessary. Heritage’s J.D. Foster explains:
America’s federal tax code is complicated beyond imagining. The arrival of personal computers and tax software has permitted the creativity of policymakers in Washington to run amok, creating tax complexities far beyond what even tax professionals could manage unaided by electronics. There are a multitude of credits, exemptions, and deductions, many of which are subject to special rules and phase out over different levels of income. As if this was not bad enough, there is a parallel tax called the Alternative Minimum Tax, and yet another in the payroll tax that funds Social Security and part of Medicare. And, all of this complexity imposed on individual taxpayers is relatively minor compared to the tortuous rules and exceptions businesses great and small must suffer.
That complexity is something almost all lawmakers will acknowledge. Last week, as the House voted on a plan to make tax reform a priority in 2013, differences began to emerge about how to fix the broken system.
“If you were to distill down the single adjective that was to describe what members are looking for in tax reform, it would be bold,” Rep. Peter Roskam (R-IL) told Bloomberg Businessweek.
Yet the same story revealed that Republicans are already ruling out bold ideas. The GOP’s set of tax-reform principles would apparently make it impossible to implement a flat tax. Some of those principles include reducing the number of individual tax brackets from six to two, lowering the top rate of 35 percent to 25 percent and abolishing the problematic alternative minimum tax.
By contrast, the New Fair Tax creates a single rate that ensures individuals are taxed only once on their income. That rate, around 28 percent, applies to wages and salaries. Remember, the New Flat Tax abolishes payroll taxes, so this rate is much lower than the combined income and payroll tax rate the middle class pays today. And the rate would decline over time so the new tax code never raises more than the current code has raised on average historically. Importantly, savings would be taxed only when spent, encouraging more Americans to save money now rather than rely on the government later in life.
Simplicity is the selling point for a flat tax, and this plan honors that principle. There are just two credits: a $3,500 health insurance tax credit for low-income and middle-income families as well as the current Earned Income Credit.
The plan has three deductions: one that lets taxpayers deduct expenses for higher education, another that preserves deductions for charitable contributions, and a third that makes the home mortgage interest deduction optional.
Think for a moment what this truly means. No longer would your paycheck have separate line items for Medicare and Social Security. And the money you save is not taxed until you spend it.
There’s more detail in Foster’s paper, but here’s the whole plan explained in under two minutes:
Lawmakers will have a choice next year on tax reform. If they want to go bold and set America on a path to prosperity, they’ll make substantive changes like the New Flat Tax.
Rob Bluey directs the Center for Media and Public Policy, an investigative journalism operation at The Heritage Foundation. Follow him on Twitter: @RobertBluey