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April 15, 1997
"Flatter, But Not Flat, is the Best Tax Reform"
San Jose Mercury News
By Timothy Taylor
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LAST YEAR, the more extreme advocates of a flat income tax took center stage, and then painted themselves into a corner. They advocated a single low tax rate. Critics pointed out that if this rate was too low, it would decrease revenue and raise the budget deficit. But if the single tax rate was set high enough to avoid reducing revenue, it would cut taxes for the wealthy and raise them on many in the middle class. Faced with that dilemma, advocates of the flat tax took a third path: they gave up and went away. Ever since, instead of focusing on a simpler tax with lower rates, politicians of both parties have been wallowing in the muddle.

Last year, Congress passed three bills that made 655 minor changes to the tax code. Today's hot proposals are for tax breaks for children, for college tuition, on capital gains, for retirement accounts, and more. But although a monomaniacal one-rate flat tax poses real problems, turning the tax code into a parade of subsidies is an overreaction. After all, high tax rates do discourage work and savings. The combination of high rates and numerous complex tax provisions means that the country pours tens of billions of dollars into tax paperwork, rather than productivity. A flatter-tax reform finds ways of paying for lower tax rates by reducing the ways of sidestepping taxes through deductions, credits, exemptions, and so on. This trade-off has the welcome side effect of making the tax code simpler and less intrusive.

William Gale of the Brookings Institution has offered one model of a flatter tax. He begins by restructuring tax deductions. Presently, tax deductions reduce your payments by the amount of your bracket; thus, $100 of tax deductions cuts $15 off the taxes of someone in the 15 percent tax bracket, but $33 off the taxes of someone in the 33 percent tax bracket. Gale suggests that the law be changed so that $100 of deductions would reduce your taxes by $15, regardless of what tax bracket you are in. This change would arguably be more fair, since deductions would have the same value to all taxpayers who itemize. It would also raise tax revenue.

But the rest of Gale's proposal would then cut the top tax rate back down to 31 percent from its current level of 39.6 percent. He would also scrap a number of tax provisions that make the tax code more complex for high income taxpayers without raising much revenue, like the alternative minimum tax, the add-on taxes for those who saved ''too much'' in their pension accounts, and the picky phase-outs of exemptions and deductions.

A complementary proposal by Daniel Feenberg of the National Bureau of Economic Research and Jonathan Skinner of Dartmouth College would reduce everyone's tax exemptions by one, and then add exactly that same value to the standard deduction. This change would have no impact on the taxes of those generally poor and middle class taxpayers who do not itemize deductions, since the sum of their exemptions and the standard deduction would not change. Some of those who presently itemize with a relatively small numbers of deductions would find that they were now better off taking the higher standard deduction, without a need to itemize. However, those who itemize with many deductions would find that although their deductions were the same, they had one fewer personal exemption. For those taxpayers, this change would mean slightly higher taxes.

According to Feenberg and Skinner, this proposal would raise $15 billion a year in additional revenue from the relatively wealthy who itemize many deductions, but reduce by 8 million the number of taxpayers who need to itemize. The Gale proposal would reduce the number of itemizers even further.

These proposals illustrate that our choice is not between an extremist single-rate flat tax, with its theoretical neatness and practical flaws, and the unrestrained distribution of tax break goodies. Instead, practical proposals for a flatter, simpler tax offer broad benefits across the economy - with the possible exception of the accounting and tax preparation industries.

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