Changing tax systems

Posted: Feb 04, 2003 12:00 AM
Every few years, interest in fundamental tax reform rises. The leading proposal has long been a flat rate tax on a consumption base, such as the Hall-Rabunshka plan. However, the interest always fades because the transition from our current system is too difficult, both politically and economically. Consequently, in recent years, flat tax supporters have concentrated more on incremental tax changes that would gradually move us in the direction of a flat tax. If enough progress were made, then perhaps at some future date we would achieve something close to it. Tax reformer Ernest Christian has identified the key steps as the 5 easy pieces: -- Lower income tax rates, especially the top rate, to get us closer to a single statutory tax rate. -- Increase depreciation allowances, so as to move closer to immediate write-offs for investments in capital equipment. -- Raise the estate tax exemption, and move toward repeal of this tax. -- Relieve the double taxation of corporate profits, and move toward full elimination of the corporate income tax. -- Raise contribution limits for Individual Retirement Accounts, Keogh plans and 401(k) accounts in order to get as much saving as possible out of the tax base. With last week's announcement that President Bush will propose expansion of deferred savings, we can see that he has proposed all five pieces, with three already enacted into law. Like many conservatives, I was disappointed by the modesty of the tax rate reductions proposed by President Bush during the 2000 campaign. I was much more excited by the flat tax proposed by Steve Forbes and, to a lesser extent, John McCain. However, I consoled myself that Bush would propose something bolder after the election. I was further disappointed when Bush sent Congress a plan identical to his campaign proposal in 2001. This was a lost opportunity, I thought. When it came time for compromise, Bush was bargaining from a weak position. The result was that a modest tax cut became even more modest by being phased in over many years. But again, I consoled myself that the party split in Congress probably made this the best deal that could be obtained under the circumstances. Finally, I was disappointed that Bush didn't use his post-Sept. 11 popularity to push a meaningful stimulus plan through Congress. Instead, he settled for a temporary increase in depreciation allowances. I was heartened, however, when Bush decided to ask for full elimination of the double taxation of corporate profits, rather than the 50 percent exclusion that was widely rumored. He correctly reasoned that he could not be attacked any more severely by Democrats for asking for 100 percent of what he wanted instead of only half. Bush also now understands -- if he didn't before -- that Congress is always going to demand its pound of flesh. Moreover, by asking for full elimination of double taxation, Bush strengthens his hand by being able to argue the point as a matter of principle. Had he only asked for 50 percent, his position would not be as strong. And if forced to compromise -- a certainty -- he would be doing so from a weaker position. With many Democrats, like Massachusetts Senator John Kerry, favoring elimination of double taxation, they will have a harder time doing so as Bush has framed the issue. Now we see Bush asking for expansion of tax-deferred saving. On Jan. 31, the Treasury Department announced that the president's budget would contain an initiative that will allow Americans to save more for their retirement. With this last proposal, we can now see that Bush has had a strategy all along that conforms exactly to the five easy pieces. If he is successful in getting relief for double taxation and further elimination of saving from the tax base, he will have achieved meaningful legislative progress on every incremental change necessary to achieve fundamental tax reform. One secret to President Bush's success is that he has always been willing to settle for what he could get in terms of taxes, so long as the principle is not compromised and it is enacted into law. Thus, he will concede to long phase-ins, if necessary, and then ask for the tax cuts to be speeded up. He is satisfied with such compromises because they always move the law in his direction, and that is what is important. By Bush's second term, it is possible that we will have made enough incremental progress toward a flat rate consumption tax that we may finally see fundamental tax reform fully enacted into law. If so, it will be testament to a very clever, yet bold strategy that was initially invisible even to people like me, who study such things for a living. I am impressed.