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WISDOM IN A NUTSHELL

Fairness and Efficiency


in the Flat Tax



By
Robert E. Hall, Alvin Rabushka, Dick Armey,
Robert Eisner, and Herbert Stein


AEI Press 1st edition (July 1996)
ISBN 0844739871
127 pages






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Robert E. Hall and Alvin Rabushka are generally acknowledged as the fathers of
the flat tax, a proposal that captured the public imagination in the 1996
presidential campaign and that continues to stir discussion and controversy in the
field of tax reform. In this volume, Messrs. Hall and Rabushka explain their plan
and explore its many subtleties. The book includes a commentary on the flat tax
by House Majority Leader Dick Armey, who has introduced legislation that would
enact the Hall-Rabushka proposal with little change. Also included are two critical
assessments, one by economist Robert Eisner, the other by Herbert Stein, a
former chairman of the Presidents Council of Economic Advisers and a senior
fellow at the American Enterprise Institute.
"Tax forms can fit on postcards." With this sentence Robert E. Hall and Alvin
Rabushka begin their description of the flat tax, and this element of their
proposal, more than any other, has caught the public fancy. But despite the
name, a uniform tax rate is certainly not the only important aspect of the flat tax,
perhaps not even the most important one. The treatment of business taxation is
arguably more significant for the economy than the individual income tax, though
the latter is of greater interest to the public at large.
Hall and Rabushka propose a wage tax that, in place of deductions, would have
generous personal allowances for individual taxpayers and their family members.
These allowances would ensure that the tax system would remain progressive
despite its single rate of 19 percent. The poor would pay no tax at all, and the tax
burden would increase gradually for those with higher levels of income.
The name "wage tax" is important. Only earned income from wages and salaries,
plus income from pensions, would be taxed. For sound economic reasons
connected with the purposes of tax reform, income from interest and dividends
would be exempt. This element of the proposal has probably given rise to the
greatest controversy, though much of the criticism has been based on a
superficial understanding of the plan.
If the change in taxation of individuals would be dramatic, the change for
businesses would be radical. The tax return of a multi-billion-dollar corporation
such as General Motors would consist of only ten or eleven lines. The most
consequential change would be that, when businesses calculated the tax they
owed, they could deduct from their revenues not only wages and purchases of
goods and services from other businesses but also the full cost of any
investments in plant and equipment during the year in question. There would be
no more impenetrable rules concerning depreciation, with different "tax lives" for
different types of equipment, and no more special incentives for select forms of
investment. The cost of capital investment would be like any other deductible
expense for purposes of business taxation.
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According to Hall and Rabushka, the flat rate of 19 percent applied both to
individuals and to businesses would be "revenue neutral." That is, it would raise
the same amount of money as the present corporate and individual income tax
system, without accounting for any additional revenues from more rapid growth
of the economy. As the tax is structured, the importance of revenue sources
would be reversed in comparison with the present system, with the business tax
raising much greater revenues and the individual tax correspondingly less.
Almost every pending proposal for tax reform aims to tax consumption, not
income as such. There are many good economic reasons for this, such as
encouragement of savings and investment. The Hall-Rabushka plan is no
exception; it is a consumption tax, as defined by economists, even though on the
surface its "wage tax" seems to be a tax on income.
The authors estimate that the reform would increase both human work effort and
business investment in plant and equipment. Consid-ering added capital
formation alone, Hall and Rabushka assert--on the basis of various studies--that
"it seems reasonable to predict a 2 to 4 percent increase in GDP . . . within seven
years."
The flat tax, with its low and uniform rate, would increase work effort. It would
prompt additional members of a wage earners family to enter the labor force
because the familys tax rate would not rise with the additional income. Hall and
Rabushka conclude that "a reasonable projection is an increase of about 4
percent in total hours of work in the U.S. economy," which would produce an
increase by itself of almost $200 billion, or 3 percent, in GDP. Of course, these
would be enormous gains, which would translate into higher living standards at
all income levels. It is this result, rather than simplicity as such, that has attracted
a wide range of supporters to the flat tax.
The essay by Hall and Rabushka explores many specific issues associated with
the flat tax, including the effects of the loss of the mortgage interest deduction
(much less harmful to housing and real estate than feared, the authors
conclude), transition problems, and taxation of international transactions.
In his essay, Congressman Armey highlights the fairness and growth potential of
the flat tax. He also explains how the version of the flat tax that he has submitted
to Congress differs in a few minor respects from the plan advocated by Hall and
Rabushka.
The essence of Robert Eisners criticism of the flat tax in his essay is that it would
not be fair. The rich, he asserts, would pay much less tax than under the present
system, primarily because unearned income from interest and dividends would
not be taxed to the individual (such income would be taxed at the business level).
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Herbert Stein raises several questions that he does not attempt to answer about
the underlying objectives and philosophy of the flat tax. After discussing whether
an income tax or a consumption tax is preferable and whether tax rates should
be graduated, Stein concludes that "proponents of tax reform have no reason to
allow flat taxers to monopolize the stage."
Fairness and Efficiency in the Flat Tax is a complete description of a far-reaching
proposal. While the book explores subtle questions, all the authors discuss the
proposal in clear and lively language.