Flat Tax Hybrid Plans May Add Trillions to Deficit
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The Fiscal Times
December 29, 2011

It sounds like a safe political gambit: Implement a new flat tax plan to simplify the federal tax code and eliminate special interest write-offs and loopholes. If Americans didn’t like it, -- no problem -- they would have the option of sticking with the current system.

GOP presidential contenders Newt Gingrich and Rick Perry have both proposed this dual tax system, and both have been lauded for their efforts by long-time flat-tax enthusiast Steve Forbes and anti-tax crusader Grover Norquist. Perry's plan calls for a 20% flat tax rate on individuals and 20% corporate rate. Gingrich's calls for a 15% flat tax rate on individuals and a 12.5% corporate rate. The problem: Their plans could cost the government a bundle, raising the deficit even more.

Operating that type of dual tax system, which lays a flat tax option on top of the current code, is a sure recipe for revenue loss and added complications for both taxpayers and the Treasury and Internal Revenue Service, they say.

Twenty-five countries including Russia, Lithuania, Hong Kong, and Iceland have enacted flat tax systems for individuals, but only Hong Kong makes that option elective. But tax experts warn that this “one from column A or one from Column B” approach would be highly risky.

“It’s somewhere between ‘impossible’ and ‘no-freaking way’ could a system like this realistically function in the U.S.,” said Paul Caron, a tax law professor at the University of Cincinnati and publisher and editor of TaxProf, the most popular tax blog on the internet.

One of the original flat tax advocates, Former Republican House Majority Leader Dick Armey of Texas, says that while a flat tax is “the single greatest instrument available to inspire growth in the American economy,” it’s not worth enacting if the current federal tax code remains, as Gingrich and Perry are suggesting.

“It takes a lot more boldness then this,” Armey told The Fiscal Times, calling these plans “cockamamie hybrids.”

“Now you’ve got to hire extra accountants who have to spend extra time figuring the tax code both ways, the old way and the flat tax way.”

“The right way to do the flat tax is to do it straightforward and completely, with no exceptions, and as a substitution for the current tax code,” said Armey, a former college economics professor. “If you double track it like that, you leave all the loopholes, and you don’t get to eliminate those big compliance costs since now you’ve got to hire extra accountants who have to spend extra time figuring the tax code both ways, the old way and the flat tax way….It’s counterproductive to good economics.”

Interest in a flat tax – a simplified system in which one or two tax rates are applied to gross income but sans most tax deductions and credits --has suddenly come back into vogue thanks to Gingrich, the former House speaker, Perry, the governor of Texas, and former Godfather’s Pizza CEO Herman Cain before he dropped out over a sexual harassment controversy.

Steve Forbes, chair of Forbes Media who ran for president on a flat tax platform in 1996, is excited by the dual approach taken by Perry and Gingrich. But the only justification for keeping the current system is to help Americans overcome their fears “that the new one will somehow hurt them because they might lose this or they might lose that,” Forbes told The Fiscal Times. “This way, you have a safety valve. So it just lowers the political temperature and lowers the political barrier to enacting the thing. That’s all it’s meant to do.”

Under both plans, those opting for the flat tax would not be taxed on capital gains, dividends, interest, or Social Security, and would still be able to claim deductions for charitable contributions and mortgage interest. Both plans would do away with the estate tax, the Alternative Minimum Tax, and cut the corporate rate—Perry’s to 20 percent and Gingrich’s to 12.5 percent.