`Jerry's Tax': Wrong Answer, Right Questionsby
Former California Governor Jerry Brown's radical plan to replace the federal tax system with a 13% flat-rate individual income tax and a 13% value-added tax on business has grabbed public attention in recent weeks. And most economists who have studied his proposal don't like what they see.
Much of the criticism is justified. "Jerry's tax," as rival Presidential hopeful Bill Clinton terms it, would raise taxes on the poor and elderly, even as it lowered taxes for well-off families. Brown's plan is also simplistic, ignoring such key specifics as what income would be taxed and what expenses could be deducted. And unlike most proposals, Brown would tax labor twice by making businesses pay taxes on their payrolls, and then hitting workers again on the same wages. This would effectively double his claimed 13% rate on individuals.
POSTCARD 1040. But Brown, always the provocateur, deserves credit for raising critical issues in a campaign that at times has paid more attention to private lives than public policy. Does the current tax code encourage excessive consumption and debt? Can some of the tax code's hideous complexity be eliminated? By trumpeting his flat-tax idea and promising a system so simple that returns could be filed on a postcard, Brown has sparked the first tax-policy debate since the 1986 reform. The exercise should be more productive than the tiresome squabbling between the White House and congressional Democrats over "economic growth" packages. Says University of Michigan economist Joel B. Slemrod: "I'm much happier to see a serious debate about a flat tax. It raises important economic issues."
While Brown's plan is labeled a flat tax, that focuses on only half the plan. The second, more far-reaching element, is a value-added tax he would impose on business sales of goods and services. Taken together, Brown's flat-rate income tax and his VAT are intended to function as a consumption tax that replaces the current individual and corporate income levies, as well as the Social Security payroll tax.
The idea of taxing consumption while exempting investment and savings is not new. Housing Secretary Jack F. Kemp raised it as a congressman in 1978. In the '80s, the approach was popular among academics. Two Stanford University economists, Robert Hall and Alvin Rabushka, developed a plan that formed the basis of Brown's scheme. Individuals would pay a flat 19% tax on wages and salaries with no deductions, but capital gains, interest, and dividends would be exempt. Businesses would pay the same rate on total receipts, less the cost of labor, equipment, and materials. No deduction would be allowed for either interest or dividend payments. A similar proposal, called the X-tax, was devised by David Bradford, now a member of President Bush's Council of Economic Advisers. And Brookings Institution economist Henry J. Aaron, along with his then-colleague Harvey Galper, designed a "cash-flow" tax that also zeroed in on consumption. In 1988, Senator Bill Bradley (D-N.J.) pushed a version of the Aaron-Galper plan.
All these proposals would work about the same way (table). They would: be simple, tax all income only once, end the bias against equity finance and personal savings, and allow business to write off capital investments immediately. For better or worse, a consumption tax to replace the current system would sharply curtail the government's ability to use the tax code to promote favored industries.
The biggest drawback, in terms of politics and social policy, is that consumption taxes tend to fall heavily on the poor. The problem is fixable, but only by adding complexity. Hall and Rabushka try to inject fairness by exempting the first $16,000 of income from their tax. Bradford adds graduated rates to the mix. And Brown responded to critics by hastily adding a $15,000 exemption to his scheme.
REPAIR JOB. For the most part, the goals of the flat-taxers are worthy. But many economists wonder whether the existing system needs to be junked. After all, double taxation of dividends can be ended by adjusting the current code. The income tax could also be changed to allow businesses to write off investment immediately and to encourage savings through incentives such as individual retirement accounts. And the consumption tax will not be immune to politics. It can be loaded up with special-interest junk just as easily as the income tax. Says Aaron: "A shift to a whole new tax system is not likely to yield simplification. It would be lovely if it did. I don't think it's sustainable."
Brown feels his tax plan is a pristine replacement for today's corruption-riddled code. Other pols don't agree. For them, a consumption tax is a money machine to supplement the tapped-out income and payroll tax system. For instance, a 3.5% broad-based VAT would yield about $100 billion a year. Washington's chronic need for funds has won the idea powerful friends, from those who want to cut corporate taxes to those who want to finance national health insurance. But properly crafted, consumption taxes can have real merit. Washington must tackle some fiscal policy issues this year. Consumption taxes ought to be part of the debate.