The Flat Tax May Be Back. Right, Bob?
It was given last rites, pronounced dead, and buried during the Republican Presidential primaries. But the flat tax--onetime GOP aspirant Steve Forbes' economic prescription for everything from stagnant wages to society's moral decay--is back.
Bob Dole, who was shooting down Forbes' flat tax just a few months ago, is now giving it a serious second look. Far behind President Clinton in the polls, the presumptive Republican nominee is weighing some combination of an immediate across-the-board rate cut, a payroll-tax credit, and--for the long haul--a promise to scrap the existing multi-tiered tax code in favor of a single-rate income tax.
FAST GROWTH. Faced with the huge tab of a Forbesian 17% flat tax, which could cost up to $1.3 trillion over seven years, Dole's not likely to swallow the plan whole. But egged on by political aides, he's sidling ever closer to the supply-side camp. On May 22, Dole and Forbes met and buried the hatchet. The powwow fueled speculation that deficit hawk Dole will adopt both the flat tax and Forbes' belief in fast-growth economics when he reveals his economic strategy in a speech expected in late June.
Senator Robert F. Bennett (R-Utah), one of the Kansan's confidants, dubs this foxhole conversion the birth of "the New Dole." But if the New Dole can bring himself to sign onto something as sweeping as the flat tax, he will discover an old problem: Although the idea sounds simple in theory, in practice it would hit Corporate America unevenly, boosting some industries and socking others. "This is about winners and losers," says Washington tax lawyer Mark Weinberger.
One potential winner is Rock-Tenn Co. Its chairman, Bradley Currey Jr., figures that the tax bill for his Norcross (Ga.) packaging and paperboard manufacturing company "would be significantly less expensive" if Congress adopted the Forbes-like 17% flattax plan proposed by House Majority Leader Richard K. Armey (R-Tex.). Rock-Tenn wins because the flat tax would let the firm take an immediate write-off for its big-ticket equipment purchases. "We spend all of our cash flow on better and faster machinery," says Currey.
But other companies wouldn't be so lucky. A recent study by accountants Price Waterhouse shows that a tax-law rewrite would produce dramatic differences for various industries. Using Armey's plan with a 21% rate--the levy needed to keep tax reform from turning into a tax cut--the accountants found that aircraft makers would turn over to the IRS an additional 1.39% of their gross sales (table). Auto makers, on the other hand, would enjoy a tax cut totaling 0.39% of receipts.
RICH INCENTIVES. Why the differences? Detroit would benefit from a generous write-off of new equipment purchases under the flat tax. Aircraft makers are equally heavy investors, but they're also the biggest U.S. exporters, and the flat tax wipes out foreign tax credits and other breaks that help promote exports.
Flat taxers haven't yet figured out how to treat the profits made by banks, insurers, and securities firms. But whatever additional levies such firms face would be small potatoes compared with the windfall created by the plan's rich incentives for savings: Individuals would not have to pay tax on any interest, dividends, or capital gains. "It could be a boon for financial services," says Gerald P. O'Driscoll Jr., Citicorp's director of policy analysis. Companies offering lots of investment products would be particularly blessed. But their lineup of products might change: Some, like tax-sheltered annuities, would lose their tax edge against other savings plans.
Reform could turn commercial real estate inside out. Today, developers depreciate the cost of buildings over 39 years and deduct interest payments over the life of the loan. Under the flat tax, they would get a staggering first-year deduction for the full cost of buildings and land--but lose interest deductions. Such a change would play havoc with cash flow and send developers scrambling to find investors. "You would have new properties creating tremendous losses that their owners couldn't use," says KPMG Peat Marwick partner Philip J. Wiesner.
Mere quibbles, say the flat taxers. They claim their reforms would produce enough economic growth to swamp any industry-specific problems. But the growth claims are suspect: Berkeley economist Alan J. Auerbach calculates that under the best case, pure tax reform could add 0.4 percentage points to the economy's annual growth rate. And Congress is hardly likely to pass an economist's dream plan. Every deal that lawmakers cut to grease the way for legislation will reduce the plan's growth-boosting potential.
CHANGEOVER. For business, though, such transition rules or loopholes will become critical. What happens to a business that is carrying millions of dollars of unused net cperating losses? How about an outfit that buys a big piece of equipment a year before any new tax law takes effect?
Don't look for any quick answers from Bob Dole. He's telling his economic advisers he wants a tax plan that's big, bold, and beguilingly simple. The details and the price tag? Dole seems inclined to worry about that another day.