Rand Paul's Implausible Flat Tax
Senator Rand Paul's new tax-reform plan is a considerable improvement over his old one. He's done what more politicians should: revise their ideas to take account of valid criticisms. But even the new plan doesn't live up to the senator's rhetoric. And it isn't going anywhere.
Paul's earlier plan was a 17 percent flat tax that would have raised taxes for much of the middle class, especially parents, while reducing them for the rich. The new plan, which Paul is calling a "fair and flat tax," avoids such big increases.
It has two main parts. First, Paul would replace the income and payroll taxes with a 14.5 percent flat tax with exemptions of $15,000 for filers and $5,000 for dependents. Families of four therefore wouldn't pay taxes on their first $50,000 of income. Second, Paul would replace the corporate income tax with a new 14.5 percent "business activity tax."
"This tax," the senator explains, "would be levied on revenues minus allowable expenses, such as the purchase of parts, computers and office equipment."
What's not on that list of allowable expenses is wages. The Tax Foundation's analysis of the plan confirms that omission wasn't accidental. What that means is Paul's business tax is the equivalent of the value-added taxes, or VATs, that many other developed countries have. It's a consumption tax that people pay in the form of higher prices for consumer goods, or of lower real wages.
But it's a hidden tax: Most people don't have to write a separate check or fill out any forms to pay it.
This feature has led some conservatives to oppose VATs. Grover Norquist, the anti-tax activist, worries that hidden taxes are more easily increased than highly visible ones.
On his presidential campaign website, Paul says, "I propose we cut taxes for everyone -- rich and poor." He delivers on at least the first half of that promise. The net effect of Paul's plan is that the top tax rate on labor income falls from its current 43.4 percent to 26.9 percent. Taxes on capital gains and dividends would fall to 14.5 percent, and taxes on estates to zero.
Paul has said that the plan "shows that we have something that we can offer to the working class." For the middle class, however, the plan looks like a wash: What middle-income households no longer owe in payroll taxes they'll pay in hidden consumption taxes. The Tax Foundation concludes that the plan would reduce federal tax revenue by $3 trillion over a decade, not counting any effects it would have on economic growth. Paul says he'd cut spending to prevent the deficit from rising, so this would mean benefit cuts that affect the middle class.
All in all, then, what Paul is proposing is a big tax cut for high earners and businesses with almost no direct benefits for most Americans. It's the latest evidence that a flat tax that cuts most people's taxes while keeping revenue at a plausible level is just not possible.
A lot of voters might like Paul's brand of libertarianism -- but if they want a federal government that costs them less money, they'll have to look elsewhere.
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