BLOOMINGTON, Ind. — Just about everyone agrees that our tax code is a mess. One reason: it is littered with tax breaks of all sorts — from exclusions for employer-provided health insurance to the deduction for mortgage interest, to credits for home improvements and hybrid cars — which make our tax code one of the most complicated in the world.
Yet, a realistic way to reform our tax system is not to scrap it completely and replace it with some theoretical flat tax, but rather to go back to a model that has worked in the recent past, namely to adjust our graduated rate structure and to broaden our income tax base by removing many of the complicated and unnecessary tax breaks.
The flat tax first became politically popular in 1996 when the publisher Steve Forbes made it a centerpiece of his presidential bid.
Forbess flat tax called for replacing our progressive income tax with a single 17 percent tax on consumption, which exempted all investment income. Forbes, of course, failed to secure the Republican nomination. And the flat tax went down with him.
Although variations of Forbess flat tax seem to reappear every four years, the levy remains a bad idea for several practical and political reasons.
First, like all so-called pro-growth tax cuts, the flat tax inaccurately presumes that reducing taxes will automatically and invariably lead to economic prosperity.
Historical and comparative studies have shown that the relationship between taxes and economic growth is too complex to believe that simply reducing taxes will necessarily lead to increasing economic output.
A second practical concern is that flat tax proposals fail to deliver the simplicity they promise. Flat tax proponents contend that by replacing our multiple tax brackets with a single rate, we would be able to file our returns on a postcard. But the current complexity of our tax code doesnt come from the graduated rate structure.
In an age of Turbo Tax, calculating tax liability is a breeze. Clicking a mouse, after all, is even easier than mailing a postcard. The harder part is calculating taxable income, which requires knowing which of the numerous tax breaks one is entitled to.
Now, to be fair, the flat tax could theoretically lead to a simpler tax base. By removing the tax on investment income, it would transform our income tax into a consumption tax and eliminate many tax preferences.
But even if such simplicity were to last — a doubtful prospect since lawmakers are always eager to enact new tax breaks — it would come at a potentially steep price in terms of fairness. Indeed, adopting a flat tax would radically alter the distribution of tax burdens, away from the wealthy onto lower and middle-income households.
Under a flat tax, high-income families would face a lower tax rate and much of their income, which comes from investments, would be tax exempt. The working poor would lose such benefits as the Earned Income Tax Credit, and the middle-class, which spends most of its earnings on everyday consumption items, would bear the brunt of the tax burden.
In short, the flat tax would mean lower taxes for the rich and higher taxes for everyone else. Ultimately, adopting a flat tax would be a radical change to our tax system.
The more politically feasible option is to return to the type of fundamental tax reform that guided lawmakers in 1986. Back then, bipartisan political leaders understood that tax reform entailed compromises and partial victories. By removing some tax breaks and lowering tax rates, lawmakers were able to secure significant and meaningful improvements that made our tax system fairer and more efficient.
Its time to return to this type of practical and realistic reform if were serious about improving our tax system.
Ajay K. Mehrotra is a professor of tax law at the Indiana University Maurer School of Law.
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