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Tax Reform Flattened on the Right

Screen Shot 2015-09-29 at 10.15.14 AMBy Stephen Moore

Here’s a no good deed goes unpunished story.‎

Rand Paul has proposed a $2 trillion tax cut over 10 years – arguably the biggest tax reduction in American history.  He wants to shave tax rates down to 14.5% the lowest rate since the income tax was introduced 100 years ago.  Ted Cruz has a tax cut nearly as large and his rate is 16%.  This compares with tax rates that are as high as 42% under the current tax code.

Both plans would eliminate the corporate income tax AND the payroll tax. They would also eliminate almost all loopholes in the tax system.

The Tax Foundation estimates the plans would add about 12% to GDP within a decade which as an extra $2.5 trillion of GDP – like adding an extra California to the economy.

This could be the biggest take-down of our $4 trillion collosal government and Washington DC’s micro-control of the economy in decades.   K Street’s million dollar lobbyists would be all but  shutdown.

If you’re a free marketer sounds like a dream come true, right?

So why are the libertarians at the Cato Institute and other purists on the right attacking the lowest flat rate tax out there?  Dan Mitchell and Chris Edwards, economists at Cato, say that the plan will grow government because it is a European-style hidden value added tax.  “The left’s dream is a value-added tax on the middle class,” says Mitchell, “so why are advocates of small government helping to advance that awful levy?”

I and others have made the case against a VAT for many years.  VATs in Europe have financed the European cradle to grave welfare states with spending zooming to as much as 50% of GDP, versus closer to 35% of GDP in the U.S.  VATs have tended to start low and rates go higher and higher.

Which brings me back to the Rand Paul and Ted Cruz plans. Both got their origins from a book that Arthur Laffer and I wrote entitled Return to Prosperity. In that book we endorse what we call the “Complete Flat Tax.”  Under the plan wages and salaries are taxed at the low flat rate and on the business side companies are taxed at a flat rate on their revenues minus their cost of production.

It is a consumption-based tax and most economists would agree it’s the proper tax base for taxing business output.  Senators Paul and Cruz call it a net business income tax.

Cato calls it a VAT.

Here’s how it is different from a VAT.  First, Europe’s VAT grew the government because it was an ADD ON to the existing income and payroll tax system. That is what financed the Euro-welfare state time bomb.

By contrast, the Rand Paul and the Ted Cruz plans – and let me shout this again – ELIMINATE the pay roll tax and corporate taxes – entirely. The corporate tax is the worst tax ever. It is costly, it is riddled with loopholes so some companies pay a lot and some pay almost nothing, and it destroys american jobs. The complete flat tax creates millions of jobs.

Skeptics say that the flat business tax is hidden from consumers and taxes should be visible. That’s true. But the current corporate tax is invisible and so is the payroll tax – especially the half paid by businesses. With electronic pay checks most workers don’t ever see what FICA takes from their check. So this is no less transparent than what we have now. And perhaps we need to find ways to make the tax more visible to consumers as Senator Cruz is proposing.

Opponents also say that the business tax is such a big revenue generator that politicians will start raising rates by a point or two at a time to raise a vault of dollars to fund more government programs. Sure, but the same danger arises under every flat tax plan. There is no way to prevent the rate from being raised later.  At least the Rand Paul plan requires a 60 percent of Congress vote to raise taxes later.

Cato has long been an admirer of a Steve Forbes/Dick Armey flat tax which also replaces the corporate tax with a form of a vat. (I worked for Dick Armey back in the mid-1990s and had a hand in that tax reform plan too. It’s a very good tax plan – we are comparing a Ferrari with a Porsche here.)  The only major difference is the Paul and Cruz plans require businesses to pay the tax on worker payrolls, while the Forbes/Armey plan retains the current payroll tax structure.

There are two advantages to taxing the employee costs at the business level. First, since ALL wages are taxed under the complete flat tax, there is no cap as under the current FICA tax. This means that the effective tax rate on wages and salaries is flat, whereas under the Forbes/Armey plan a worker who earns $100,000 pays a higher marginal tax rate, than a worker who earns a million dollars.  So the distributional impact across income groups is more evenly – and I would argue, fairly – distributed under the complete flat tax.

Second, and this is CRUCIAL: the Paul and Cruz plans tax imports at the low rate and don’t tax exports. So for manufacturing workers and Trump voters this plan is a big jobs producer here at home. Currently our tax system perversely taxes what we produce, but not what we import. That’s dumb policy and even worse politics.  Republicans can win middle class union voters by persuading them that the complete flat tax is a GATT-legal tariff on all goods and services imported into the United States and no tax on what they produce for export – just as a national sales tax accomplishes the same thing.  That’s huge for Trump voters.

Then there is the argument by some folks at American Enterprise Institute and NR’s Ramesh Ponnuru that the Paul and Cruz plans will cause inflation.  Really? A $2 trillion tax cut will be inflationary? That’s what the left warned about the Reagan tax cuts. Instead we had the biggest cut in inflation ever.   ‎The flat tax increases production of goods and services, which reduces inflation. Duh.

There’s probably about a dozen different ways to craft a flat tax – everything from the 9 9 9 plan devised by Herman Cain to the national sales tax to the Paul and Cruz plans. They are variations on the same theme and conservatives should be for ‎which ever one of them that is politically most salable and can pass. A circular firing squad on the right by those who only want THEIR plan is counterproductive.

The my way or the highway mentality only benefits the left – and the politicians, accountants, lawyers, lobbyists, and redistributionists – who want to strangle tax reform altogether.

Stephen Moore is an economic consultant with Freedom Works and co-founder of the Committee to Unleash Prosperity.

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