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Rick Perry’s flat tax isn’t very good at being a flat tax

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As flagged in Wonkbook this morning, Rick Perry’s flat-tax plan, or at least a précis of it in the form of a Wall Street Journal op-ed, is finally out. It actually comes with a few surprises. The plan calls for a flat income tax of 20 percent, which is higher than past notable flat-tax proposals. Steve Forbes, for example, called for a 17 percent flat tax in his 1996 and 2000 presidential runs, as did a proposal introduced in Congress in 1995 by then-House Majority Leader Dick Armey and Sen. Richard Shelby.

Nati Harnik

AP

But more notably, Perry’s plan doesn’t actually replace the existing tax code. Taxpayers would instead get to choose between paying taxes under the current system and paying the flat tax. The flat tax thus serves as a kind of upside-down version of the Alternative Minimum Tax. As it stands, taxpayers have to pay either their regular income tax burden or their AMT burden, whichever’s higher. Under Perry’s system, taxpayers will get to pay their flat tax burden or their regular burden, whichever’s lower. What’s more, the flat tax would preserve major tax deductions that benefit the middle-class (like the mortgage-interest deduction) for people making under $500,000 a year, though credits that largely benefit the poor, like the Earned Income Tax Credit, are eliminated.

This is good for people who benefit from middle class-targeted tax breaks, and for those whose income mostly fall in the current 10 and 15 percent brackets, because they can just keep paying taxes normally. But this approach also eliminates two of the flat tax’s main selling points.

For one thing, flat tax advocates frequently point to the plan’s simplicity, that tax forms could “fit on a postcard.” Indeed, Perry uses just this talking point in his op-ed. But by making the flat tax optional, Perry’s plan actually complicates the tax code. It would force households to determine whether they should pay the flat tax or the regular income tax, making the process more time-consuming and expensive, not less. And keeping major deductions for the vast majority of taxpayers means that even those who opt for the flat tax won’t face a much simpler code. The main cause of tax complexity is the plethora of credits and deductions, not the number of brackets. Perry’s plan greatly reduces the latter, but doesn’t do nearly as much as most flat tax proposals to reduce the former.

The second big selling point of flat taxes is that they, as Len Burman explained in a post yesterday, are secretly consumption taxes. Indeed, it’s a lot like a value-added tax. A VAT taxes the difference between a business’s revenue and the cost of its inputs. The corporate side of the flat tax does this, but also lets companies deduct wages. Individual wages are then taxed, albeit with a standard deduction, but the overall effect is basically identical to that of a VAT.

Economists like consumption taxes, as they tend to encourage investment and discourage consumption-based bubbles like the one that led to the financial crisis. VATs, and thus flat taxes, are particularly regressive consumption taxes compared with some alternatives, but the focus on consumption is at least an advantage. But because he keeps the traditional income tax around, Perry negates this advantage somewhat. By offering the choice not to pay the flat tax, Perry’s plan results in a more limited shift toward taxing consumption.

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