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On the Road to a Flat Tax, a Curve or Two

By Clay Chandler
Washington Post Staff Writer
Sunday, January 21, 1996; Page A01

To hear several Republican presidential hopefuls tell it, the flat tax could do it all: simplify the tax code, lower tax rates for almost everyone, include generous deductions for families and businesses, and raise enough revenue to keep the deficit from growing.

A Republican advisory panel, chaired by former housing secretary Jack Kemp, unveiled its recommendations for a single-rate tax amid much fanfare last week. But a leading accounting firm's analysis of the approach suggests flat-tax math is far from simple.

The analysis of the Kemp commission's recommendations, conducted by the accounting firm of Coopers & Lybrand, concluded that a flat tax offering exemptions for homeownership, charitable contributions, investments, payroll taxes and other priorities favored by the panel would require a rate of at least 25 percent to keep from adding to the deficit.

Alternatively, if the rate for the tax plan were set at 19 percent – the rate Kemp says he favors – preserving the many exclusions apparently advocated by the commission would add about $200 billion annually to the deficit, roughly doubling its current size, the firm concluded.

The firm's assessment highlights the perils of raising the flat tax as a campaign issue. Opinion polls suggest that Americans dislike the complexity of the current tax code and are interested in the flat-tax concept as an alternative. But many political strategists warn voters would recoil at the prospect of a 25 percent tax rate.

Kemp's proposal tries to be the most politically pleasing – and the most politically doable – by giving voters what they want: low rates and lots of deductions.

A more bare-bones flat tax, more along the lines of the 17 percent flat tax advocated by multimillionaire publisher Malcolm "Steve" Forbes Jr., already is being attacked by rivals as a sop to the rich. Forbes's plan shelters investment income from taxes, but doesn't allow deductions for mortgage interest, payroll taxes, charitable contributions or state and local taxes, all of which have strong support from middle-income voters.

Sen. Phil Gramm (R-Tex.) proposed a more populist 16 percent flat tax last week, one that would tax investment income but preserve the mortgage interest deduction. Republican front-runner and Senate Majority Leader Robert Dole of Kansas eschews support for a specific plan but says he favors a "flatter" tax than the current, multi-tiered income tax.

Flat-tax proponents argue that a single-rate tax system would trigger an explosion of economic growth by lifting the tax code's many deterrents to savings and investment. In a meeting Thursday with editors and reporters of The Washington Post, Kemp predicted the flat-tax approach outlined by his commission could double the growth rate of the U.S. economy, thereby raising revenue collected by the Treasury more than enough to finance operations of the government over the longer term.

Kemp said he is open to the idea of setting the flat rate as high as 25 percent initially if necessary to keep from running up deficits. That rate could be lowered over time, he argued, as growth improves and revenue rises after the adoption of the new tax system.

The Coopers & Lybrand analysts calculated the economy would have to enjoy a decade of record growth rates to keep the flat-tax rate at less than 20 percent without widening the deficit.

For example, if the economy expanded by 5 percent a year for the next 10 years – double its current pace – a flat tax offering exemptions for mortgage interest payments, charitable contributions, investment income, payroll taxes and state and local taxes could be set in 1996 at a rate of 16 percent. The low rate would increase the deficit in the early years, but by the end of the decade it would achieve what's called "revenue neutrality."

Assuming the same growth rate, a less-generous tax plan offering exemptions only for investment income and payroll taxes could use a 14 percent rate, according the firm.

The annual growth rate of the U.S. economy, however, has exceeded 5 percent only seven times since 1959, according to economists at the Treasury Department. Since World War II, it has never sustained growth of more than 5 percent for more than three years in a row.

For most economists, the likelihood of economic growth doubling under a flat tax "just isn't something that's on anybody's radar screen," said John Wilkins, chief tax economist for Coopers & Lybrand and the director of the analysis.

If the promised growth did not materialize, a flat tax of 19 percent rate and with all the exemptions endorsed by Kemp would add more to the national debt than the amount Congress and the White House are seeking to cut to balance the budget by 2002.

In its analysis of the Kemp plan, Coopers & Lybrand made several assumptions. Because the Kemp group did not specify the level of personal exemptions allowed – except to say they should be "generous" – the accounting firm used a basic deduction of about $32,000 for a family of four.

It then calculated the revenue impact of two versions of the plan: one that excluded investment income from tax and allowed deductions for payroll taxes, and a second that included additional deductions for mortgage interest, charitable contributions and state and local taxes.

Grace-Marie Arnett, the tax reform panel's executive director, disputed the analysis. She said the panel's report had deliberately steered clear of making precise recommendations.

"Anybody who tries to put numbers in there has put them in themselves," she said. "It's irresponsible and it makes me angry."

© Copyright 1996 The Washington Post Company

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