Flat tax could spur stock boom, but hurt bonds


All you ever wanted in a tax. And less.

The flat tax, designed to simplify taxes while encouraging saving and investing, would tax all business and personal income at a lower flat rate to be determined by Congress.

Since it's the hot ticket in Washington these days, average American investors should closely monitor the heated debate over its viability.

On the one hand, it could be a dramatic boon to investments, especially the stock market, and eliminate tons of paperwork and billions of dollars associated with tax compliance.

But it might throw a monkey wrench into the municipal bond market and erase important deductions for housing and charities. Furthermore, a flat rate set too low would trigger a deficit.

The most talked-about proposal, from House Majority Leader Dick Armey, a Texas Republican, is a flat 17 percent tax rate, but negotiations could push that as high as 21 percent. It depends on where it's determined overall revenues would remain the same as they are now. With a flat tax, deductions and depreciation schedules would be eliminated and the personal exemption raised.

Mr. Armey's plan would end so-called "double taxation," which occurs when companies are taxed and their investors are taxed again on dividends, interest and capital gains. It would sweep away estate, capital gains and interest and dividends taxes. Businesses could immediately deduct all expenses, structural expenditures and equipment.

The belief is these changes would produce higher productivity and economic growth.

In other plans, House Democratic Leader Richard Gephardt, of Missouri, talks about a flat tax with a 10 percent rate for most families but higher rates for the well-off. A proposal from Sen. Arlen Specter, a Republican from Pennsylvania, would retain charitable and mortgage interest deductions, unlike Mr. Armey's plan.

There are plenty of opinions in the investment community, though no one is recommending specific investment moves just yet. After all, two completely opposing strategies -- a tax on what people consume ("value-added tax") and a national sales tax -- are under consideration.

"We see a scenario in which the flat tax develops momentum and believe there's a 50 percent chance it can be done in 1997," said David Tappan, analyst in the Washington research office of Prudential Securi ties.

Republican grass-roots organizations are lining up, Mr. Tappan noted. Expect a large number of Republicans running for office in the next election to endorse the flat tax. It's likely the Republican presidential candidate, whoever that may be, will forcefully back the concept.

"The flat tax is a moving target right now, and it will be a minimum of two years before it could be considered for passage," said Leslie Alperstein, managing director of Washington analysis for NatWest Securities.

There are inherent problems, such as the loss of deductions that could cripple municipalities, he warned. And if the flat tax is determined at too low a percentage, it won't bring in enough money to the government.

While no taxpayer is likely to sell a house as a result of the debate, a number may hold off buying municipal bonds or consider selling some, Mr. Alperstein said.

Current talk has already done some damage to the tax-exempt muni market.

One hope is that municipal bonds, if taxable, would become attractive investments for giant pension funds, which currently don't invest in them because they don't need their tax advantage.

"Odds of a flat tax becoming law are less than 40 percent right now and I wouldn't expect to see it until 1997," said Louis Navellier, editor of the MPT Review investment letter, Incline Village, Nev.

"But we're one of the few countries in the world that really taxes investments to a great magnitude, and a flat tax would be very bullish for growth stocks." It would also mean less cheating on taxes and easier enforcement, he maintained.

"Odds are currently against the flat tax, for it would take away a lot of existing congressional power to give out tax-law favors to various constituencies," said Robert Genetski, president of the Genetski & Associates economic and financial consulting firm.

The beauty of a true flat tax, Mr. Genetski believes, would be the ability to fill out your tax return on the back of a postcard and eliminate billions of dollars spent on filling out tax forms.

The proportion of investor portfolios devoted to stocks would grow significantly because taxable securities would be more attractive.

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