Authors' claims aside, tax-reform plans carry risks

LAST SUMMER, a boastful Congress passed 824 new income-tax changes, most of them cuts. The big beneficiaries were investors and families with children.

Yet hardly were the photo-ops over when that very same Congress started to denounce "the government" for the tax code's deranged complexity.


They're swearing to pull the entire system out by its roots. It sounds like the classic cry from the murderer: "Stop me before I kill again."

There are two main camps. One says, "Quit taxing personal and business incomes; pass a national sales tax instead." The other says, "Tax only earnings, at a low, flat rate." Neither camp would tax personal interest, dividends, capital gains or inheritances.


Roughly speaking, here's how the proposals would work:

The national sales tax: The bill on the table comes from Republican Rep. W. J. "Billy" Tauzin of Louisiana. You'd be taxed at least 15 percent on most goods and services bought at retail -- food, clothing, insurance, cars, doctor bills, homes, rent, banking and brokerage accounts (although college would be exempt).

In theory, you could afford the higher price because you're no longer paying an income tax.

In real life, however, some people would pay more and others less.

Furthermore, that 15 percent is based on a weird calculation. At the cash register, the markup is actually 17.6 percent. With state sales taxes, too, your total tax might run 22 percent to 28 percent.

Some risks if we switch to a sales tax:

-- Collectibility. Tauzin crows that he's going to wipe out the IRS. Retailers and service-providers (banks, hospitals, plumbers) would collect the tax, keep 0.5 percent of it for themselves and remit the rest to the states. The states would keep 1 percent to cover costs and remit the rest to Washington.

But why should a state work its butt off to collect for the feds? Conceivably, it could net more money (and leave its citizens richer) by raising its own tax and going easy on federal tax evasion.


-- Tax evasion. Tauzin says that sales taxes are a cinch to collect, even without tax reporting and automatic withholding. But a survey of high sales taxes in other countries, done by the International Monetary Fund, found serious tax-dodging once the rate topped 10 percent.

-- Federal revenues. Tauzin's sales tax is supposed to raise the same amount of money that the income tax does. But will it? David Burton of the Argus Group, a Washington, D.C., law and lobbying firm, says yes. Daniel Feenberg of the National Bureau of Economic Research in Cambridge, Mass., says no.

The Tauzin bill gives every worker a tax credit, regardless of income.

The intent is to exempt from tax as much as a poverty-level income could buy. To cover this revenue loss, the sales tax would have to rise at least to 22 percent, Feenberg says.

I can't sort out this argument, but the country runs a big red-ink risk if Feenberg is right and Burton is wrong.

-- Winners and losers. High-income folks would save a fortune in taxes. In the middle brackets, gains and losses are mixed, says economist William Gale of the Brookings Institution. The working poor would be -- to put it technically -- screwed. They'd face higher taxes on lower incomes, because their earned-income-tax rebate would be snatched away.


In addition, fewer employees would get health insurance, because their companies wouldn't be able to write off the cost. Older people about to spend after-tax savings would be taxed a second time. But savers building long-term accounts would do just fine.

The flat tax: Under this tax, championed by Republican Rep. Dick Armey of Texas, all current deductions and credits would vanish -- gifts to charity, mortgage interest, state-tax deductions, child-care credits, everything.

There's a tax-free allowance depending on family size. On the rest of your earnings, you'd pay a flat 20 percent the first two years, then drop to 17 percent.

Taxes would go down for the rich, but rise for the working poor.

The flat tax would raise less revenue than the income tax does today. That was a political choice; Armey needs that low rate to cut taxes for the middle class.

To balance the budget, his bill requires deep, unspecified program reductions.


As much as anyone, I'd like to see the tax code cleaned up -- but separately from the bloody battle over government spending. My choice is an Armey-type tax with two or three brackets (to raise enough federal revenue) and a promise not to throw the working poor to the sharks.

Pub Date: 12/22/97