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The tax/budget/deficit debate -- a tale of two taxes and what's fair, or not

By MARCELLA S. KREITER, United Press International   |   May 22, 2011 at 4:01 AM   |   Comments

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Two ideas that have been lurking in the shadows of the U.S. budget-deficit debate have received little attention of late: a change to the tax code that would eliminate nearly all deductions and impose instead a flat, across the board income tax and a value-added tax on all sales and services.

The former usually enjoys a bit more support than the latter but both are subject to sharp debate.

With the budget deficit in the $1 trillion realm and the national debt breaching $14.3 trillion, it is clear something has to be done to clean up the precarious U.S. financial position.

The idea of a flat tax has been floating around for decades and gained some traction in the 1980s and 1990s as tax rates on the rich were slashed dramatically.

During the Reagan administration, high-income earners saw their tax rates cut from 70 percent to 31 percent. Currently the top personal income tax rate is 35 percent with President Barack Obama pushing to end tax cuts for those in high-income brackets. Historically, the rate has gone as high as 90 percent -- that during World War II.

Most of the argument against a flat tax has centered on the impact on the poor: A 10 percent tax on someone earning $40,000 is more onerous than a 10 percent tax on someone earning $250,000 -- something former Rep. Dick Armey, R-Texas, has said could be addressed by shielding the amount and size of some household income.

The Economist has argued a flat tax would eliminate what is perceived as unfair treatment for corporations, eliminating all so-called "corporate welfare."

Among the advocates of the flat tax are Steve Forbes, who proposed a 17 percent rate during the 1996 and 2000 presidential campaigns that would have defined taxable income as income minus savings, beginning at $42,000 for a family of four.

Proponents say a flat tax would increase revenues because it would encourage more people to comply with the tax code. They point in part to Russia where personal income tax revenue rose 25.2 percent in the first year of a flat tax, 24.6 percent in the second year and 15.2 percent in the third, according to Wikipedia. However, a 2006 IMF study discounted the results.

Among the other countries with flat tax rates are the Baltic states -- Estonia, Latvia and Lithuania -- Ukraine, Slovakia, Romania, Macedonia and Albania. In the United States, a number of states have flat tax rates, including Pennsylvania, which has no zero-bracket.

The issue becomes even more complicated when addressing a value-added tax.

Richard Kaplan, a law professor at the University of Illinois at Urbana-Champaign, said though academics like the idea and such taxes already are in use in Europe and elsewhere, U.S. politicians tend to shy away. Both the Reagan and Bush administrations examined the idea but rejected it even though people prefer a stealth tax to one that presents them with a bill on April 15.

"Taxing consumption appeals to folks with a strong savings propensity," Kaplan said in an interview with the U of I News Bureau. "More broadly, some policymakers believe that society benefits when personal savings are increased, so they prefer a tax system that rewards this behavior instead of an income tax, which tends to penalize savers.

"Furthermore, countries that have a VAT have found that it has been a very effective way of raising revenue without upsetting the populace so much because it is less obvious. The VAT is not like a sales tax, which hits you in the face each time you buy something. Instead, a VAT is embedded in the price of a good or service."

The problem comes with implementation.

"For example, a VAT would have a huge impact on older Americans who typically spend a lot of money on medical services. Should such purchases be exempt? If so, what about college tuition that younger families typically pay? Or for that matter, what about home purchases?"

And politicians still tend to dole out exemptions.

"The point here is that a VAT is not a path out of the tax complexity maze; it is just a different maze. And as long as it is Congress that is writing the VAT, which the Constitution requires, then there will be special exemptions and rate reductions, and that is really what complicates the tax law," he said.

© 2011 United Press International, Inc. All Rights Reserved. Any reproduction, republication, redistribution and/or modification of any UPI content is expressly prohibited without UPI's prior written consent.
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