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The Heritage Foundation offers a new twist on the flat tax

By MARCELLA S. KREITER   |   Dec. 25, 2011 at 4:17 AM   |   Comments

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CHICAGO, Dec. 25 (UPI) -- While most agree the U.S. tax code is needlessly complicated and chock full of loopholes for various pet projects and the wealthy, Washington has done little more than talk about minor tweaks.

Billionaire Warren Buffett brought the system's inequities to the fore this year, noting he was paying a lower effective tax rate than his secretary. Former Republican presidential hopeful Herman Cain created a buzz when he proposed his 9-9-9 tax system -- 9 percent individual income tax, 9 percent national sales tax and 9 percent corporate income tax.

The idea of a flat tax is nothing new. Both Jerry Brown and Steve Forbes proposed their own versions during their presidential runs. In fact, the Reagan and Bush administrations both examined the idea and rejected it.

The conservative Heritage Foundation gave the idea another look recently and concluded a simplified flat tax system would not only ease the burden of complying with the law, it would allow taxpayers to be more confident everyone is paying a fair share and spur economic growth.

"The current tax system discourages saving. It discourages investment. It discourages entrepreneurship," the foundation said in an abstract of its "Saving the American Dream" report.

"It causes decision-makers to misallocate the nation's resources, limiting productivity gains, wage gains and the nation's overall level of international competitiveness. And, it is far, far too complicated. …

"America's federal tax code is complicated beyond imagining. The arrival of personal computers and tax software has permitted the creativity of policymakers in Washington to run amok, creating tax complexities far beyond what even tax professionals could manage unaided by electronics," the report says.

Foundation senior fellow J.D. Foster argues a new flat tax could replace all major taxes collected by the federal government to keep revenue neutral, giving non-seniors one rate, two credits and three deductions and seniors on Medicare, one credit and four deductions, coordinated with Social Security and Medicare reforms.

"The existing tax system is manifestly indefensible, especially in its complexity and its drain on economic vitality," Foster wrote. "The tax system's complexity is inflicted on taxpayers of all walks of life.

"Low-income citizens must navigate the enormously complex earned income credit. Those who save must overcome the system's inherent discouragements and sort through a passel of tax rates and regimes for different forms of saving. Businesses investing in new plant[s] and equipment must pay extra to obtain equity capital and must then overcome extra tax hurdles on their investments. The net result is a chaotic tax system and a much smaller economy."

Foster takes a different approach to a flat tax than has been taken in the past. The report notes past proposals dealt only with individual and corporate income taxes. The new proposal also would eliminate the death tax, payroll taxes and all excise taxes not dedicated to a trust fund.

The proposed flat tax, which does not address arguments over progressive rates, would set the level of federal tax receipts to the historical average of 18.5 percent of gross domestic product.

Foster suggests a 28 percent tax rate on wages, salaries and related benefits (compared with the current average of 30.3 to 35.3 percent), minus all net savings. Savings would be taxed only after being spent.

Taxes would further be reduced by two non-refundable credits: $3,500 ($2,000 for singles) for health insurance and the earned income credit for low-wage workers.

"These are the only features of the New Flat Tax that intentionally violate economic neutrality," Foster said.

The three available deductions would be for charity, higher education expenses and home mortgage interest.

On the business side, the tax on sales of domestic goods and services would be replaced with deductions for labor and business costs, including capital purchases.

"After a brief transition period, all business activity, including corporate, will be taxed at the same low rate that applies to individuals," Foster said.

Seniors would get a standard deduction based on their Social Security benefit and Medicare contribution. To encourage seniors to stay in the workforce, the first $10,000 of wages and salary would be excluded from taxation.

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