Dueling Tax Plans In the GOP

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TRAVELING IN SOUTH CAROLINA-Gray Court, a tiny town in northwestern South Carolina, is an unlikely place for a presidential candidate to unveil his proposal for overhauling the federal income tax, but Governor Rick Perry of Texas did just that on Tuesday.

Why did Perry announce his tax plan in South Carolina? Because on January 21, 2012, the Palmetto State will hold the second presidential primary, after New Hampshire (where Mitt Romney is expected to win). Perry must come in among the first three in South Carolina in order to stay in the race.

The Republican Party is seeing the battle of the dueling tax plans. Herman Cain, former CEO of Godfather's Pizza, who is also vying for the Republican presidential nomination, is ahead in some of South Carolina's polls. His plan, which he calls 9-9-9, would replace all federal taxes, including the payroll tax, with three single-rate levies of 9 percent, on individual income, corporate income, and sales.

Perry has to do better. He can't appeal to voters by making his taxes lower than 9 percent because that would lose revenue. Instead, Perry has made his tax more appealing by proposing a flat 20 percent levy on all income, with an exemption of $12,500 for each dependent family member, and a 20 percent corporate tax.

William Fowler, who runs Po Boys Food Store in Coosawhatchie, in the southern part of the state, said he was all in favor of a flat tax. "No matter how good my accountant is, I assume Donald Trump has a better one, so he'll end up paying less tax than Po Boys does," he told me. "They could do away with three-quarters of the IRS."

But Fowler liked the Cain tax plan even better. "I'd rather pay 9 percent than 20 percent," he said.

The structure of Perry's flat tax plan is especially appealing to families and adults caring for elderly parents because of the large personal exemptions. A family of four would not pay any federal income tax on the first $50,000 of income.

Cain has said that Americans under the poverty level would not pay tax. The current Department of Health and Human Services poverty line is $11,000 for a single person, $15,000 for a couple, and $22,000 for a family of four.

As well as the larger personal exemption, Perry's biggest difference is no new sales tax, which many Americans see as a worrisome source of new revenue and spending.

Like Cain, Perry would exempt from federal income tax all capital gains and dividends on stock. Unlike Cain, Perry would retain the mortgage interest deduction. Both candidates would keep deductions for charitable contributions. Since the 20 percent rate takes effect after individual exemptions, the tax system retains progressivity. Perry's sample one-page tax form is available at www.rickperry.org.

Under Perry's plan, taxpayers can choose between the existing system and his new flat tax plan. A major characteristic of the new flat tax is that it is optional. Presumably, only those taxpayers who find it saves them money would use it. However, Perry appears to be trying to make it a money-saver for most taxpayers.

The element of choice is important because it is meant to disarm the opposition to a new tax. Previous efforts to simplify the tax code have failed because many taxpayers are attached to their deductions - and because Congress seeks to use tax law to achieve social goals, such as home ownership and helping low-income parents with the earned-income tax credit, a stunningly complex provision.

Perry's tax proposal is similar to the 19 percent flat tax suggested in 1981 by Hoover Institution senior fellows Robert Hall and Alvin Rabushka. House Majority Leader Dick Armey advocated such a one-rate tax in 1995, and Steve Forbes, the publisher, proposed it in his presidential platform in 1996 and 2000. But it never came to a vote on the House or Senate floor.

The flat income tax has had better success in Eastern Europe. Estonia, Latvia, Lithuania, Russia, and Slovakia have all adopted it, in addition to national value-added taxes of around 20 percent.

The corporate tax would decline from 35 percent to 20 percent. Perry would grant a tax holiday-how long is unclear-to repatriated earnings, lowering the rate to 5.25 percent. He would move to a territorial tax system, where companies are just taxed on the income they generate in the United States. Currently, America is one of the few countries to have a worldwide tax system, meaning that companies are taxed on income they earn anywhere in the world.

Cain would get rid of the payroll tax. Perry would keep it, but allow younger workers to put a portion of their payroll tax into private retirement accounts.

How would a family of four earning $100,000 fare under the two plans? Our family, for simplicity, has no charitable contributions and no mortgage.

The family would pay $7,020 in federal tax under the Cain plan (9 percent of $78,000), and $10,000 under the Perry plan (20 percent of $50,000), due to differences in tax rates and personal exemption allowances. On the surface, it seems like the family is $3,000 ahead with the Cain plan.

But under the Cain plan, the family would pay another 9 percent sales tax on expenditures. Say the family saved 5 percent of its income after $7,020 federal income taxes, about average these days, and so spent $88,331. It would pay another $7,949 in federal sales tax, for a total of $14,970. When the sales tax is included, the family is $4,970 better off with the Perry plan than with the Cain plan.

Not so fast, though. The Cain plan gets rid of payroll taxes, about $15,000 on an income of $100,000, whereas the Perry plan does not. So under the Perry plan, our hypothetical family would pay $25,000, compared with $14,970 under the Cain plan. That's an extra $10,000.

If Cain could get rid of the payroll tax as well as keep tax rates to 9 percent, many taxpayers would gain substantially. But he has not said how he will replace the payroll tax revenues or transition to private accounts. Until this is spelled out, the numbers lead to more questions than answers.

Another vital question is how often the Perry plan would allow taxpayers to choose between the current system and the 20 percent flat tax. Annually? Every five years? Every ten years? Despite repeated calls, my efforts on Wednesday to elicit a clarification from the Perry campaign were unsuccessful.

If annual changes were allowed, Perry's flat tax would not necessarily result in less time spent on tax preparation, because every year some people would draw up two tax returns, the current system and the flat tax, and choose the one with the lowest amount of tax.

House Budget Committee Paul Ryan addressed a similar optional flat tax system in his 2010 Roadmap for America. His proposal allowed taxpayers to change only once in a lifetime, except in the case of what Ryan calls "a life-changing event," such as death, divorce, or marriage, when an additional change would be allowed.

With rare permitted changes, the current complicated tax system would be gradually displaced in favor of the flat tax.

Regardless of who is the Republican presidential nominee, the large field of candidates has led to a competition of ideas. Noticeable among these new ideas is tax reform. All Republican candidates recognize that our current tax system is broken and needs change. They are right.

Diana Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is senior fellow and director of Economics21 at the Manhattan Institute. Follow her on Twitter: @FurchtgottRoth.   

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