Sign up for the lastest information from the IBEW!

Dare we say that no one enjoys paying taxes? While most realize that taxes are the burden citizens bear in a democratic society, the perception that the current federal tax code in the United States is unwieldy, needlessly complex, and unfair remains widespread. As a result, numerous proposals have been floated in the U.S. Congress to replace the existing tax system. While nothing will happen before the 1998 elections, it is likely that Congress will take a serious look at a major overhaul of the tax code. It is worth looking at some of the major proposals now, because working people may not like what could emerge from the debate.

The Flat Tax

Representative Richard K. Armey (R-Texas), the Majority Leader in the House of Representatives, has introduced the so-called Freedom and Fairness Restoration Act, a tax-reform measure which, he claims, will revolutionize everything the government does—taxing, spending and regulating—and allow people to keep more of their money. His plan would abolish all current deductions, credits, exclusions and exemptions and the five current tax brackets. The bill would establish a single, 17 percent tax rate spread over a much broader tax base. Armey claims this rate is low enough to give virtually all Americans a major tax cut, yet high enough to meet government revenue needs—needs which will be reduced under this plan.

For individuals, the tax base would consist of all wages, salaries and pensions. From this gross income, a married couple filing jointly could deduct a personal allowance of $26,200; the personal allowance would be $13,100 for singles and $17,200 for a single head of household. Taxpayers could deduct $5,300 for each dependent. Therefore, a family of four would pay no tax on the first $36,800 of income. Armey claims his proposal would exempt half the households from any personal income tax. In addition, he says all taxpayers would file their returns on a postcard, instead of on multiple, often complicated forms.

For businesses, the tax base would comprise total receipts less cash wages and purchases of goods, services and materials used in business, as well as all capital equipment. The 17 percent tax rate would be levied on the remaining balance. Companies, too, would be able to file their tax returns on a postcard-size form.

Armey claims his plan is revenue neutral because the 17 percent rate is phased in—for three years the rate would be 20 percent, then fall to 17 percent—and because the plan calls for caps on government spending, including entitlements. Proponents of Armey’s plan also claim it will stimulate economic growth by removing excessive taxation on capital.

Publisher Malcolm S. (Steve) Forbes, who ran for President in the Republican primaries in 1996 and is expected to run again in 2000, is also a major proponent of the flat tax.

The National Sales Tax

Representative W. J. "Billy" Tauzin (R-La.) would abolish the federal income tax entirely and replace the revenue through a national sales tax of at least 15 percent on most retail goods and services—food, clothes, cars, insurance, medical bills, homes, rent, and bank and brokerage accounts, to name a few items. As the flat tax would, Tauzin’s plan eliminates taxes on interest, dividends, capital gains and inheritances.

Proponents of the sales tax claim people would be able to afford the higher price of goods because they would not be paying federal income tax. Some people extol Tauzin’s plan because it promises, in effect, to wipe out the Internal Revenue Service. States would be collecting the sales tax. Tauzin and his followers also believe this 15 percent sales tax will raise as much revenue as the income tax does now.

What Are the Downsides to These Proposals?

Are these proposals as simple, fair and progressive as their proponents claim?

The flat tax would eliminate taxation of capital income at the individual level, rendering the tax code much less equitable than it is now. Families with the same total income might not pay the same taxes, depending on the source of the income. For example, of families with the same total income, those earning a larger share of income from labor (wages, salaries) will pay higher taxes than families that collect more of their income through interest, dividends and capital gains. And families with different total incomes might pay the same taxes if both families earn the same amount of income through labor. This taxation disparity is referred to as a bias against labor-generated income.

The tax-reformers’ argument that reducing the tax burden on capital will increase savings and investment rates has not been supported by past practice. In the early 1980s, the tax burden on capital was sharply reduced and real rates of return increased; but personal savings and net investment rates declined. Also, from 1977 to 1985 the capital-gains tax rate was cut four times, yet the net investment rate did not increase.

The flat-tax proposal does, however, represent a windfall for the rich. It exempts not only income from future saving and investment, but also income from existing saving and investment, a huge windfall to current investors (most of whom rank in the top 5 percent of income distribution). In addition, the flat tax would not tax capital income derived from the sale of nonfinancial assets, such as real estate or collectibles.

Armey admits his proposal would increase the deficit by $40 billion a year, but he counters that this possibility would act as an incentive to cut spending further. The Treasury Department’s calculations, however, predict a deficit of $160 billion a year, a level that would decimate savings, push up interest rates and lead to higher taxes in the future. To make the proposal revenue neutral, the basic flat-tax rate would need to rise from 17 percent to between 21 percent and 23 percent. This high rate of taxation, combined with no deductions or credits, would levy higher taxes on millions of middle-income families and the working poor—but, again, would lower taxes for wealthy investors.

The Earned Income Tax Credit (EITC) is a wage supplement which helps raise the income of families with a full-time, year-round worker up to the poverty level. For many, their federal income tax burden is negative because they receive a net refund. The Armey proposal would eliminate the EITC, reducing work incentives for low-paid people and thrusting several million families below the poverty level. The large personal exemption would not help the working poor, because their incomes are already too low to require federal income tax. Thus, the flat tax would be a tax increase for those who rely on the EITC. In addition, means-tested programs could be rendered meaningless, since the flat tax considers only labor income for individuals and does not carry forward business income to individuals. Consider: a person who receives a large inheritance and has no labor income could be eligible for food stamps. Or: a retiree with substantial capital income and no pension income would be eligible for government-funded, long-term care under Medicaid.

Finally, one area of deductions eliminated by the flat tax would be employer payments for employee benefits other than pension plan contributions. At a time when a national healthcare program is not even being discussed, this tax-reform plan would push employers who offer health insurance to eliminate such coverage, since the employers cannot take a tax deduction or exclusion for the benefit. And, since taxpayers could not claim a deduction for out-of-pocket medical expenses, they would have to swallow the cost of medical care and suffer its detrimental effect on the rest of their budgets. Other employee benefits which could face the ax include education and training, life insurance and childcare.

Under the Tauzin proposal, on a day-to-day basis, some people would pay more taxes and others would pay less. And, as financial columnist Jane Bryant Quinn has noted, the actual amount paid at the cash register would not be 15 percent, but 17.6 percent. So, in states where you do not now pay sales tax, particularly on food, medicine, doctor bills, rent or mortgages, this proposal will increase your taxes at the consumer level. Your tax bill would also increase to anywhere from 22 percent to 28 percent if you already pay sales taxes.

Tauzin claims sales taxes are easy to collect: Retailers and service providers collect the tax, keep a portion for themselves, and send the rest to the states. The states keep about 1 percent to cover their costs, then send the remainder to Washington, D.C. However, an International Monetary Fund survey of high sales taxes in other countries discovered serious tax dodging when the rate exceeded 10 percent. How much might this proposal eventually cost states and the federal government to enforce compliance?

Tauzin says the proposed sales tax should raise as much money as the income tax does. Economist Daniel Feenberg, however, believes that, since the proposal gives every worker a tax credit (regardless of income), the tax rate would need to be at least 22 percent to cover the revenue loss.

As with other alternative tax proposals, high-income people would enjoy a large decrease in their taxes; and middle-income people would gain or lose depending on their circumstances. But the working poor would suffer higher taxes, since their earned-income-tax rebate would disappear. Also, many companies would withdraw health insurance benefits since they could not write off the cost any longer; and older people preparing to dip into their after-tax savings funds would find themselves taxed a second time.

Serious Questions

The proponents of so-called tax reform have used many tactics to "prove" the practicality of their alternatives and the "need" to abolish the nemesis of all taxpayers: the IRS. But the reformers have not demonstrated that a majority of the American people want such revolutionary tax reform. While it is fair to say that people would welcome tax simplification, it seems very few taxpayers want to abolish the deductions and credits that favor them.

As the tax-reform debate develops, America’s workers need to ask themselves these questions: Given the uncertainties about fairness inherent in the two major tax proposals, would you respect a system which taxes labor income, but allows unearned income to escape taxation? How would either of the alternatives affect state income tax systems, many of which are based on the federal system and its provisions? Considering all levels of taxation (federal, state and local), would these proposals actually lower your total tax bill? And do you want a taxation system that permits the wealthy to escape paying their fair share, while the middle- and lower-income taxpayers foot the bulk of the bill?

Related Articles

Be Careful What You Wish For