The flat tax is making a comeback. Banished to the political wilderness after Steve Forbes made it the central issue of his losing presidential campaign in 1996, interest is perking up again. One of the Democrats running for president could do himself (or herself) a lot of good by bringing it back.
The immediate cause for renewed interest in the flat tax is an order by Paul Bremer, administrator of the Iraqi Provisional Authority, establishing a 15 percent flat-rate tax in that country. The order was signed on September 19 and takes effect on January 1. A November 2 report in the Washington Post said that Bremer’s action was sparking a new drive among those like Forbes to revive the issue here.
Actually, the Post didn’t quite get the story right. Bremer’s order merely says the following: “The highest individual and corporate tax rates for 2004 and subsequent years shall not exceed 15 percent.” While the intent may have been to have a single 15 percent rate, the order does not preclude progressive rates up to 15 percent. Moreover, because the tax base is not specified, one could easily create effective tax rates well above the statutory maximum by allowing multiple taxation of the same income.
While advocates of the flat tax are, nevertheless, pleased with the Iraqi initiative, they are actually much more excited by what is going on in many former Soviet bloc countries. Estonia established a flat tax in 1994, Latvia in 1995, and Russia in 2001. Earlier this year, Ukraine adopted a flat tax beginning next year, and on October 28 Slovakia became the latest country to do so. China is said to be interested as well.
A key factor driving all of these countries to adopt radical tax simplification and a lowering of rates is tax evasion. They were simply unable to collect sufficient revenue under their formerly complex, high-rate tax systems. In every case, implementation of a flat tax caused collections to rise, as the benefit of evasion was reduced. (If the top rate is 50 percent, failing to report $1 of income saves you 50 cents in taxes. But if the rate is only 13 percent, as it is in Russia, evasion saves you only 13 cents — no longer worth the risk of getting caught for many evaders.)
According to Hoover Institution economist Alvin Rabushka, inflation-adjusted personal income tax revenues in Russia rose 28 percent the first year the flat tax was in effect, and 21 percent the following year. So far this year, real revenues are up about 17 percent. Revenues were flat or falling before the flat tax was imposed. Even the liberal New York Times took notice of the turnaround. A March 23, 2002 report was headlined: “Russia Imposes Flat Tax on Income, and Its Coffers Swell.”
In the U.S., governor-elect Arnold Schwarzenegger of California is said to be looking at some sort of flat tax there, according to an October 30 report in the Los Angeles Times. Economist Arthur Laffer of San Diego, who has been pushing the flat tax for many years, is advising him. Laffer’s principal argument is that progressive income-tax rates cause too much volatility in the state’s revenue collections. Revenues flood the treasury when times are good and crash when times are bad, encouraging excessive spending during the former and painful spending cuts during the latter. A flat tax, Laffer argues, would create more stable revenues over the business cycle.
While the flat tax has historically been a conservative issue, the fact that it has been adopted in several countries ruled by left-leaning parties shows that it cuts across ideological lines. The political experience here reinforces that view.
It is worth remembering that former California governor Jerry Brown ran on a flat tax in the Democratic presidential primaries in 1992, giving his campaign a big boost. According to Gallup, Brown’s support rose steadily as he campaigned on the flat tax, rising from the low single digits to about 25 percent of the Democratic electorate, second only to Bill Clinton. Brown was also able to beat Clinton in primaries in Maine, Colorado, Vermont, Connecticut, Utah, and Nevada. He was the only candidate able to challenge Clinton all the way to the Democratic convention.
I would suggest that Dick Gephardt is probably best positioned to duplicate Brown’s success. He has already staked out a rightward position on Iraq and was a prime mover of tax reform in the 1980s as co-author of the Bradley-Gephardt tax plan. I think he would generate a lot of excitement by endorsing a flat tax — something his campaign desperately needs to challenge Howard Dean — and give him a better shot at the Democratic presidential nomination. It has the added virtue of being good policy.