Flat and simple, stupid - flat tax

National Review, Feb 26, 1996 by Stephen Moore

The Treasury Department analysis suggesting that the flat tax raises the deficit by $180 billion is unadulterated bunk. The results are based on static revenue analysis -- the assumption that people will behave exactly the same way with or without a flat tax and that the economy will not grow any faster even if tax rates are cut in half. This was the same analytical model that assured us that the 1990 budget deal was going to give us a balanced budget by 1995.

Alan Auerbach, an economist at the University of California at Berkeley, and former head of the Joint Tax Committee under the Democrats, says that a Forbes flat tax would expand economic output by 5.7 per cent in five years. This translates into an economy that produces $520 billion more output, $3,000 higher average family income, and $88 billion more tax revenue than the Treasury assumed.

But how do you enact a flat tax that doesn't raise anyone's taxes and also doesn't increase the deficit? Cut government spending, stupid. If higher economic-growth rates were combined with a cut in federal spending of about 3 per cent, the 17 per cent Forbes flat tax would harm no taxpayer while still not adding a drop of red ink.

"Real-estate depression." The real-estate industry in Washington worships at the altar of the mortgage-interest deduction. The industry has threatened to spend up to $10 million to discredit the flat tax. The disinformation campaign has begun. The National Association of Realtors recently released a flimsy DRI McGraw-Hill econometric "study" suggesting a 10 to 20 per cent decline in the value of homes if the mortgage-interest deduction is taken away.

In fact, the mortgage-interest deduction does not drive real estate -- interest rates and income levels do. That was the experience of the 1980s, when the value of the mortgage deduction fell after the Reagan tax cuts but real estate experienced a boom. A recent study by Federal Reserve Board economist John Golob predicts that a flat tax would lower interest rates by as much as 25 per cent, because the pool of savings would rise. This would mean a decline of 150 to 200 basis points in mortgage-interest rates. The savings from an interest-rate decline this significant on a new home mortgage would more than compensate (by an average of $384 per year) for the loss of the mortgage-interest deduction. Meanwhile, the lower rates would cause a stampede of current home owners rushing to refinance their mortgages.

To put it plainly: there's no economic case whatsoever for preserving the mortgage deduction with a flat tax. Retaining this deduction would merely undercut the integrity of the flat-tax concept. If the real-estate industry is permitted to cut a separate deal with Congress, we're right back having deductions and loopholes auctioned off to the highest bidder. This is a vote for preserving the flat tax's virginity.

"Charitable giving." Hospitals, churches, and museums existed long before 1913. Americans surely don't need an income-tax write-off to be charitable. The great value of low tax rates is that deductions become increasingly irrelevant. At a 16 per cent flat rate, it would hardly be worth the effort to keep the charitable receipts. In the 1980s the top income-tax rate fell from 70 per cent to 28 per cent. But guess what? The 1980s saw the fastest growth in charitable giving in history -- even as the charitable deduction's value fell by 60 per cent. Charitable giving in the United States over the past forty years almost exactly parallels the growth in personal income. Since the flat tax will raise Americans' take-home pay, it will cause a boom in giving.