Advocates of flat tax say it works for states

0 Comments | Insight on the News, Feb 19, 1996 | by Gene Koprowski, | Chi Chi Sileo

The rise of publisher Steve Forbes in Republican presidential-primary polls seems unfathomable to many pundits who castigate his 17 percent federal flat-tax proposal as fiscally irresponsible. Sen. Phil Gramm of Texas, another GOP presidential contender and House Majority Leader Dick Armey also have been received skeptically for similar proposals. Jerry Brown was virtually ridiculed when he broached the subject of a flat-rate income tax during the Democratic presidential primaries in 1992.

But Forbes' grassroots appeal in New Hampshire - staging ground for the first presidential primary on Feb. 20 - might be explained by the fact that the Granite State already has the "ultimate flat tax," in the words of Richard Veder, an economist at Ohio University and adviser to the congressional Joint Economic Committee, or JEC. That is to say, New Hampshire does not have a state income tax. Nor do Florida, Texas, Washington and South Dakota. Other states, including Illinois, Michigan, Indiana, Wisconsin, Massachusetts and Pennsylvania, have marginal income-tax rates of just a few percent.

Voters in these areas already know what impact a flat tax can have, Vedder tells Insight. "States with broad-based [flat] income taxes at relatively low rates do better than states with marginal tax rates that rise significantly with income."

More importantly, people who reside in states with flat rates have seen their incomes rise about 40 percent higher than those who live in states with progressive income taxes, according to Vedder. He claims his new study, conducted for the JEC, shows that flat-tax states can serve as a model for the policy proposals of several presidential contenders.

The study indicates that progressive income taxes have a negative impact because people make economic decisions based upon marginal tax rates. A tax rate on extra income influences the decision of whether to work overtime or invest in a promising business venture, the study says. According to Vedder's calculations, growth in real personal income in states with flat-tax rates was 223 percent from 1962 to 1994, while those with a nonflat rate saw growth of 175 percent.

"Over time, a greater proportion of the nation's output, and the income derived from production, came in states that chose not to increase income-tax rates as individual incomes rose," says Vedder. "Economic vitality was greater in the flat-rate states."

As an example, Vedder compares California with Florida. The Golden State has a steep, progressive tax rate reaching 10 percent, while the Sunshine State does not tax income. But during the last 32 years, Florida has grown economically by 457 percent, while California has grown 192 percent.

"States put themselves in double jeopardy by enacting progressive-rate individual income taxes," says Vedder. "The income tax itself has negative growth effects. But those effects are compounded by the fact that progressivity the rate structure materially worsens the climate for growth in incomes and output."

Several state officials and economists who study state growth rates agree with the findings of the report. Dan Mitchell of the Heritage Foundation, a conservative think tank in Washington, indicates that many states, such as Illinois, Michigan and Massachusetts, have flat taxes written into their constitutions so politicians cannot change the rates at will. "There was a referendum recently in Massachusetts to see if the rates should be changed," recalls Mitchell, "and it was rejected resoundingly."

The income-tax rate in Michigan Engler from 4.6 to 4.4 percent. That's still too high, says William T. Wilson, a fellow at the Mackinac Institute, a free-market think tank in Midland, Mich., and an economist and vice president at Comerica Bank. "There's a big debate here now as to how much credit Engler can take for the economic recovery," Wilson adds.

Forbes has aired commercials in New Hampshire touting his 17 percent flat-tax proposal as a means to replace the bloated federal tax code. (A brochure from his) campaign decries the fact that the tax code is much longer than the Bible.) He would eliminate all deductions, including that for home-mortgage interest. A family of four would pay no tax on its first $36,000 in income.

"These states prove wrong the skeptics and the critics," Forbes notes during an interview with Insight. "If it works for them, why not let it work for the rest of America? By enacting a flat tax, America's best days will be ahead."

Armey also advocates a 17 percent federal flat tax. "The evidence shows that a flat tax leads to more jobs and higher take-home pay," he said in a statement prepared for Insight. "This is another area where Washington could learn from the states."

The flat tax has altered the national debate about income tax in a way not seen since 1913, the year the Internal Revenue Service was created and income taxation began, with only a small portion of the electorate required to pay. Jack Kemp's National Commission on Economic Growth and Tax Reform has embraced the idea of a flat tax, for example, although it has not recommended a specific rate.