(Bloomberg News) Texas Governor Rick Perry's 20 percent flat-tax plan avoids one the pitfalls of similar single-rate proposals by protecting any filers from a guaranteed tax increase. In the process, it retains some tax complexity and ensures federal revenue collections will fall.
The Republican presidential candidate's plan would create a $12,500 per-person exemption with only a few other deductions, offering a boon to high-income taxpayers who would face lower rates and no longer pay taxes on investment income. People could choose that regime or continue to file under the current code.
Perry's tax plan is part of his broader "cut, balance and grow" economic proposal that calls for balancing the U.S. budget by 2020 and capping spending at 18 percent of the gross domestic product, down from 24.1 percent for 2011. In a speech yesterday in South Carolina, Perry called for shrinking entitlement programs such as Medicare and Medicaid and adopting a balanced budget amendment to the Constitution.
"It's very aggressive," said Pete Sepp, executive vice president of the National Taxpayers Union, a small-government group in Washington. "The fact that Perry has come out forcefully for a balanced budget amendment as well as an 18 percent of GDP spending cap is a good sign."
Perry's 18 percent and balanced budget targets would require him to cut government spending by far more than the plan drafted by Representative Paul Ryan and passed by the House in April, which would delay reaching balance until 2040.
Tax, Program Cuts
Saving money from Medicare or Social Security between now and 2020 would likely require affecting current retirees or people who are going to enter the programs soon as the retirement of the baby-boom generation places additional strain on the programs. Democrats have been campaigning against the Ryan plan, which delayed changing Medicare into a voucher-based system until the next decade.
In 2020, the year in which Perry wants to balance the federal budget, the Ryan budget would have a deficit of $405 billion. Perry made his budget-balancing task even bigger by arguing yesterday against "arbitrary cuts" to defense spending and saying that the defense budget should be based on what it costs to keep the country secure.
Further, it would be even more difficult to reach a balanced budget under Perry's plan than in Ryan's because Perry's proposed tax cuts are deeper. Ryan's House-passed budget called for top rates of 25 percent for individuals and corporations and wouldn't eliminate taxes on capital gains and dividends, as Perry's simplified plan does.
Perry, who has been lagging in the polls of the Republican race, said his plan would simplify tax filing, reduce tax compliance costs and unleash economic growth.
"It's important to get our taxes under control and have a tax system that is fair, that is simple, that is flat," he said at a news conference in Columbia, South Carolina. "I mean, how many people in America would rather have the old tax system in place and the lawyers and the accountants and the costs?"
Perry's proposal deviates from the flat-tax regime embraced by his advisor, the publisher and former presidential candidate Steve Forbes. Like the Forbes plan, Perry offers a single rate, eliminates taxes on investment income and provides exemptions for low-income taxpayers.
Flat-Tax Twist
Still, Perry is proposing a few twists on the flat-tax concept. By giving taxpayers a choice between systems, he avoids the kinds of tax increases for lower-income people that have led to criticism of rival Herman Cain's 9-9-9 plan for 9 percent income, business and sales taxes.
In the simpler system Perry proposes, he would retain tax breaks for mortgage interest, charitable contributions and state and local taxes for people earning less than $500,000 a year. He also would end taxation of Social Security benefits.
"He's just taken the fear out of tax reform," said Grover Norquist, president of Americans for Tax Reform, a small- government group in Washington.
Such efforts usually involve politicians making changes that leave taxpayers fearing that they will get hurt, he said.
Other Republican Plans
Other Republicans, including Ryan and presidential candidate Newt Gingrich, have offered optional tax system proposals.
Ryan's plan wouldn't allow taxpayers to make an annual choice between the systems. Instead, his proposal would require individuals to choose the current system or a simpler system within 10 years and then switch only once in their lifetimes or upon a major event such as marriage or divorce.
Perry's description of his plan doesn't say how taxpayers would choose between the systems or whether they could reverse their decisions. Campaign spokesman Mark Miner didn't return an e-mail yesterday requesting an answer.
Allowing annual choices wouldn't make the system much simpler, because taxpayers would have to calculate their liabilities both ways. Preventing taxpayers from switching tax systems could lock them into a less preferable option if their personal finances change.
The mechanics of the choice are an important detail that will determine the revenue estimate and economic effects of the proposal, said Douglas Holtz-Eakin, a former director of the Congressional Budget Office who advised Republican presidential candidate John McCain in 2008.
"If you let people go back and forth, you give up a lot of those efficiency gains," he said.
Choice Of Systems
Under the choice offered by Perry, taxpayers will gravitate to the system that gives them the most benefits, Norquist said. Perry's proposal doesn't punish people who have organized their financial lives around tax breaks such as the mortgage interest deduction or the earned income tax credit, he said.
"It just strikes me as political pandering at its worst," said Leonard Burman, a former Treasury Department official who now teaches at Syracuse University in New York. "It doesn't seem like a serious policy proposal."
Low-income taxpayers, who benefit from refundable tax credits for work and children that generate benefits in excess of their tax liability, might prefer the existing system. So would many middle-income taxpayers. The current top marginal rate doesn't exceed 15 percent until taxable income reaches $34,500 a year for individuals and $69,000 for married couples.
Perry, who has described himself as "dismayed at the injustice" that nearly half of households don't pay federal income taxes, wouldn't change that percentage with his plan, Burman said.
"He may still be dismayed, but he's not going to raise their taxes, because he wants them to vote for him," Burman said.
Wealthy Benefit
Wealthy taxpayers, attracted by the lower rate and the elimination of taxes on capital gains, dividends and estates, likely would migrate to the new system. The top rate on wage income is now 35 percent, and the top tax rate on most long-term capital gains in 15 percent.
Former Massachusetts Governor Mitt Romney, who polls show is vying with Cain for frontrunner status in the nomination contest, wants to extend expiring income tax cuts, eliminate the estate tax and get rid of taxes on investment income for people making less than $200,000. Romney's plan also would cut the corporate tax rate to 25 percent from 35 percent.
Perry's plan would cut the corporate tax rate to 20 percent and eliminate corporate breaks. He would allow multinational companies to repatriate profits earned overseas at a 5.25 percent rate and would set up a territorial tax system that essentially ends U.S. taxation of profits earned outside the country.
Companies such as Google Inc. and Cisco Systems Inc. have been urging Congress to enact a repatriation holiday, which would cost the government $78.7 billion in forgone revenue. A larger group of U.S.-based multinational corporations is lobbying for a territorial tax system.
Norquist said Perry's 18 percent goal would improve on the record of the George W. Bush administration, which cut taxes and not spending.
"There was no North Star for what they were trying to do," Norquist said. "This tells you what the goal is, what we're trying to do. It's huge. Just thinking that way changes the world."