Breaking the code: neither a flat tax nor a sales tax will happen. here's how Republicans could get serious

Ramesh Ponnuru

Mr. Ponnuru is NR's national reporter.

CONSERVATIVES have reached an impasse on tax policy. Congressional Republicans have not attempted to repeal the tax increases of 1990 and 1993, nor even seriously challenged the conventional wisdom that attributes the Clinton "boom" to those increases. The income-tax system produced by the 1986 tax-reform, with its top rate of 28 per cent, is a distant memory.

The tried-and-true formula of across-the-board reductions in tax rates -- implemented by Reagan in 1981 with the Kemp - Roth bill and, on a smaller stage and in less purist fashion, Christine Todd Whitman in 1994 -- seems, for the time being anyway, to be a political non-starter, tainted by its association with the Dole campaign.

Many conservatives seem to have concluded from the failure of Reagan's tax-rate cuts to endure that sweeping tax reform must come before tax cuts. In addition, they believe they can harness populist anger against the complexity and unfairness of the tax code to achieve supply-side goals. These goals include, in order of importance: ending the double taxation of savings and investment; replacing the progressive tax-rate structure with one rate; and trading the tax code's panoply of deductions, credits, and other breaks for lower marginal tax rates. Reformers also want to cut average tax rates, both as an end in itself and to build popular support.

But the cause of sweeping tax reform is stalled, and neither the Democrats' control of the White House nor the Republicans' tenuous control of the House nor the attacks on Steve Forbes from other Republicans in 1996 nor even the divisions among reformers themselves fully explain why. Plenty of Republicans, and not just moderate-to-liberal ones, worry that a flat tax or a national sales tax could be a political disaster.

The chief substantive problem with both proposals is that they would expand the constituency for liberalism. A national sales tax would spread individuals' tax burden over so many transactions that they would cease to register the burden. And the flat taxes offered by Steve Forbes and Dick Armey would take millions of voters off the income-tax rolls through generous exemptions, thus expanding the ranks of people who can vote for big government at no obvious cost to themselves. This feature of the flat tax is designed, of course, to defuse the "fairness issue."

It won't. For eight years -- ever since then-Senate Majority Leader George Mitchell single-handedly sank President Bush's proposed capital-gains tax cut -- tax "fairness" has spooked Republicans. Ever since Republicans took control of Congress they have made tax policy with nervous glances toward the tax-distribution tables. Hence the income ceilings on the child tax credit and IRA expansion that Congress passed last year. But if they won't take the fairness issue head-on, they're hardly going to eliminate the progressive rate structure entirely.

The tax reformers ignore such political obstacles because, fundamentally, their project is anti-political. In their heart of hearts, reformers would like to have a bunch of free-market economists sit around a table, design the ideal tax code, and ram it through the political system. That's why most of them refuse to work with Rep. Dick Gephardt (D., Mo.), even though most of the provisions of his reform plan move in the right direction. At a meeting in 1996, after a senator had proposed a compromise, one grim activist exclaimed, "Our goal should be perfection!" But that's not the way the system works, or should work.

Political realities have forced reformers to wise up of late. But even the most sophisticated strategies for reform depend on Republicans winning the Presidency, a filibuster-proof majority in the Senate, and a large margin in the House. Then they'll be able to ram something through. Until then, the thinking goes, Republicans should enact some small tax cuts -- repeal the estate tax, end the marriage penalty -- but mainly avoid mucking up the tax code. Meanwhile, reformers will take their case to the American people.

This isn't a strategy, it's a fantasy. Neither the small tax cuts nor the proselytizing is likely to yield the requisite Republican realignment. And with a consolidated majority, Republicans might be even more averse to risk than now. Politicians can gloss over difficult details on the stump. But actual legislation would pit the abstract goal of tax simplification against voters' concrete interest in various deductions. Republicans did something similar in 1995, pitting the abstract goal of a balanced budget against voters' concrete interest in Medicare benefits. They do not seem eager for a reprise.

AS A result of the conflicting pressures from reform activists and the realities of the political system, Republican tax policy has oscillated wildly between interest-group pandering and pure abstraction. The flat tax could become what the commitment to a Balanced Budget Amendment was for years: boilerplate that Republicans insert in their speeches without ever delivering; or, worse, an excuse for not enacting achievable cuts. In 1996, some conservative senators proposed making the GOP's tax cuts temporary; after all, we would have systematic reform in a few years. In 1997, the prospect of future reform became a reason not to worry about making the code worse in the meantime.

The American people deserve tax cuts now. In their absence, the economy is performing below its potential. And a disproportionate amount of economic growth is going into bigger government. This phenomenon is an inevitable feature of a conventional progressive rate structure: as incomes rise, more people move into higher tax brackets. Supply-siders Lawrence Kudlow and Stephen Moore have dubbed the phenomenon "real-income bracket creep." Bill Clinton is using it, along with tax refunds and targeted tax breaks, to build a majority willing to raise other people's taxes -- the same result into which flat-taxers might stumble.

There is a way out. Republicans can push -- now, in 1998 -- for tax cuts that advance the goal of tax reform and build the constituency for further reform, while avoiding the political traps outlined above. Those tax cuts would be designed to exploit and accelerate the most important favorable trend in political demographics: the development of the first large class of worker-stockholders in history (see "Stock Populi"). So, for instance, Congress could enact a massive expansion of IRAs, as proposed by Joint Economic Committee chairman Jim Saxton (R., N.J.), raising contribution limits and easing restrictions on the permissable uses of accumulated balances. Even better, they could create Individual Investment Accounts (IIAs) with no limits or restrictions. (Sen. John Breaux [D., La.] and Rep. Jim McCrery [R., La.] have introduced a bill.) But almost any policy that expanded investment options, or encouraged their use, would serve the purpose.

This option has at least seven political advantages.

1. It would accelerate the growth of the investing class. It stands to reason that people who invest more in the markets will have more free-market proclivities in general. They will certainly be less dependent on the state, and particularly on Social Security. And they will be more amenable to reforms of that program or of the tax code. Indeed, they are likely to demand them.

2. It provides what tax reform has so far lacked: a plausible incremental strategy. If full-scale tax reform is for economic conservatives what the Human Life Amendment has been for social conservatives, expanded IRAs are the equivalent of a ban on partial-birth abortions: an attainable first step that lays the groundwork for further progress. Congress could let IRAs be used to finance not just retirement but also emergency medical care, education, home purchases, etc. -- eliminating the multiple taxation of savings for most of the purposes for which people actually save. IIAs would totally eliminate such multiple taxation. Either expanded IRAs or IIAs would significantly flatten tax rates: the rich save more, and the progressive system would have less reach.

3. IIAs can themselves be achieved incrementally. If conservatives don't get everything they want, they can come back for more later. Every year they can raise the contribution limits further. Every year they can expand the purposes for which tax-free saving is allowed.

4. The IIA option gives Republicans a conservative social policy as an alternative to Bill Clinton's, and a conservative labor policy superior to Pat Buchanan's or Dick Gephardt's. Clinton wants to help families pay for health care or college? Fine. Let's make saving for those purposes tax-free. That wouldn't set back reform like the typical Republican alternative, selective tax credits. And instead of restricting trade, immigration, and freedom of contract, the IIA option would expand the benefits available to workers in a free market. Not bad for a party founded on the principles of free men and free labor.

5. It would close the rift over tax policy between economic and social conservatives. The arguments between the two sides over per-child tax credits have flown back and forth for more than three years with no end in sight. Here's a policy that supply-siders should like and that offers more to social conservatives than any tax credit. Some proponents of the child credit, such as Sen. Dan Coats (R., Ind.) and anti-tax activist Grover Norquist, regarded it as a back-door way to school choice. Why not explicitly exempt savings for parochial schools -- and private schools, and home schools -- from taxation?

6. IIAs can accommodate Washington's superstitions about debt. Republicans have shied away from tax cuts because of their alleged short-term revenue effects. Luckily, IIAs can be "front-loaded" so that the deposit is taxed but not the withdrawal. That way, any projected revenue "loss" can be deferred into the future, which is Never-Neverland so far as Washington is concerned.

7. It would not create a large class of people with unwholesome enthusiasms for progressive taxation.

The chief political disadvantage of the IIA option is that it would, indeed, be "regressive." As noted earlier, the rich save more. But nobody outside Washington or New York really cares about regressivity per se -- so long as the rich are still seen to pay a higher rate and nobody less affluent faces a tax increase.

And the regressivity could be offset by pairing any IRA expansion with a proposal that directly addresses "real-income bracket creep." Right now the 28 per cent tax rate kicks in at $23,500 for singles and $42,350 for couples; why not expand the 15 per cent bracket to include singles making up to $35,000 and couples making up to $70,000? Sen. Paul Coverdell (R., Ga.) and Reps. John Thune (R., S.D.) and Jennifer Dunn (R., Wash.) are championing this proposal, first floated by Kudlow and Moore in NR ("Raise the Roof," Jan. 26). It would be a progressive and pro-growth tax cut. It would eliminate the "marriage penalty" for millions of households without penalizing homemakers or making the tax code more complex (as some proposed fixes would). And it would benefit more than 29 million taxpayers, many of them Reagan Democrats whom the GOP has lost in the last two presidential elections.

Successful political movements create the conditions for their own success. Tax reformers can't do that with their existing strategy. To change course now is not to abandon principle; it is to take principle so seriously as to plot how to put it into practice. If tax reformers don't, they have only years of wasted effort ahead of them.

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