GOP Hopefuls Square Off Over Flat-Tax Proposal

One of the first serious issue debates of the 1992 U.S. Senate campaigns in California has a peculiar twist.

Wherever conservative Republican Bruce Herschensohn goes to promote his flat-tax plan, his moderate GOP opponent, Rep. Tom Campbell, tries to show up right on his heels--to promote Herschensohn’s flat-tax plan.

Candidates usually follow each other around to denounce their foes’ statements. Campbell wants to make sure every California homeowner and Republican voter knows exactly what Herschensohn is saying.

What Campbell emphasizes, however, is just one isolated section of Herschensohn’s plan--the one that would eliminate the homeowner’s federal income tax deduction for interest paid on mortgages. That is the biggest single tax break for most home-owning Americans.

Campbell hopes to saddle the Herschensohn campaign with the albatross of a threat to the home mortgage deduction--without giving credit for the rest of the plan, which Herschensohn says will make winners of all Americans and the economy.

As economic theory, it is not hard to find experts who like the flat tax. John H. Makin of the conservative-leaning American Enterprise Institute in Washington, D.C., said it makes economic sense.

“That’s the right way to do it,” Makin said of the plan that would set a single tax rate for all personal and corporate income and do away with all deductions, including those for oil companies and banks.

“But he’ll lose the election,” Makin said in reference to any candidate daring enough--or foolish enough--to propose it. Even if the plan eventually would make home ownership more affordable, said Makin and other experts, the mortgage deduction is one of those middle-class sacred cows to be tampered with only at great political risk.

In the latest flare-up, Herschensohn ventured into Campbell’s Stanford-area home turf last Tuesday to pitch what he believes are the flat tax’s key benefits: a single lower tax rate by the end of a 10-year transition period, a leaner federal budget that must be balanced, and an economy unshackled from a web of rules and exceptions that distort economic decisions and inhibit enterprise.

Then along came Campbell to declare that the plan would double the income tax of the average California family and virtually destroy the American dream of home ownership. His campaign manager also crowed about the fact that former California Gov. Edmund (Jerry) Brown Jr. just endorsed the flat tax in his Democratic presidential campaign in New Hampshire.

Herschensohn knows that the Campbell drumbeat is not likely to let up between now and the June 2 primary election.

“That’s fine,” Herschensohn said in an interview later in the week. He is confident he will win GOP support when voters understand the full sweep of his program’s benefits.

The Herschensohn proposal also gets support as attractive economic theory from Henry J. Aaron, a senior fellow in economic studies at the more liberal Brookings Institution. Aaron said there is no reason to believe that the average Californian’s tax bill would double, as Campbell has alleged. The tax probably would not change much, Aaron said.

“There is a lot of appeal (to the flat tax) if you are designing a system afresh,” Aaron said. “But it doesn’t look so good when one takes into account all the details of the transition. This is one of those ideas where the attractions of being there are much greater than the attraction of getting there.”

An author of the flat-tax plan Herschensohn has supported for nearly a decade is Alvin Rabushka, a senior fellow of the Hoover Institution at Stanford University. He said that the transition would be designed so that no homeowner would lose from the elimination of the home mortgage interest deduction.

But even Rabushka acknowledged that the complexities of the plan are difficult to explain, especially how the homeowner would emerge a net winner after the loss of his mortgage deduction. Thirty-second television commercials are much better vehicles for cries of alarm--such as “Save your home!”--than they are for discourses on tax policy.

Independent economists interviewed were not nearly as quick to dismiss the potential advantages of the flat tax as was Campbell, who has a doctorate in economics from the University of Chicago. He is on leave as a professor at Stanford Law School while serving his second term in the U. S. House of Representatives and running for the Senate.

Campbell is locked in a battle with Herschensohn, a conservative Los Angeles radio and television commentator, for the Republican nomination for the six-year Senate seat now held by Democrat Alan Cranston, who is retiring. Campbell defines himself as a “new conservative,” positioning himself as strictly conservative on fiscal matters but moderate to liberal on social issues such as abortion and the environment.

Also in the contest is Palm Springs Mayor Sonny Bono, the former entertainer. Bono has not embraced the flat tax, but has called for lower tax rates and reinstatement of certain tax deductions and credits that, he says, would generate more business activity.

Herschensohn’s plan would replace the current dual-rate system (15% and 28% with some income taxed at 33%) with a single-rate flat tax, which he now says would be 19%.

“As a U. S. senator, I will spark a national debate on my proposal, which I believe will spur economic growth, put more money in the pockets of average Americans and rein in federal spending,” he said last week.

The plan, based on 10 years of study by Rabushka and Robert E. Hall, an economics professor at Stanford and also a fellow at the conservative Hoover Institution, would broaden the tax base by eliminating all deductions. With a broader base, the government can get all the revenue it needs through a single individual and corporate income tax rate that is far lower than the current maximum levy, the authors said.

Herschensohn won the endorsement of Rabushka and Hall during a news conference near Stanford on Tuesday.

Herschensohn barely had finished when Campbell appeared at the same hotel with his own economist, saying: “If we follow Bruce Herschensohn’s proposal and eliminate all deductions and exemptions, including the home mortgage interest deduction, the result would be disastrous. The crash of ’29 would be nothing compared to the crash of ’92.”

Campbell claimed that the federal tax bill of a “typical California family” earning $50,000 would nearly double. But Campbell did not factor in a $15,000 personal exemption designed to exempt low-income families from any taxes and to maintain progressiveness of the tax through middle-income levels. The tax on Campbell’s typical family would have been much lower if it had been calculated correctly.

Campbell later complained that Herschensohn had changed the plan so that it became “a moving target” and difficult to attack.

Herschensohn argued that the tax bill would be lower still because the flat tax would not kick in until the federal budget had been reduced in size and balanced. Each year’s rate would be pegged at the level necessary to finance a balanced budget. The rate would not necessarily increase from year to year even if the cost of government rose, the authors said, because new economic activity would generate more revenue for the government at the same level of taxation.

“Realistically, actually and logically, under a flat tax, people would be better off,” said Makin. “There would be some difficult transition. The way to do it is to phase it in gradually. The economy would be far better off and much more competitive. It would be exactly the right thing to do.”

The Brookings’ Aaron acknowledged the flat tax has appeal, but said that economic stimulus should not be its major justification.

The best argument is that it is “drastically simpler,” he said.

Both Makin and Aaron said the long-term effect of eliminating the deduction is that houses would cost less than they do now, “thereby making them much more affordable to young Americans,” Makin said.

In the interim, however, current homeowners would lose much of the equity in their homes because the prices they paid were inflated to include the mortgage tax benefit, Aaron said.

“There would be enormous turmoil,” Aaron said. “Transitions matter in tax reform. There are real costs involved. There are large windfall losses and gains.”

Aaron concurred with Rabushka that it would be possible to phase out the deduction over a long period so as not to penalize existing homeowners. The Catch-22, Aaron said, is that “the revenue you are counting on to keep the rates low under the flat tax wouldn’t be produced.”

While portraying himself as a conservative on fiscal matters, Campbell said he believes the government should use the tax structure to channel investments and spur capital formation.

Free-market conservatives, led by Milton Friedman of Campbell’s own economics school at Chicago, favor the least government interference in the markets and tax system. Friedman has said the Hall-Rabushka plan would be “a major step forward toward revitalizing the U.S. economy.”

Campbell has proposed a reinstatement of several of the tax reforms of 1986, including the preferential tax treatment of capital gains, the investment tax credit and passive loss rules that had spurred real estate development.