Republicans Wary of Land Mines Surrounding Proposal for Flat Tax

Republicans sensitive to the temptation of ideological hubris now salute each other with a new watchword: avoid Magazinerism. By which they mean it is a good thing to avoid policy initiatives of gargantuan complexity that look brilliant on paper but create more problems than they solve and eventually alienate the public, searing their sponsors in the process.

The most prominent example of Magazinerism, of course, features the man who inspired the word: Ira Magaziner, who with First Lady Hillary Rodham Clinton designed the Clinton administration’s doomed effort to reconstruct the American health care system in a single bound. That was too much change too fast, and the contraption eventually collapsed under its own weight.

Now more and more Republicans are worrying that the conservative dream of a flat tax may mark their own descent into Magazinerism. The flat tax is every bit as ambitious as President Clinton’s health care plan--in a single spasm of reform, it would sweep away virtually the entire tax code.

The leading version of the idea, backed by House Majority Leader Dick Armey (R-Texas) and GOP presidential hopeful Steve Forbes, would replace the progressive income tax with a single flat rate of 17% on corporate income and personal wages. Armey would exempt the first $33,300, Forbes the first $36,000 in earnings for a family of four. All income to individuals from investments--capital gains, interest, dividends--would be free from taxation.

In return, the plans would eliminate virtually all tax deductions--including those for interest on mortgages, charitable contributions and state and local taxes. Businesses could no longer deduct the cost of fringe benefits, such as health insurance, or even their share of payroll taxes.

The flat tax will get a boost early next month when a GOP commission on tax reform, chaired by founding supply-sider Jack Kemp, releases a report that will call for radically simplifying the tax code. But suddenly, a growing number of Republicans is having second thoughts about the flat tax--particularly in the purist forms offered by Armey and Forbes. “It isn’t a viable proposal for the Republican Party to run on,” says conservative economic consultant Jeff Bell, a longtime supply-sider and Kemp ally.

Most important, these anxieties are radiating from those around Senate Majority Leader Bob Dole (R-Kan.), the front-runner for the GOP presidential nomination. The Kemp Commission was the brainchild of Dole and House Speaker Newt Gingrich (R-Ga.). Dole’s aides (who include several former Kemp advisors) dreamed up the commission largely to link Dole with the tax-cutting wing of the party Kemp represents. Conversely, those close to Kemp say he will consider the commission a success to the extent Dole endorses its conclusions.

But as the commission finishes its work, the Dole campaign has increasingly pressured Kemp not to recommend any specific flat tax plan that Democrats could attack. Kemp has heard the message. Friends say that he initially hoped to lay out a new tax system in the report but later realized that his privately funded commission lacked the staff resources to draft anything that specific. The pressure from Dole--reaffirmed at a meeting Thursday between Kemp, Dole and Gingrich--sealed the decision not to detail a precise plan.

Now, Kemp’s final report is likely to indict the existing tax system and affirm a set of broad principles for simplification: among them that all income should be taxed only once and at a single flat rate. But to preserve Dole’s maneuverability, the report will only discuss the pros and cons on some of the most contentious issues--such as whether the home mortgage deduction should be preserved, sources say. Still under negotiation with Dole is whether the report, as Kemp hopes, will identify a specific tax rate (probably around 20%) as ideal.

Dole’s insistence on vagueness reflects the growing anxiety in his camp--and elsewhere in conservative circles--over the potential political risks of a flat tax. “If a serious person, meaning us, ever endorsed a flat tax, Clinton would be nuts to ever talk about anything else,” says one senior Dole advisor.

As the positive response to Forbes’ ad barrage in the first primary states suggests, the flat tax is not without political appeal, especially among GOP primary voters. Under Forbes’ or Armey’s plan, voters could fill out their taxes on a postcard. John McLaughlin, Forbes’ pollster, says that many voters see that simplicity as a means of ensuring everyone pays their fair share. Supply-siders also insist that slashing rates and ending taxes on investment would spur growth.

But critics, and even some supporters, see a more formidable list of problems. Eliminating the mortgage deduction could cause housing values to drop. Ending the deductibility of charitable contributions could squeeze donations even as conservatives seek to transfer more authority for social programs to private charities. If employers could no longer deduct their share of payroll taxes, they would probably seek to cut wages or hold down future raises.

Potentially even more disruptive are the provisions in the Forbes and Armey plans that would prevent employers from deducting fringe benefits (except pension contributions) on their taxes. If employers could no longer deduct the cost of health care, they might report it as income to their employees--forcing workers to pay taxes on its value. Or they might turn over the money they now spend on health care to workers as wages and send them out to buy their own insurance. Almost incidentally, the flat tax could thus undermine the system of employer-provided health insurance on which most Americans now depend. Magazinerism indeed.

All of this merely contributes to the largest potential vulnerability of the pure flat tax plans: They would raise taxes on most Americans while cutting them on the wealthiest. Bell states it flatly: Under “any version [of the Armey or Forbes] plan that is revenue neutral . . . the broad middle class . . . will pay significantly higher taxes.”

The reason is simple. By reducing the top rate from roughly 40% to 17%, and exempting from taxation all income from capital gains and interest--income disproportionately received by the wealthy--the flat tax would significantly reduce taxes on the affluent. The only way to keep it revenue neutral is to raise taxes on everyone else. “That’s the hydraulics of the flat tax proposals,” said Leslie B. Samuels, the Treasury Department’s assistant secretary for tax policy.

In an upcoming analysis, the Treasury Department estimates that Armey’s plan would lose about $130 billion annually. To break even, Treasury calculates the flat tax rate would have to be set around 21%. At that level, the tax burden would rise between 8% and 11% for middle-class families, while falling 26% for those with incomes over $200,000. In the most extreme case, a millionaire living entirely off investments would pay no income tax--while his butler pays 17%.

Not surprisingly, that idea finds few converts: In a private GOP poll earlier this year, 81% of Americans said they would oppose a flat tax that cut taxes on the wealthy while raising it on the middle class.

Faced with such economic and political hurdles, some Republicans are already scrambling for alternatives. Most of the GOP presidential contenders, including Dole, have endorsed a flatter tax in principle.

But Sen. Phil Gramm (R-Texas), Lamar Alexander and Patrick J. Buchanan want to preserve the mortgage and charitable donation deductions while setting a higher flat rate than Armey and Forbes; Buchanan further says he would tax some investment income. Dole hasn’t been that specific.

Kemp shares many of those concerns--he personally supports the mortgage and charitable deductions and wants to maintain some progressivity, friends say. But he’s committed to a single flat rate. Some other influential Republicans aren’t so sure that idea can be salvaged: There’s already quiet talk that the party should instead offer a streamlined two-tiered system that preserves a higher rate on the more affluent. “The basic problem with the flat tax,” acknowledges the senior Dole advisor, “is you just can’t charge a guy who makes $1 million a year the same as a guy who makes $30,000.”

The Washington Outlook column appears here every other Monday.