POLITICS : Gramm to Include Flat Tax in New Economic Proposals

Seeking to identify himself as the rightful heir to the “Reagan revolution,” Texas Sen. Phil Gramm will propose today a 16% flat tax and reductions in federal spending that would reduce the government to its smallest share of the economy since the Korean War.

Gramm’s proposals are embedded in a sweeping economic agenda that also promises to slash government regulation, eliminate the inheritance tax, expand the North American free trade zone throughout South America and begin paying down the national debt.

And Gramm would impose what he calls “a spending pause” after achieving a balanced budget--a fiscal restraint he said could lead to further deep cuts in most federal programs.

Taken together, Gramm’s plan constitutes a dramatic attempt to reestablish himself as the Republican presidential candidate most committed to reducing the size and scope of the federal government--and to seize back the spotlight that publishing magnate Steve Forbes has attracted through his relentless advocacy of the flat tax.

Gramm’s version of the flat tax shares many broad similarities with Forbes’ plan: Forbes, for instance, would tax income at a flat 17% rate, just one percentage point higher than Gramm. But Gramm’s plan sharply contrasts with Forbes’ proposal in ways aimed at making it more attractive to the middle class.

Unlike Forbes’ plan, Gramm would preserve the deductions for mortgage interest and charitable donations--two tax code provisions highly popular with middle-class voters. Also, Gramm’s plan would impose the flat 16% tax rate on income earned from interest, such as bonds and capital gains. Forbes’ plan would exempt from taxation all income from interest or capital gains--a provision critics say would be a boon for wealthy investors.

“I do not believe it is defensible to say that if someone earns their income by laboring, that that income should be subjected to a tax, but if they earn their income by investing capital that income should not be subject to a tax,” Gramm said.

The flat tax is rapidly emerging as the most divisive issue in the GOP presidential race. Recently, several candidates have escalated their criticism of the “purist” flat tax plan that Forbes advocates.

The debate could ratchet up again today with the scheduled release by a commission chaired by former Bush Cabinet member Jack Kemp of a report expected to call for taxing income at a single flat rate (without endorsing a specific plan to do so).

Responding to Gramm’s plan, Forbes said: “I’m delighted that Sen. Gramm has finally seen the light on the flat tax. . . . I hope his conversion is more than poll deep.”

Gramm aides note he had endorsed the flat tax--albeit in general terms--even before Forbes joined the race in September.

The aides also said his plan would have roughly the same revenue effects as the flat-tax plans proposed by Forbes and Rep. Dick Armey (R-Texas), the House majority leader. Armey says his plan would lose about $40 billion annually under conventional economic assumptions; the Treasury Department estimates the plan would lose as much as $138 billion. Flat-tax advocates say such estimates are flawed because they fail to account for the increased economic growth and resulting tax collections they maintain their proposals would spur.

In his speech, Gramm will reaffirm his promise to balance the budget by the end of his first four-year term as president or not seek reelection.

But he breaks new ground in promising to then limit federal spending to the rate of inflation over the next four years after the budget is balanced. At the end of that period, Gramm aides calculate, federal expenditures would equal only about 15% of the gross domestic product--a level one-third lower than today.

Gramm does not specify which programs would be cut to pare back government to that level. But he did say that “no spending would be exempt” from reductions under what he called the “spending pause.”