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Explainer: The Perry Plan Flat Tax

Thursday, October 27, 2011

Republican presidential nomination hopeful Rick Perry isn’t counting himself out of the race yet. Despite slipping steeply in the polls, the Texas governor is back with a new approach, and it involves reforming America’s ridiculously complicated federal tax policy. Perry has been coy with some of the intricacies, and so far independent tax analysts haven’t been able to gather enough details about Perry’s plan to rate it. But for now, here is what we know so far about Rick Perry's flat tax:

The appeal of his plan is evident. Taxes you could file on a postcard! One simple rate for all! Only four deductions! Perry's plan sounds attractive, and does simplify some areas, though a closer inspection reveals several hidden complications.

Progressive? Regressive?

A flat tax can be a progressive tax, but only if the lower income tiers were exempted from paying. Under a ten percent flat tax, as long as you exempt, say, the first 20,000 of income, the percentage of a person’s total income that was paid as taxes, would increase as that person’s total income increased.  Under the Perry plan, there is a standard $12,500 deduction per person and dependent, regardless of income.

The question, though, is what gets designated as income under the tax? Is income just the money earned at a job, or does it include things like investments, capital gains, and inheritances? Alec Gershberg, Associate Professor or Urban Policy at the New School, said this is an important question in evaluating the fairness of a tax.  “If under any kind of comprehensive definition of income we do a better job of measuring poor and middle class income than we do of rich people’s income, than the tax would actually turn out to regressive.” That’s true of any tax plan, not just Perry’s.

The Money-Maker

By Perry’s own estimation, under his flat tax total federal revenues would average 18% of GDP, "the 50-year average for federal tax receipts." While it's true that 18 percent is the 50-year average; it’s unclear how that revenue is possible, and Perry doesn't show his math.

To the contrary, it seems certain that tax revenue would decrease, because Perry allows for the opt-out provision if taxpayers prefer the old tax code. Unless tax-payers deliberately chose to pay the higher amount, it makes sense that most (if not all) payers would choose the payment plan that costs them less, reducing the overall revenue.

About that opt-out business.

Perry's plan would be optional. Taxpayers could opt to pay the 20 percent flat tax, or to filed under the current tax bracket. That option gives Gershberg a problem with Perry’s claim that the tax will also reduce “up to $483 billion a year” in compliance costs. “The whole idea is you're supposed to make it simple, and the current system is anything but simple. You're really requiring a good large swath of taxpayers to do even more calculations and even more work on compliance than they currently do to figure out which system they want to pay under.”

Speaking of calculations...

As part of the streamlining of income taxes, Perry eliminates all deductions and credits—except for Mortgage Interest, Charity, State/Local Taxes, and Capital Gains and Dividends. That’s good news if you are a tax preparer (or maybe not—will you lose your job?), but bad news if you have medical expenses, or you don’t own your home, or have investments.

Meanwhile the corporate income tax rate would be reduced to 20 percent. Here, Perry seems to agree with supply-side economists in thinking that a lower tax rate would reduce tax evasion, and therefore actually increase tax revenue, as so many more people would pay. Whether that theory is correct or not is an ongoing debate among economists, and as it is empirically difficult to prove, tends to reflect political priorities rather than any sort of science. There is anecdotal evidence from other nations with a flat tax that revenue may indeed increase under the policy, but it is just that: anecdotal. And correlation does not equal causation.

Everyone Agrees on One Thing

Even Cain and Perry agree with each other about one thing: current tax policy is too complicated. Perry's plan needs more clarification, and what we do know now seem more than a little contradictory. But there may be some value in public discussion of even flawed plans. Gershberg thinks the public conversation might be a start toward addressing the countries current tax policy quagmire. "I wouldn't rule out this being a stepping stone to some kind of major tax overhaul that could be good."

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