Something remarkable has consumed the field of Republican presidential hopefuls. The “flat tax,” once the province of a few obscure economic scribblers (like me) and an occasional no-hope presidential wannabe (Steve Forbes), has become the hottest topic in town. You can almost hear them staring at the mirror asking, “Mirror, mirror on the way, who has the flattest tax of them all?”
Those of you who are not Republican primary voters shouldn’t dial out this conversation. If some variety of a “flat tax” should ever become law, it could affect everyone who pays Indiana income taxes. I’ll explain.
Flat taxes come in a variety of flavors, but they all contain two common elements.
First, they broaden the base by eliminating—or curtailing—some or most deductions, credits and exclusions. These are the infamous “loopholes.”
Everyone hates loopholes. They conjure up visions of midnight deals for a few fat cats, although the really big-bucks deductions are those that most ordinary-folk itemizers wouldn’t consider loopholes, such as mortgage interest and state and local taxes.
Second, in exchange for giving up these goodies, you get a lower single tax rate or, in bastardized versions, lower but mostly graduated rates.
Flat-tax proponents claim that the spider-web complexity of the tax code stifles economic growth, an argument I support. Besides, isn’t there something noxious when over half of federal income tax filers have to pay someone else to figure out how much they owe their government? Compliance costs roughly $400 million per year.
Plus, we have this hideous $10 billion monster called the IRS to collect it. Which would you rather see in your mailbox—a letter from the IRS or a letter from your spouse’s cutthroat divorce attorney?
Here’s where Indiana fits in. A few states have no personal income tax, notably Texas, Florida and New Hampshire. Of the states that have one, most figure the tax on federal taxable income (adjusted gross income minus personal exemptions and standard or itemized deductions).
Indiana has an adjusted gross income tax, which is the bottom line on the front page of your federal Form 1040 before turning the page and taking off personal exemptions and deductions. You start with that, subtract a modest personal exemption, and multiply by a flat 3.4 percent. Simple.
For the hardy minority of us who still do our own taxes, by the time we’re done with the feds, Indiana is like the last out in the bottom of the ninth.
So, here’s your Reader’s Digest version of what the various flat-tax ideas will do to your adjusted gross income tax.
• It will do absolutely nothing to eliminate or curtail deductions for mortgage interest and state and local taxes.
These are taken off after you compute your adjusted gross income tax and don’t affect your Indiana adjusted gross income tax. Fiddling with any deductions hurts taxpayers in states using federal taxable income as the state income tax base. But Indiana uses adjusted gross income.
• If Herman Cain, Newt Gingrich, Jon Huntsman and Rick Perry mean to exclude or curtail dividends and capital gains from adjusted gross income, your adjusted gross income will go down by that amount, and your Indiana tax will go down 3.4 percent of that. Good deal for Hoosiers.
None of these flat-tax ideas are likely to become law in their proposed form. Behind every loophole is a lobbying platoon sworn to protect it.
Behind them is a whole armored division of tax accountants, lawyers and H&R Blocks who make their living keeping the IRS code incomprehensible to mere mortals.
Nonetheless, taxpayers would be unwise to assume a flatter tax can’t happen. Reagan pulled off a flatter-tax deal in 1986.
And we live in turbulent times in which strange things can happen. On Jan. 1, 2008, you could have gotten 100-to-1 in Vegas on a freshman senator named Barack Obama’s winning the presidency.•
Styring is an economist, a former Indiana Chamber of Commerce lobbyist, and a former senior fellow at the Hudson Institute. Send comments on this column to email@example.com.