The “SMART Tax” Proposal

The economy needs restructuring, and strategic tax reform should be part of the picture.  This is the first presidential race since 1992 to focus on how we might change the way we tax ourselves at the federal level.  Perhaps this is the year that sweeping tax reform receives the attention it deserves.

We have had Herman Cain’s 9-9-9 plan, Rick Perry’s version of the flat tax, and Mitt Romney’s struggle with revealing how he has managed to pay less than 15% in taxes.  In October 2010, Gov. Mitch Daniels’ floated the idea of replacing personal and corporate income taxes with a VAT balanced by a flat tax on personal income; most disappointing, his suggestion of a VAT was roundly criticized with knee-jerk opposition in Republican ranks.

For a short time in 1992, tax reform looked like it might have its day.  Gov. Jerry Brown excited the press with his notion of a VAT and a flat personal income tax.  (This plan was designed by economist Gary Robbins, who this year envisioned the Cain 9-9-9 plan.) Steve Forbes was running on the flat tax.  Sen. Phil Gramm, the only economist in the Senate, also endorsed the flat tax, but wanted unearned and earned income treated equally.  Unfortunately, candidate Bill Clinton dismissed Brown’s VAT as a “double-tax” and “Jerry’s tax,” and it was never fairly vetted, but, today, Bill Clinton endorses a VAT.

Replacing the Corporate Income Tax (CIT) by a VAT will be stimulative (a component in a growth strategy):

(1)       Ends double-taxation of dividends;

(2)       Ends a competitive disadvantage in world trade, as all our trading partners and over 150 countries use the border-adjustable VAT, which is subtracted from exports and added to imports;

(3)       Ends incentive for multi-national corporations to park profit in lower-taxed countries, as the U.S. with zero CIT will be the best place to evidence profits;

(4)       U.S. becomes a stronger magnet for foreign investment;

(5)       As Brookings’ Aaron and Sawhill have suggested, the implementation of a time-certain VAT would speed purchases, i.e., an off-budget stimulus.

Gov. Daniels did not present details to analyze when he made the observation that a VAT plus a progressive VAT “might suit our current situation pretty well.  It also might fit Bill Simon’s line in the late ’70′s that the nation should have a tax system that looks like someone designed it on purpose.”  The attached “SMART Tax” plan is intended to offer what such a solution might really look like.

Working with figures on revenues from OMB, and the breakdown of tax revenues by income brackets from IRS, and VAT revenue projections provided by Urban Institute/Brookings, the following parameters were used to present the plan:

“SMART Tax” Illustration (click here)

1)         Overall plan is revenue neutral;

2)         The VAT replaces the Corporate Income Tax entirely, and, per Brookings, provides protection for the lower income brackets via Earned Income Tax Credits;

(3)       The VAT also covers for the elimination of income taxes for below $50,000 income and reduction of income taxes for income $50,000 and $100,000;

(4)       Progressive income tax brackets;

(5)       Zero tax preferences or deductions to eliminate the corrupting gamesmanship in lobbying for loopholes.