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Flat tax plan poses serious problems for middle class

A recent Associated Press headline indicated that Republican presidential candidate Rudy Giuliani was jeered in Jacksonville, Fla., for refusing to commit to a flat federal income tax. While there are many issues, primarily social, that conservatives rightly disagree with Giuliani on, the flat tax should not be one.

The idea of a flat tax is appealing because of its simplistic nature, but looking beyond its bumper-sticker sloganeering reveals serious problems for middle class taxpayers and tax collection in general. The flat tax proposal is presented to taxpayers as simple to calculate, reducing paperwork, creating more government revenue and being fairer.

The model works off of proposals made by Steve Forbes as a central part of his 1996 Republican presidential primary campaign and more recently in his 2005 tome, "Flat Tax Revolution." To fully understand his tax proposal, it is important to note that Forbes is a conservative in the mode of the 19th century robber barons as opposed to the compassionate conservatives of the later 20th century. The robber barons were akin to Gordon Gecko who, in the movie "Wall Street," famously stated: "Greed, for lack of a better word, is good."

What the Forbes flat tax proposal consists of is a 17 percent tax on personal and corporate income. While it sounds simple, workable and fair, the details reveal something more complicated and harmful. First, businesses would be able to expense all of their investments immediately, carrying forward any losses indefinitely against future taxes. Creating an incentive to carry forward losses forever, rather than the three-year limit that currently applies, will encourage more of the creative accounting that harmed the economy during the Enron era of corruption.

In addition, the Forbes proposal would tax only business income earned in the United States. The outsourcing that has occurred since NAFTA and other "free trade" agreements, which served to decimate the manufacturing base in this country, would pale in comparison to the outsourcing that would happen to take advantage of what, in essence, would be a 0 percent tax rate.

Second, the Forbes flat tax is levied only on payroll income. It eliminates the declaration and payment of taxes on capital gains, dividends and estates and eliminates any taxable deductions. In fact, when writing about the estate tax, Forbes breathlessly declares, "No taxation without respiration!" in spite of the fact that the exemption for estate taxes, which in 2009 is $3.5 million per person or $7 million per couple, is well above the taxable value of most estates.

According to the Tax Policy Center, the estate tax was levied on only 12,600 estates in 2006. Warren Buffet, the second-richest person in the United States, has said of the elimination of the estate tax that, "Without the estate tax, you in effect will have an aristocracy of wealth, which means you pass down the ability to command the resources of the nation based on heredity rather than merit."

It hardly benefits members of the middle class for capital gains and dividend income to be tax exempt when the bulk of their investments earn capital gains and dividends in nontaxable accounts such as an IRA or a 401(k). Elimination of the mortgage deduction for the middle class may have unforeseen consequences on the value of the largest asset of most middle class families -- their homes.

Even the Forbes assumption that a family of four wouldn't pay taxes on the first $46,165 of income is based on the unproven and suspect premise that his plan would generate $56 billion in new taxes over a 10-year period. If this wildly optimistic tax collection goal is not met, the hypothetical family of four will find itself not only paying income taxes, but without the benefit of any tax deductions.

Another suspect premise is that the value of assets in the United States would rise by $6 trillion during this 10-year period.

An interesting sidelight to the flat tax notion is that the bulk of Forbes' income would be untaxed. His wealth, I suspect, comes from the three areas he is so eager to exempt from taxation: the wealth he inherited from his father, dividends and capital gains. In the utopian world of Forbes, what causes him to pay taxes is ignored and what causes the middle class to pay taxes is taxed.

Giuliani is right to reject the flat tax as proposed by Forbes. What Giuliani should do is embrace the following two principles, both of which are dear to the hearts of real conservatives: fairness and cutting spending. Fairness would support a flat tax that taxes all income that flows into a household. No exceptions; no phony arguments that payroll income should be taxed at a higher rate than passive income or inherited income.

Taxing all inflow of income would result in a much lower rate of taxation across all income levels, including the estate tax, which currently can reach as high as 47 percent.

Giuliani also should pledge to reduce federal spending. Our nation cannot continue to have it both ways: wanting tax reduction but also more spending.

He can go a long way in placating conservatives by presenting a fiscal message that lowers tax rates fairly, does not enrich modern-day robber barons and cuts out unnecessary spending. There may not be the perfect conservative candidate at present in the 2008 race for the presidency, but Giuliani can take a large fiscal step in that direction by pledging to fairly reduce taxes and cut spending.

Remy C. Orffeo is chairman of the Town of Orchard Park Conservative Committee and a professor of business administration at Erie Community College.

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