Flat Tax Proposals and Fundamental Tax Reform: An Overview

Publication Date: May 2006

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Banking and finance

Type:

Abstract:

President George W. Bush has stated that tax reform is one of his top priorities. He appointed a nine-member bipartisan panel to study the federal tax code, and November 1, 2005, this panel proposed two alternatives to reform the code including simplification elements. Consequently, the concept of replacing our current income tax system with a "flat-rate tax" has received renewed congressional interest. Although referred to as "flat-rate taxes," many of the recent proposals go much further than merely adopting a flat-rate tax structure. Some involve significant income tax base broadening whereas others entail changing the tax base from income to consumption.

Proponents of these tax revisions often maintain that they would simplify the tax system, make the government less intrusive, and create an environment more conducive to saving. Critics express concern about the distributional consequences and transitional costs of a dramatic change in the tax system. Most observers believe that the problems and complexities of our current tax system are not primarily related to the number of tax rates but rather stem from difficulties associated with measuring the tax base.

Most of the recent tax reform proposals would change the tax base from income to consumption. One or more of the following four major types of broad-based consumption taxes are included in these congressional tax proposals: the valueadded tax (VAT), the retail sales tax, the consumed-income tax, and the flat tax based on a proposal formulated by Robert E. Hall and Alvin Rabushka of the Hoover Institution. Proposals introduced in the 109th Congress include the Linder proposal (H.R. 25) and the companion bill S. 25 (Chambliss) for a national sales tax; the DeMint proposal (S. 1921) for a combination of a national retail sales tax and a subtraction-method value-added tax; the Specter proposal (S. 812) and Shelby proposal (S. 1099) for a flat tax; and the English proposal (H.R. 4707) for a combination of a consumed-income tax and a subtraction-method VAT. In addition, Representative Fattah proposed (H.R. 1601) that the Treasury conduct a study of the implementation of a transaction fee as a replacement for all existing federal taxes on individuals and corporations.

Other tax reform proposals in the 109th Congress focus on income as the base. The proposals of Senator Wyden (S. 1927) and Representative Emanuel (H.R. 5176 in the 109th Congress) would keep income as the tax base but broaden the base and lower the tax rates. Representative Burgess's proposal (H.R. 1040) would permit each taxpayer to choose between the current individual income tax or an alternative flat tax based on the Hall-Rabushka concept.

This report replaces IB95060 and will be updated as issues develop, new legislation is introduced, or as otherwise warranted.