Mike Hihn, Editor Publisher

Dick Armey's Free Lunch

"I'd love a 60% tax cut. But there's a big difference between real tax policy and election year pandering."

"Granted, the tax code now penalizes investment. But go too far in the other direction and we'll wind up like Japan: a rich country filled with poor people."

UPDATE: As originally published (1994) and included here, I calculated $300 billion in new deficits - versus $200 billion reported by later analysts. What I missed was Armey's treatment of business taxes.

In his original op-ed, Armey states that businesses simply deduct expenses from revenues, then pay the same 17% of what's left. Not quite.

His bill (including the revised version) significantly changes "taxable business income" by EXCLUDING any deduction for employee benefits (like group insurance). Robert Hall, a creator of the flat-tax concept calls Armey's business tax a form of VAT (Value Added Tax). This amounts to a $100 billion tax increase on business (consensus estimate).

(The tax increase could be quite severe for many small businesses which now pay the 15% rate, but with all current deductions.)

In other words, Armey would shift $100 billion in taxes to business, to partially offset those middle-class tax cuts. So Armey's rhetoric may be supply-side, but the reality is New Deal economics.

See ''Sources'' at the end of this page.

Two years ago, Jerry Brown's flat tax created a lot of early interest. Voters were genuinely excited by tax simplification and the idea of postcard-size tax returns. It finally collapsed when Brown's numbers were proven false.

It's election time again. And we see another flat-tax proposal. This one comes from the political right, and has been introduced as a bill in the House (HR4585). The political rhetoric is even better than Brown's. But the numbers are much worse.

Representative Dick Armey (R-Texas) announced his Freedom and Fairness Restoration Act in a Wall Street Journal op-ed piece, on June 16th of this year. More recently, Armey's flat tax was endorsement by George Will's syndicated column.

Both the Journal and Will can spot a misplaced comma in the Clinton Health Plan at 100 yards. But they somehow missed $300 billion in new deficits, per year. Armey never mentions the impact of his tax cuts on revenues. A phone call to his office got the answer that economists haven't finished studying it. 

I'm no economist. (Armey is!) But Armey's plan is quite simple, so we can apply simple math to analyze it. We won't be as exact as a formal budget but close enough to see the consequences: roughly $350 billion in lost revenues, but only $50 billion in real spending cuts.

Armey's bill has much to praise, beyond the tax elements.

  • The President would be required to issue a regulatory budget, exposing the hidden cost of government regulations.
  • Congress would be required to do a cost-benefit analysis on any bill with new regulatory authority.
  • Government would be required to compensate property owners, if regulations cause a significant reduction in a property's value.

There's also a 'sunset' provision on all federal programs, but it's weak, and this is where the bill starts falling apart.

Armey calls his bill a ''shrink the government'' plan. He does mandate ''unbreachable'' spending caps, based on the inflation rate. ''Unbreachable'' is a nifty adjective, but spending caps cap spending - they don't cut a darn thing.

Will's column notes, correctly, that Dick Armey has always opposed the hypocrisy of cutting future budgets and calling it a spending cut. When Congress has budgeted a $10 billion spending increase, then cuts the increase to $8 billion, that's not a spending cut. Not yesterday. ...

But today, for his own bill, Armey uses the same fiction he would have ridiculed in the past. Massive tax cuts would be paid for by slowing the rate of growth in government spending. Look familiar? Armey would do, intentionally, what Ronald Reagan was falsely accused of.

Quoting Armey's op-ed. ''It will guarantee the government will become NO LARGER in real terms than it is today.'' (emphasis added). You tell me: Does ''no larger'' mean smaller? Or does it mean the same size? Do spending caps reduce spending? And how can Armey, only a few paragraphs later, also call his bill a ''shrink-the government'' plan?

There is a first-year freeze in spending, before the inflation-adjusted caps kick in. But total spending is growing less than $100 billion per year, at roughly twice the inflation rate. At the most, that means a $50 billion cut in real spending.

Now let's consider the impact on revenues. I've already done the math. So here's the premise: If every individual and corporation sees their income-tax bill go down by 50% or more, then tax revenues will fall by 50%.

In the Journal, Armey stated a 50% rate cut on corporations. I did find some clinkers in backup material from his office. For now, let's assume a 50% revenue loss here. (It's much more.)

On individual returns, Armey creates a 100% exemption on shareholder dividends, to eliminate the double-tax on corporate profits, and repeals the capital gains tax. He also exempts all interest income, under a bizarre notion that taxing interest is a double-tax on savings. (Savings principle comes from after-tax dollars. But interest is entirely new income.)

Already, something looks wrong. The flat-tax philosophy calls for eliminating exemptions to expand the tax base - then reducing marginal tax rates, while also reducing tax-related distortions in the marketplace. Armey is going in the wrong direction.

Granted, the tax code now penalizes investment. But go too far in the other direction and we'll wind up like Japan: a rich country filled with poor people.

On wages, salaries and pensions, Armey has a flat 17% tax with hefty exemptions. He phases that in. But let's stay with the eventual tax structure, then work backwards. Individuals would get a $13,100 exemption. Single heads of household would get $17,200. A married couple filing jointly would get a $26,200 exemption. There's also a $5,300 exemption per dependent child.

If you're like me, you'd whip out last year's tax return and compare the numbers. If you're a median-income household, with two adults and a child, you'll calculate something like a 60% cut in your tax bill. You may even think, ''This is too good to be true.'' It is too good to be true. Armey never pays for it.

In the table below, I've compared Armey's tax cut at four different income levels for a family of three, where $40,000 is roughly their median income.

Income Current Tax Armey Tax Tax Cut
$31,500 $2,509 -0- 100%
$40,000 $3,776 $1,445 62%
$250,000 $58,429 $37,145 37%
$1,000,000 $321,049 $164,645 49%

Armey's flat tax has drawn fervid support from most conservatives and some libertarians. But feel free to check the comparison above, using your most recent 1040 tax booklet. Or just consider the brief political analysis at the end.

The comparison table shows tax savings of less than 50% on higher incomes. But that's where most of the 100% cut on capital gains, dividends and interest will be found. And tens of millions of households would receive a 100% tax cut.

On that basis, a 50% cut in tax revenues may even be conservative. In dollars, that's at least $350 billion per year, versus only $50 billion in real spending cuts the first year, and no real spending cuts after that.

Now let's consider Armey's phase-in. He'd start with a 20% flat tax and smaller exemptions. From that alone, he says economic growth will permit the full tax cut in the third year. Translation: only if we assume the economy will nearly double in just three years, in real after-inflation dollars.

Don't hold your breath. After Ronald Reagan's 27% income tax cut, real economic growth was only 17%, for the five years (combined) starting in 1984. And that was our biggest postwar boom.

I'd love a 60% tax cut. But there's a big difference between real tax policy and election year pandering. For years, conservatives have assailed Democrats for promising voters a free lunch. Voters seem to be getting the message. So why snatch defeat from the jaws of victory - by intentionally fulfilling the worst claims of liberal Democrats? The numbers are bad. But the political strategy may be even worse. It's like a business plan that looks great on paper, but fails to anticipate any response from the competition.

Remember the 1980s? Liberals kept chanting, in unison, ''Profitable corporations pay no taxes.'' That was demagoguery. But it worked. In 1986, Congress reversed Reagan's accelerated depreciation. And, for good measure, they also repealed the Kennedy-era investment tax credit. In relative terms, our manufacturing base ended the decade in worse shape taxwise than it started.

Under Armey's bill, the depreciation incentive is seven times larger than Reagan's. Most manufacturers would never pay taxes again. In addition to the 50% corporate rate cut, Armey also wants immediate expensing for all purchases of new equipment and structures. These purchases are now depreciated over 7 - 37 years.

Armey writes that his bill will be opposed by ''the Beltway's leftist ideologues.'' But it was the business community, non-manufacturers, that lobbied hardest to kill Reagan's (and Kennedy's) depreciation program.

At the grassroots level, claims of ''tax cuts for the rich'' helped cost Republicans the Senate in 1988 and the White House four years later. I know that. You know that. What does Dick Armey do? He does remove the bottom half of the middle class from the tax rolls, and also removes ... wealthy professional investors!

If I was a liberal Democrat, I'd be salivating. Full tax exemption for wealthy coupon clippers. And even more corporations paying no taxes. I could run all my old campaign ads, untouched. Plus one new ad: ''Now they want another decade of greed!''

Then I'd hug Dick Armey, for postponing the death of American liberalism.


Sources:

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