The Problem with Perry’s Optional Tax

By :: October 26th, 2011

One of the biggest problems with Texas Governor Rick Perry’s optional flat tax may be the choice it gives taxpayers. Perry says you can either pay his new tax or pay under today’s system, whichever results in a lower bill. That sounds great, but it is a policy disaster. This is the tax code we're talking about, not some TV game show.

Perry says he wants a system that is simple. But his option could well make tax filing far more complicated, especially for middle-income households. He says he wants certainty. But the optional tax will create more confusion. He says he wants people to be able to file on a postcard. But his option may require taxpayers to prepare their returns three times.

The option does solve one problem—the regressive nature of any consumption tax. Herman Cain has learned this the hard way as he’s struggled with his 9-9-9 tax. Perry’s semi-consumption tax has a similar problem. And he’s chosen to cure it by telling lower income people that if his plan doesn’t work for them--which it won’t--they can continue to pay under the current system.

This will help blow an even bigger hole in the budget. For Perry, a small government guy, that may be a good thing since it would drive even deeper spending cuts. And, if he can avoid describing what cuts he’d make, it might even be good politics—at least through the primaries.

The trouble is that Perry’s choice creates a tax compliance mess. How much of one depends on a detail he has yet to share: How often will we get to choose which tax to pay? If we can pick each April, filing will be an even bigger headache for most Americans than it is today, although the ability to switch yearly would also make it possible for people to maximize their tax savings. On the other hand, Perry could require you to make the choice only once in your life. That would make filing relatively simple. There’s just one minor downside: The wrong choice could cost you hundreds of thousands of dollars over your lifetime. A third option could allow you to switch every, say, 10 years, or if you have an important lifecycle event.

The choice between the current tax system and the Perry plan will be a no-brainer for the very rich, who would do much better under his system. And it will lbe easy for most low-income working-class families, especially if they have kids. They’d be far happier under a system that preserves refundable credits such as the earned income and child credits than under Perry’s plan.

But for everyone else, picking between the two tax laws will a huge pain in the butt. The only way to get the right answer will be to do your taxes twice. And if you happen to be among the millions at risk for paying the dreaded Alternative Minimum Tax, you’ll have the pleasure of doing your returns three times each year. As my former Tax Policy Center colleague Len Burman says, the Perry choice is something like an Alternative Maximum Tax. At least with Perry’s AMT you get to pay the lowest possible tax instead of the highest.

Making a one-time election would avoid this annual headache, of course. But what a choice. When you first start paying taxes on your own, you’d have to anticipate how many kids you’re going to have, how much money you’re going to make, and whether you’re going to itemize decades in the future (and unless Perry exempts dependent filers from the election, some 3-year-olds would be forced to choose). Guess right, and you can maximize your lifetime tax savings. Guess wrong, and you’ll be an unhappy camper for a lot of years.

Oh, and there is one other question: Which current system do you get to choose from? Does Perry assume the Bush tax cuts are extended indefinitely or do they expire? If the former, the pre-Perry tax code would itself be quite generous. So far, he has not said.

Whatever you think of the rest of Perry’s plan, giving taxpayers a choice about how much tax to pay is just plain dumb. If Perry really wants to make his tax plan progressive, there are far better ways to do it.

4Comments

  1. Michael Bindner  ::  7:25 pm on October 26th, 2011:

    The concept of chosing your complaince plan is not at all unheard of in the anals of tax proposals. Indeed, it is becoming a common talking point. There is little danger Perry will enact this, as he won’t get the crossover votes to beat Romney, although if he is the VP choice to appeal to evangelicals, tragedy could make this a presidential tax plan. The flat tax itself could be fixed with the political process, provided you add exemptions and rebates at the low end, which could be substantial if the House falls back into Democratic hands and Perry must compromise to enact a plan. The worst part of his plan is still that he wants every household to go through the pain of filing, which is simply a boon to tax preparation services, who also make money on refund anticipation loans. Shifting filing responsibilities to employers, which is not hard to do with a flat tax, would make his plan more palatable to most voters and taxpayers, but not to Steve Forbes and the GOP hard core anti-taxers. Compromise might also add a surtax rate at the high end, which a President Perry might accept as the price of passage. Of course, if you change the plan too much, it begins to look like my plan.

  2. Kelly  ::  10:43 am on October 27th, 2011:

    The irony of this plan and this article is that we already perform this choice with the current system. Each year I prepare my taxes using the itemized deductions and standard deductions to see which one benefits me most. Not that much different than his plan. And it is not all that difficult and wouldn’t be that difficult for the millions of Americans who use tax preparation software…plug in the details and it will inform the user of the best plan to use.

    Now, I will be curious how the choice works…is it a year by year choice, or once every 10 years, or perhaps the choice might only exist for say 5 years before fully switching over to the new system. The last option would be my choice for simplicity sake.

    As with all new tax plans…it will never pass anywhere close to its current form, but it makes for some nice talking points, brings tax reform to the forefront of the policy debates, and at least gets something on the table.

  3. Michael Bindner  ::  3:47 pm on October 27th, 2011:

    It would be nice, by the way, if TPC scored my plan.

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