Order Code IB95060
CRS Issue Brief for Congress
Received through the CRS Web
Flat Tax Proposals and Fundamental Tax
Reform: An Overview
Updated January 10, 2001
James M. Bickley
Government and Finance Division
Congressional Research Service ˜ The Library of Congress

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CONTENTS
SUMMARY
MOST RECENT DEVELOPMENTS
BACKGROUND AND ANALYSIS
The Relationship Between Income and Consumption
What Should Be Taxed?
Types of Broad-Based Consumption Taxes
Value-added Tax
Retail Sales Tax
Consumed-Income Tax
Flat Tax (Hall/Rabushka Concept)
International Comparisons
Other Types of Fundamental Tax Reform
Income Tax Reform: Base Broadening
Option of the Current or an Alternative Income Tax System
Description of Selected Proposals
The Armey Proposal
The Shelby Proposal
The Domenici/Nunn Proposal
The English Proposal
The Specter Proposal
The Tauzin Proposal
The Linder Proposal
The Gephardt Proposal
The Souder Proposal
The Crane Proposal
The Gramm Proposal
The Faircloth Proposal
The Largent/Hutchinson Proposal
The Snowbarger Proposal
The Dorgan Proposal
LEGISLATION
FOR ADDITIONAL READING

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Flat Tax Proposals and Fundamental Tax Reform: An Overview
SUMMARY
The idea of replacing our current income
change the tax base from income to consump-
tax system with a “flat-rate tax” is receiving
tion.
renewed congressional interest. Although
referred to as “flat-rate taxes,” many of the
One or more of four major types of
current proposals go much further than merely
broad-based consumption taxes are included in
adopting a flat rate tax structure. Some in-
these congressional tax proposals: the value-
volve significant income tax base broadening
added tax (VAT), the retail sales tax, the
while others entail changing the tax base from
consumed-income tax, and the flat tax based
income to consumption.
on a proposal formulated by Robert E. Hall
and Alvin Rabushka, two senior fellows schol-
Proponents of these tax revisions are
ars at the Hoover Institution.
often concerned with simplifying the tax sys-
tem, making the government less intrusive, and
Other tax reform proposals focus on
creating an environment more conducive to
income as the base. Representative
saving. Critics are concerned with the distri-
Gephardt’s proposal would keep income as the
butional consequences and transitional costs of
tax base but broaden the base and lower the
a dramatic change in the tax system.
tax rates. Representative Crane’s proposal
would levy a tax on the earned income of each
Most observers believe that the problems
individual as a replacement for the current
and complexities of our current tax system are
individual income tax, corporate income tax,
not primarily related to the number of tax
and estate and gift taxes. Former
rates, but rather stem from difficulties associ-
Representative Snowbarger’s proposal would
ated with measuring the tax base.
permit each taxpayer to choose between the
current individual income tax or an alternative
Most of the recent tax reform proposals
individual tax with a flat rate. Senator
(the Armey, the Shelby, the Domenici/Nunn,
Dorgan’s proposal would allow most taxpay-
the English, the Specter, the Tauzin, the
ers to choose between the current individual
Linder, the Souder, the Gramm, the Faircloth,
tax system and his “shortcut” tax plan under
and the Largent/Hutchinson plans) would
which taxes withheld would equal the
employee’s tax liability.
Congressional Research Service ˜ The Library of Congress

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MOST RECENT DEVELOPMENTS
On January 3, 2001, Representative Phil English introduced H.R. 86, Simplified USA
Tax Act of 2001. This bill would replace the individual income tax, the corporate income
tax, and the estate and gift taxes with a border-adjustable business tax (subtraction-method
VAT) and a progressive consumed-income tax. Individuals could utilize the equivalent of
universal Roth IRAs to encourage savings.
BACKGROUND AND ANALYSIS
Currently, fundamental tax reform is a major congressional issue. Most proposals would
change the tax base from income to consumption.
The Relationship Between Income and Consumption
Although our current tax structure is referred to as an income tax, it actually contains
elements of both an income- and a consumption-based tax. For example, the current tax
system includes in its tax base wages, interest, dividends, and capital gains, all of which are
consistent with an income tax. At the same time, however, the current tax system excludes
some savings, such as pension and Individual Retirement Account contributions, which is
consistent with a tax using a consumption base.
The easiest way to understand the differences between the income and consumption tax
bases is to define and understand the economic concept of income. In its broadest sense,
income is a measure of the command over resources that an individual acquires during a given
time period. Conceptually, there are two options an individual can exercise with regard to
his income: he can consume it or he can save it. This theoretical relationship between
income, consumption, and saving allows a very useful accounting identity to be established;
income, by definition, must equal consumption plus saving. It follows that a tax that has a
measure of comprehensive income applies to both consumption and savings. A consumption
tax, however, applies to income minus saving.
A consumption tax can be levied at the individual level in a form very similar to the
current system. An individual would add up all of his income in the same way as he does now
under the income tax but then would subtract out his net savings (saving minus borrowing).
The result of these calculations would be the consumption base on which tax is assessed.
Equivalently, a consumption tax can also be collected at the retail level in the form of a sales
tax or at each stage of the production process in the form of a value-added tax (VAT).
Regardless of the form or point where a consumption tax is collected, it is ultimately
paid by the individual doing the consuming. It should be noted that consumption, in the
economy as a whole, is smaller than income. Thus, to raise equal amounts of revenue in a
given year, tax rates on a comprehensive consumption base would have to be higher than the
tax rates on a comprehensive income base.
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What Should Be Taxed?
Should the tax base be income or consumption? Is one inherently superior to the other?
How do they stack up in terms of simplicity, fairness, and efficiency — the three standards
by which tax systems are generally assessed? There appears to be insufficient theoretical or
empirical evidence to conclude that a consumption-based tax is inherently superior to an
income-based tax or vice versa.
One issue associated with the choice of a tax base is equity — how the tax burden will
be distributed across income classes and different types of taxpayers. For example, a tax is
“progressive” if its burden rises as incomes rise. While some types of consumption taxes can
be designed to achieve any desired level of progressivity with respect to consumption alone,
their progressivity with respect to income could only be approximated. Also, a consumption
tax would involve a redistribution of the tax burden by age group, with the young and old
generally bearing more of the total burden than those in their prime earning years. And the
transition from an income-based tax to a consumption-based tax would have the potential for
creating windfall gains for some taxpayers and losses for others.
A definitive assessment cannot be made of the effects of taxing consumption on either
economic efficiency or the aggregate level of savings. Although the current tax system’s
distortions of the relative attractiveness of present and future consumption (saving) would be
eliminated, to raise the same amount of tax revenue, a consumption-based tax would require
an increase in marginal tax rates (since consumption is smaller than income). This action, in
turn, would increase the current system’s distortion between the attractiveness of market and
nonmarket activities. The net effect on overall economic efficiency cannot be ascertained
theoretically. In addition, economic theory indicates a consumption tax would not necessarily
produce an increase in saving. The increase in after tax income might reduce saving, while
the increase in the return to saving may increase it; the net result is uncertain.
A positive aspect of a consumption-based tax is the ease with which the individual and
corporate tax systems could be integrated. In addition, the problems introduced by separate
provisions for capital gains, attempts to distinguish between real and nominal income, and
depreciation procedures would essentially be eliminated. It is doubtful, however, that a
consumption-based tax would have much effect on the complexities introduced into the
system to promote specific social and economic goals. Many of the same factors that
influenced the design of the current income tax system would exert the same influences on
the final design of a consumption tax.
Whether one prefers income or consumption, one tax rate or multiple tax rates, the
critical point to remember is that the benefits to be derived from tax revision would result
from defining the tax base more comprehensively than it is under current law. A tax with a
base that is comprehensively defined would prove more equitable and efficient than a tax with
a less comprehensively defined base.
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Types of Broad-Based Consumption Taxes
There are four major types of broad-based consumption taxes that are included in
congressional tax proposals: the value-added tax (VAT), the retail sales tax, the
consumed-income tax, and the flat tax based on a proposal formulated by Robert I. Hall and
Alvin Rabushka, two senior fellows scholars at the Hoover Institution.
Value-added Tax
A value-added tax is a tax, levied at each stage of production, on firms’ value added.
The value added of a firm is the difference between a firm’s sales and a firm’s purchases of
inputs from other firms. The VAT is collected by each firm at every stage of production.
There are three alternative methods of calculating VAT: the credit method, the
subtraction method, and the addition method. Under the credit method, the firm calculates
the VAT to be remitted to the government by a two-step process. First, the firm multiplies
its sales by the tax rate to calculate VAT collected on sales. Second, the firm credits VAT
paid on inputs against VAT collected on sales and remits this difference to the government.
The firm calculates its VAT liability before setting its prices to fully shift the VAT to the
buyer. Under the credit-invoice method, a type of credit method, the firm is required to show
VAT separately on all sales invoices and to calculate the VAT credit on inputs by adding all
VAT shown on purchase invoices.
Under the subtraction method, the firm calculates its value added by subtracting its cost
of taxed inputs from its sales. Next, the firm determines its VAT liability by multiplying its
value added by the VAT rate. Under the addition method, the firm calculates its value added
by adding all payments for untaxed inputs (e.g., wages and profits). Next, the firm multiplies
its value added by the VAT rate to calculate VAT to be remitted to the government.
Retail Sales Tax
In contrast to a VAT, a retail sales tax is a consumption tax levied at only a single stage
of production, the retail stage. The retailer collects a specific percentage markup in the retail
price of a good or service which is then remitted to the tax authorities.
Consumed-Income Tax
Under this consumption tax, taxpayers would keep their assets in an account equivalent
to a current IRA (individual retirement account). Net contributions to this account
(contributions less withdrawals) would be deducted from income to determine the level of
consumed-income. In contrast to a VAT or sales tax, policymakers would have the option
of applying a progressive rate structure to the level of consumed-income. Each individual
would be responsible for calculating his consumed-income and paying his tax obligation.
Flat Tax (Hall/Rabushka Concept)
A flat tax could be levied based on the proposal formulated by Robert E. Hall and Alvin
Rabushka, two senior fellows scholars at the Hoover Institution. Their proposal would have
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two components: a wage tax and a cash-flow tax on businesses. (A wage tax is a tax only on
wages; a cash-flow tax is generally a tax on gross receipts minus all outlays.) It is essentially
a modified VAT, with wages and pensions subtracted from the VAT base and taxed at the
individual level. Under a standard VAT, a firm would not subtract its wage and pension
contributions when calculating its tax base. Under this proposal, some wage income would
not be included in the tax base because of exemptions. But, under a standard VAT, all wage
income would be included in the tax base.
International Comparisons
There are two major distinctions between recent flat tax proposals for the United States,
that would change the tax base from income to consumption, and the current tax systems of
other developed nations. First, although the United States is the only developed nation
without a broad-based consumption tax at the national level, other developed nations adopted
broad-based consumption taxes as adjuncts rather than as replacements for their income-based
taxes. Most of the congressional proposals would replace our current income taxes with
consumption taxes, rather than use consumption taxes as adjuncts to our current income-
based system.
Second, all developed nations with VATs, except Japan, calculate their VATs using the
credit-invoice method. Most of the current U.S. flat tax proposals, which include VAT
components, however, would use the subtraction method of calculation.
Other Types of Fundamental Tax Reform
Two other types of fundamental tax reform are income tax reform and a tax plan that
gives taxpayers a choice of systems.
Income Tax Reform: Base Broadening
Income tax base broadening would involve eliminating most tax preferences, increasing
the standard deduction and personal exemption allowances, and reducing tax rates. House
Minority Leader Gephardt’s proposal is in this category.
Option of the Current or an Alternative Income Tax System
Two proposals would give taxpayers the option of either paying taxes under the current
income tax or paying a flat rate income tax. Former Representative Snowbarger’s proposal
and Senator Dorgan’s proposal are in this category.
Description of Selected Proposals
Fifteen flat tax (or modified flat tax) proposals are receiving the most congressional
attention. Eleven of the proposals (the Armey, the Shelby, the Domenici/Nunn, the English,
the Specter, the Tauzin, the Linder, the Souder, the Gramm, the Faircloth, and the
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Largent/Hutchinson plans) would change the tax base from income to consumption.
Representative Gephardt’s proposal would keep income as the tax base. Representative
Crane’s proposal would levy a tax on the earned income of individuals as a replacement for
our current individual income tax, corporate income tax, and estates and gift taxes. Former
Representative Snowbarger’s proposal would allow each taxpayer to choose between the
current individual income tax return and an alternative individual income tax return with a flat
rate. Senator Dorgan’s proposal would allow most taxpayers to choose between the current
individual tax system and his “shortcut” tax plan under which taxes withheld would equal the
employee’s tax liability. While some of these plans are more detailed than others, none of the
proposals has the level of detail that would be required to make a plan operational. Many
difficult details and transitional considerations have yet to be addressed. Some proposals have
been formulated into bills introduced in the 104th, 105th, 106th, or 107th Congresses. After the
heading of each proposal, bills introduced, if any, are specified by number.
The Armey Proposal
H.R. 1040 in the 106th Congress. The flat tax proposal of House Majority Leader
Armey is modeled after a proposal formulated in 1981 by Robert E. Hall and Alvin Rabushka,
two senior fellows at the Hoover Institution. The Armey flat tax would levy a consumption
tax as a replacement for the individual and corporate income taxes, and the estate and gift
taxes.
This proposal would have two components: a wage tax and a cash-flow tax on
businesses. It is essentially a modified VAT, with wages and pensions subtracted from the
VAT base and taxed at the individual level. (Under a normal VAT, a firm would not subtract
its wage and pension contributions when calculating its tax base.) Under this proposal, some
wage income would not be included in the tax base because of exemptions. But, under a
VAT all wage income would be included in the tax base.
For the first two years, the individual wage tax would be levied at a 19% rate, but in the
third year, when the tax is fully phased in, this rate would decline to 17%. The individual
wage tax would be levied on all wages, salaries, and pensions. In addition, government
employees and employees of nonprofit organizations would have to add to their wage tax
base the imputed value of their fringe benefits.
The individual wage tax would not be levied on Social Security receipts. Thus, the
current partial taxation of Social Security payments to high income households would be
repealed. Social Security contributions would continue to be taxed; that is, they would not
be deductible and would be made out of after tax income. Firms would pay the business tax
on their Social Security contributions. Individuals would pay the wage tax on their Social
Security contributions. The individual wage tax would have no deductions but would have
the following exemptions:
! $23,200 for a married couple filing jointly;
! $14,850 for a single head of household;
! $11,600 for a single person; and
! $5,200 for each dependent.
All exemptions would be indexed for inflation.
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In the first two years, businesses would pay a tax of 19% (declining to 17% in the third
year) on the difference (if positive) between gross revenue and the sum of purchases from
other firms, wage payments, and pension contributions. This business tax would cover
corporations, partnerships, and sole proprietorships. Pension contributions would be
deductible but there would be no deductions for fringe benefits. In addition, state and local
taxes (including income taxes) and payroll taxes would not be deductible.
The Shelby Proposal
S. 1040 in the 106th Congress. Senator Shelby and House Majority Leader Armey
introduced companion bills in the 105th Congress. Senator Shelby has reintroduced his bill
in the 106th Congress, consequently it is very similar to the current proposal of House
Majority Leader Armey. Both proposals would repeal the corporate income tax, the
individual income tax, and the estate and gift taxes; and replace these taxes with a flat rate
consumption of 17%. But the Shelby proposal would have exemption levels slightly lower
and the initial flat tax rate would be 20% declining to 17% after two years.
The Domenici/Nunn Proposal
S. 722 in the 104th Congress. Senator Domenici and former Senator Nunn proposed
that the individual income and the corporate income taxes be replaced with two
consumption-based taxes.
On the business side, the corporate income tax would be replaced by a cash flow
business tax (a subtraction method VAT). The gross tax base (value-added) would equal
gross receipts less purchases from other firms. According to the sponsors, a tax rate of 11%
would be levied on the gross tax base. A tax credit would be allowed for the 7.65%
employers’ share of the payroll tax (commonly called FICA or Social Security Tax).
The individual income tax would be replaced by a tax on consumed income. The tax
base would be gross income less the net addition to savings, personal and dependence
exemptions, a deduction for a family living allowance, and other specified deductions. The
dollar value of each personal exemption would be $2,550 and the family living allowance
would be the following:
! $4,400 for each single filer;
! $7,400 for a joint return; and
! $5,400 for a head of household.
Hence, the amount of gross income exempt from taxation for a family of four would be
$17,600 (a $7,400 family living allowance and four $2,550 exemptions).
The Domenici/Nunn proposal would preserve existing deductions for home mortgage
interest, charitable contributions, and alimony. In addition, this proposal would permit a post
secondary education deduction of up to $2,000 per person for the taxpayer, a spouse, and up
to two dependents (maximum of up to $8,000 per year). All other deductions would be
eliminated including those for state and local taxes.
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For taxable years beginning after 1999, a progressive rate structure (8%, 19%, and 40%)
would be applied to the tax base. There would be a tax credit for the employee’s 7.65%
payroll tax. In addition, low-income individuals would receive an earned income tax credit
similar to the existing earned income credit. The sponsors maintain that this proposal would
be approximately as progressive as the existing individual income tax system. Furthermore,
sponsors claim that this proposal would be revenue neutral.
The English Proposal
H.R. 86 in the 107th Congress. This proposal of Representative English (Simplified
USA Tax) is based on the Domenici-Nunn proposal. The corporate income tax would be
replaced by a cash-flow business tax (a subtraction-method VAT). The gross tax base (value-
added) would equal gross receipts less purchases from other firms. The tentative tax would
be determined by multiplying the value-added by the appropriate tax rate. A tax rate of 8%
would apply to the first $150,000 of a business’s value-added, and a tax rate of 12% would
apply to all of the business’s value-added over $150,000. A business tax rate of 12% would
apply to all imports. A credit for the 7.65% employer-paid OASDHI payroll tax (commonly
called FICA or the Social Security tax) would be subtracted from the tentative tax to calculate
the business’s tax liability for the year.
The individual income tax would be replaced by a tax on consumed-income. An
individual’s tax liability would be calculated by (1) calculating gross income, (2) subtracting
exemptions and deductions, (3) applying a progressive rate structure to the difference, and
(4) subtracting a credit for the 7.65% employer-paid OASDHI payroll tax payments. Gross
income would equal wages and salaries plus interest, dividends, pension receipts, and amounts
received from the sale of stock and other assets. Deduction would be allowed for charitable
contributions, home mortgage interest, and higher education tuition. Deductions would also
be allowed for retirement-oriented 401(k) contributions and IRAs for lower income families.
The Simplified USA Tax eliminates the double taxation of savings by allowing everyone
to contribute after-tax income to a USA Roth IRA which is a universal savings vehicle. After
five years, accumulated principal and earnings on principal can be withdrawn on a tax-free
basis at any time and for any purpose.
The federal estate and gift tax would be repealed.
The Specter Proposal
S. 822 in the 106th Congress. The flat tax proposal of Senator Specter also is modeled
after the Hall-Rabushka proposal and thus is similar to that of Representative Armey. The
Specter flat rate consumption tax would replace the federal individual and corporate income
taxes.
This proposal would have two components: a wage tax and a cash-flow tax on
businesses. It is essentially a modified VAT, with wages and pensions subtracted from the
VAT base and taxed at the individual level.
The individual wage tax would be levied at a 20% rate on all wages, salaries, and
pensions. In addition, government employees and employees of nonprofits would have to add
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to their wage base the imputed value of their fringe benefits. The individual wage tax would
have “standard deductions” that would equal the sum of the “basic standard deduction” and
the “additional standard deduction.”
The “basic standard deduction” would depend on filing status. For tax year 2000, the
basic standard deduction would be the following:
! $17,500 for a joint return;
! $17,500 for a surviving spouse;
! $15,000 for a head of household;
! $10,000 for a married taxpayer filing separately; and
! $10,000 for a single taxpayer.
The “additional standard deduction” would be an amount equal to $5,000 times the
number of dependents of the taxpayer. All deductions would be indexed for inflation.
Individuals would be allowed to deduct up to $2,500 ($1,250 in the case of a married
individual filing a separate return) annually for charitable contributions. Individuals also
would be allowed to deduct “qualified residence interest” on acquisition indebtedness not
exceeding $100,000 ($50,000 in the case of a married individual filing a separate return).
The business tax would be levied at a 20% tax rate on gross revenue less the sum of
purchases from other firms, wage payments, and pension contributions. Purchases from other
firms would include capital goods. If the business’ aggregate deductions exceed gross
revenue, then the excess of aggregate deductions can be carried forward to the next year and
increased by a percentage equal to the 3-month Treasury rate for the last month of the taxable
year.
The Tauzin Proposal
H.R. 2001 in the 106th Congress. This proposal would replace the personal and
corporate income taxes, estate and gift taxes and all non-trust dedicated excise taxes with a
15% national retail sales tax. Each qualified family unit would receive a sales tax rebate
equal to the product of the sales tax rate and the lesser of the poverty level (adjusted for the
number of dependents claimed) or the wage income of the family unit. The rebate amount
would be included in each paycheck for that pay period. Any business required to collect and
remit the sales tax would keep 0.5% of tax receipts to offset compliance costs. Any state
choosing to do so could administer, collect and enforce the sales tax. To qualify as an
“administering state,” a state would have to conform its sales tax base to the federal base. A
super majority vote of two-thirds of both Houses of Congress would be necessary to raise the
sales tax rate or to create any exemptions to the sales tax.
The Linder Proposal
H.R. 2525 in the 106th Congress. This proposal repeals the individual income tax, the
corporate income tax, all payroll taxes, the self-employment tax, and the estate and gift taxes
and levies a 23% national retail sales tax as a replacement. Every family would receive a
rebate of the sales tax on spending up to the federal poverty level (plus an extra amount to
prevent any marriage penalty). The rebate would be paid monthly in advance. It would allow
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a family of four to spend $22,120 annually tax free each year. The 23% national retail sales
would not be levied on exports. The sales tax would be separately stated and charged. Social
Security and Medicare benefits would remain the same with payroll tax revenue replaced by
some of the revenue from the retail sales tax. States could elect to collect the national retail
sales tax on behalf of the federal government in exchange for a fee. Taxpayers rights
provisions are incorporated into the act.

The Gephardt Proposal
H.R. 3620 in the 105th Congress. House Minority Leader Gephardt’s calls his proposal
the “10% tax.” Unlike most proposals, this proposal would reform the current income tax
base rather than changing to a consumption base. The taxable income base for individuals
under this proposal includes all items of income currently taxed (salaries and wages,
investment income, capital gains, business profit or loss, etc.) plus employee fringe benefits
(other than health insurance), employer pension plan contribution, and tax-exempt state and
local interest. Social Security benefits would be included to the same limited extent as they
are under current law. Deductions from gross income (called “above-the-line” deductions,
as distinct from the itemized deductions taken from adjusted gross income) would be allowed
for alimony paid, one-half of the self-employment tax, investment interest, and job-related
expenses. The only itemized deduction allowed would be home mortgage interest. Since
pension contributions would be make taxable, an exclusion would be allowed from pension
income for the previously taxed contributions, the way annuities are taxed under current law.
Accumulated earnings under pension plans, IRAs, and life insurance policies would remain
tax-deferred, as under current law. The only credits allowed would be the earned income tax
credit (EITC) and the foreign tax credit.
The standard deduction and personal exemption allowances would be increased and tax
rates would be decreased from current law. In addition, the “marriage tax penalty” arising
from these factors would be eliminated by making the joint filer allowances and tax brackets
exactly twice those of a single filer. “Head-of-household” filers, which are single individuals
with dependent children, would receive allowances and the first two tax brackets halfway in
between the amounts for single and joint taxpayers; the higher tax brackets are equal the
single-filer brackets. There would be no separate tax rates for capital gains.
The tax-free allowances would be:
! $9,000 for a joint return;
! $6,600 for a head of household;
! $4,500 for an individual; in addition
! $2,900 for each personal exemption.
The tax rate schedule would be:
! 10% marginal rate: married (joint) $0-$46,000; head of household $0-
$32,000; single $0-$23,000.
! 20% marginal rate: married (joint) $46,000-$80,000; head of household
$32,000-$40,000; single $23,000-$40,000.
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! 26% marginal rate: married (joint) $80,000-$150,000; head of household
$40,000-$75,000; single $40,000-$75,000.
! 32% marginal rate: married (joint) $150,000-$275,000; head of household
$75,000-$137,500; single $75,000-$137.000.
! 34% marginal rate: married (joint) over $275,000; head of household over
$137,500; single over $137,500.
This proposal would reduce “corporate welfare” by more than $50 billion. The plan
apparently retains payroll and other taxes as under the current system. The plan is said to be
revenue-neutral, to allow a post-card sized tax return for some taxpayers, and to require no
return at all for over one-half of individual taxpayers. It also stipulates that future changes
in tax rates could be made only by national referendum.
The Souder Proposal
H.R. 2971 in the 105th Congress. This proposal would repeal the corporate income tax
and the individual income tax and replace these taxes with a flat rate tax of 20% only on the
earned income of individuals and on business taxable income. For the individual income tax,
there would be a standard deduction equal to:
! $16,500 for a joint return;
! $14,000 for a head of household;
! $9,500 for an individual; in addition
! $4,500 for each dependent.
Interest of the first $100,000 of a home mortgage would be deductible, and there would
be an unlimited deduction for charitable contributions.
Business taxable income is defined as gross income less the cost of business inputs,
employees’ wages and contributions to qualified retirement plans, and the cost of tangible
personal and real property. For any taxable year, if aggregate business deductions exceed
deductions then the business may carryover the excess deductions (plus interest) to the
succeeding taxable year.
The Crane Proposal
H.R. 214 in the 104th Congress. This proposal would repeal the corporate income tax,
the individual income tax, the estate tax, and the gift tax, and replace these taxes with a flat
rate tax of 10% on individuals’ earned income. The first $10,000 in earned income would be
exempt from taxation. This exemption level would be indexed for taxable years after
December 31, 1995, for changes in the consumer price index. Earned income would be
defined as the sum of wages, salaries, and other employee compensation; the amount of the
taxpayer’s net earnings from self-employment; and the amount of dividends which are from
a personal service corporation. Fringe benefits included in earned income would be valued
at the cost to the employer. This proposal would establish an amnesty for all prior tax liability
attributable to legal activities.
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The Gramm Proposal
This proposal would repeal the corporate income tax, the individual income tax, and the
estate (and gift tax) tax, and replace these taxes with a single, uniform tax of 16% on all
income. He also proposes an exemption of $22,000 for every couple and an additional
exemption of $5,000 for every child or dependent. He would keep the deductions for home
mortgage interest and charitable contributions. This tax reform proposal would result in a
substantial decline in federal revenues that Senator Gramm would offset with reductions in
federal spending.
The Faircloth Proposal
S. 1555 in the 105th Congress. Former Senator Faircloth’s proposal would establish
an Internal Revenue Service Oversight Board, eliminate the Internal Revenue Code of 1986
by December 31, 2000, and terminate the Internal Revenue Service by September 30, 2000.
This proposal would create a new federal tax system with a low flat rate that eliminates the
bias of the current system against savings and investment. This proposal would require a
super majority of both Houses of Congress to raise taxes.
The Largent/Hutchinson Proposal
H.R. 3097 (amended) and S. 1673 (amended) in the 105th Congress. This proposal
would terminate the tax code except for Social Security taxes and Railroad Retirement taxes
on December 31, 2002. According to the proponents, the new federal tax system would be
simple and fair with the following six features:
! applies a low rate to all Americans,
! provides tax relief for working Americans,
! protects the rights of taxpayers and reduces tax collection abuses,
! eliminates the bias against savings and investment,
! promotes economic growth and job creation, and
! does not penalize marriage or families.
The fourth feature (eliminates the bias against savings and investment) suggests that the
new tax system would be some type of consumption tax.
Any new federal tax system would be approved by Congress in its final form not later
than July 4, 2002.
The Snowbarger Proposal
H.R. 2685 in the 105th Congress. Former Representative Snowbarger’s proposal
would allow each taxpayer to choose between the current individual income tax return and
an alternative individual income tax return with a flat rate of 20% on taxable income (adjusted
gross income minus the FAIR standard deduction). The FAIR standard deduction would
equal the sum of the basic standard deduction plus the additional standard deduction.
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The basic standard deduction would be
! $21,400 in the case of either a joint return or a surviving spouse;
! $14,000 in the case of a head of household;
! $10,700 in the case of an individual who is not married and who is not a
surviving spouse or head of household, or who is a married individual filing
a separate return.
The additional standard deduction would be
! $5,000 for each dependent.
In calculating the FAIR standard deduction, an individual’s taxable income includes the
taxable income of each dependent child who has not attained age 14 as of the close of the
taxable year. The dollar amount relating to the FAIR deduction would be indexed to changes
in the consumer price index (CPI).
A married couple must file a joint return in order to be able to select the flat alternative
individual return. A three-fifths vote (super majority) of both Houses of Congress would be
required to increase the tax rate, levy an additional tax rate, or reduce the FAIR deduction.
The Dorgan Proposal
S. 3087 in the 106th Congress. Under this “Fair and Simple Shortcut Tax Plan,” most
employees would be allowed to provide employers with additional information on their W-4
(deduction) Form. For example, whether the employee is a homeowner. Single taxpayers
earning up to $50,000 in annual wage income (and with nonwage income of up to $2,500)
and married couples filing jointly with up to $100,000 in annual wage income (and with
nonwage income of up to $5,000) could choose the “shortcut” tax plan. The employer would
file the W-4 Forms with the federal government. The employer would compute family
deductions, factor in a deductions for home mortgage interest and property taxes, and
determine the amount of federal income tax to withhold by taking 15% of wages after
deductions less the child care credit. Under this “shortcut” plan, the amount of tax withheld
would equal the employee’s tax liability, and consequently, the employee would not have to
file a tax return. If the employee calculates that his tax liability would be less under the
current income tax, he would still have the option of filling out and filing a tax return rather
than paying tax under the “shortcut” plan. Senator Dorgan believes that up to 70 million
taxpayers would be relieved from having to file a yearly federal individual income tax return.
Senator Dorgan’s proposal would also make five other changes in the current tax code.
First, the first $1 million in self-employment income would be exempt from the alternative
minimum tax (AMT). Second, a taxpayer, who cannot use the shortcut method, would be
allowed a tax credit for 50% of the costs (maximum of $200) of paying a preparer if the tax
return is filed electronically. Third, a small business would be allowed a tax credit (maximum
$1,000) for 50% of the costs of complying with the exact withholding option. Fourth, the
marriage penalty would be reduced by making the standard deduction for married couples
filing jointly double the amount available for single filers. Fifth, taxpayers would be offered
a substantial incentive for savings and investment by exempting up to $500 of dividend and
interest income for an individual and up to $1,000 for a couple.
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LEGISLATION
The 107th Congress
H.R. 86 (English)
Simplified USA Tax Act of 2001. Replaces the individual income tax, the corporate
income tax, and the estate and gift taxes with a border-adjustable business tax (subtraction-
method VAT) and a progressive consumed-income tax. Individuals may utilize the equivalent
of universal Roth IRAs to encourage savings. Introduced January 3, 2001; referred to House
Committee on Ways.
FOR ADDITIONAL READING
CRS Issue Briefs
CRS Issue Brief IB91078. Value-added tax as a new revenue source, by James M. Bickley.
(Updated regularly)
CRS Issue Brief IB92069. A value-added tax contrasted with a national sales tax, by James
M. Bickley. (Updated regularly)
CRS Reports
CRS Report RL30351. Consumption taxes and the level and composition of saving, by
Steven Maguire.
CRS Report 98-248 E. A federal tax on consumed income: background and analysis, by
Gregg A. Esenwein.
CRS Report 98-529 E. Flat tax: an overview of selected policy issues relevant to the Hall-
Rabushka proposal, by James M. Bickley.
CRS Report 95-1141 E. The flat tax and other proposals: who will bear the tax burden?
by Jane G. Gravelle.
CRS Report 96-315 E. The flat tax and other reform proposals: overview of the issues, by
Gregg A. Esenwein, Jane G. Gravelle, and Jack Taylor.
CRS Report 98-901 E. Short-run macroeconomic effects of fundamental tax reform, by
Thomas G. Woodward and Jane G. Gravelle.
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