Order Code RL33443
CRS Report for Congress
Received through the CRS Web
Flat Tax Proposals and Fundamental
Tax Reform: An Overview
May 31, 2006
James M. Bickley
Specialist in Public Finance
Government and Finance Division
Congressional Research Service ˜ The Library of Congress

---

Flat Tax Proposals and Fundamental Tax Reform: An
Overview
Summary
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 value-
added 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.

---

Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
The Relationship Between Income and Consumption . . . . . . . . . . . . . . . . . . . . . . 1
What Should Be Taxed? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Types of Broad-Based Consumption Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Value-Added Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Retail Sales Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Consumed-Income Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Flat Tax (Hall/Rabushka Concept) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
International Comparisons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Other Types of Fundamental Tax Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Income Tax Reform: Base Broadening . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Option of the Current or an Alternative Income Tax System . . . . . . . . . . . . 5
Description of Legislative Proposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Senator Richard C. Shelby’s Proposal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Representative Phil English’s Proposal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Senator Arlen Specter’s Proposal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Representative John Linder’s Proposal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Senator Saxby Chambliss’s Proposal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Senator Jim DeMint’s Proposal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Senator Ron Wyden’s Proposal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Representative Rahm Emanuel’s Proposal . . . . . . . . . . . . . . . . . . . . . . . . . 10
Representative Michael C. Burgess’s Proposal . . . . . . . . . . . . . . . . . . . . . . 10
Representative Chaka Fattah’s Proposal . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Status of Other Relevant Legislation in the 109th Congress . . . . . . . . . . . . . . . . 11
For Additional Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

---

Flat Tax Proposals and Fundamental Tax
Reform: An Overview
Introduction
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 “complicated mess” posed
by the federal tax code and to propose options to reform the code. On November 1,
2005, the final report of the President’s Advisory Panel of Federal Tax Reform was
released. The panel made two proposals for fundamental tax reform: a proposal to
broaden the income tax base and reduce tax rates and a proposal to shift to a
predominantly consumption-based tax system. Consequently, fundamental tax
reform is a major legislative issue in the 109th Congress. Fundamental tax reform has
been an important issue in prior Congresses, and some past bills have been
reintroduced. Most proposals for fundamental tax reform would change the tax base
from income to consumption.
The Relationship Between Income
and Consumption
Although our current tax structure is primarily 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, individuals can
exercise two options with regard to their income: they can consume it or they 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 income in the same way as he
or she does now under the income tax but then would subtract out net savings (saving

---

CRS-2
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.
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 tax paid as a percentage of income increases as
income rises. Although 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 tax 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 (e.g., purchased products)
and nonmarket activities (e.g. leisure). 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.1
1 For an analysis of this issue, see CRS Report RS22367, Federal Tax Reform and Its
Potential Effects on Saving, by Gregg A. Esenwein.

---

CRS-3
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,
a 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.
Types of Broad-Based Consumption Taxes
Four major types of broad-based consumption taxes 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 of the Hoover Institution.2
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
2 For an overview of the economic issues relevant to broad-based consumption taxation, see
CRS Report RL32603, The Flat Tax, Value-Added Tax, and National Retail Sales Tax:
Overview of the Issues, by Gregg A. Esenwein and Jane G. Gravelle.

---

CRS-4
multiplying its value added by the VAT rate.3 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 only at 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 of the Hoover Institution. Their proposal would have two
components: a wage tax and a cash-flow tax on businesses. (A wage tax is a tax
only on salaries and 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. Under a standard VAT, all wage income would be included
in the tax base.4
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
3 For a comparison of the credit-invoice method and the subtraction method, see Value-
Added Tax: Methods of Calculation (a general distribution memo), by James M. Bickley,
available on request from the author.
4 For a comprehensive overview of this concept, see CRS Report 98-529, Flat Tax: An
Overview of the Hall-Rabushka Proposal, by James M. Bickley.

---

CRS-5
developed nations adopted broad-based consumption taxes as adjuncts to or
replacements for other consumption taxes rather than as replacements for their
income-based taxes. Most of the congressional proposals would replace our current
income taxes with consumption taxes.
Second, all developed nations with VATs, except Japan, calculate their VATs
using the credit-invoice method. In contrast, most of the current U.S. flat tax
proposals, which include VAT components, 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. Proposals of Senator Wyden and Representative Emanuel are in this
category.
Option of the Current or an Alternative Income Tax System
Representative Burgess’s proposal would give taxpayers the option of either
paying taxes under the current income tax or paying a flat rate income tax.
Description of Legislative Proposals
In the 109th Congress, there are a number of flat tax (or modified flat tax)
proposals receiving considerable attention. Some of the proposals (the Shelby, the
English, the Specter, the DeMint, and the Linder plans) would change the tax base
from income to consumption. Representative Burgess’s proposal would allow each
taxpayer to choose between the current individual income tax return and an
alternative individual tax return with a flat rate. Proposals of Senator Wyden and
Representative Emanuel would broaden the income tax base and lower tax rates.
Representative Fattah’s proposal would require 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. Although 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.
Senator Richard C. Shelby’s Proposal
S. 1099. The Tax Simplification Act of 2005 was introduced on May 23,
2005, and referred to the Committee on Finance. This act was modeled after the

---

CRS-6
proposal formulated in 1981 by Hall and Rabushka. This 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 has 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 this proposal, some
wage income would not be included in the tax base because of deductions, while
under a VAT all wage income would be included in the tax base.
Initially the individual wage tax would be levied at a 19% rate, but when the tax
was fully phased in, this rate would decline to 17%. The individual wage tax would
be levied on all wages, salaries, pensions, and unemployment compensation. 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 from 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 “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
2005, the basic standard deduction would have been the following:
! $25,580 for a married couple filing jointly or a surviving spouse;
! $16,330 for a single head of household;
! $12,790 for a single person; and
! $12,790 for a married person filing a separate return.
The “additional standard deduction” would be an amount equal to $5,510 times
the number of dependents of the taxpayer.
All deductions would be indexed for inflation using the consumer price index
(CPI).
Initially businesses would pay a tax of 19% (declining to 17% when the tax was
fully phased in after December 31, 2007) 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.
Activities of government entities and tax-exempt organizations would be
exempt from the business tax.

---

CRS-7
If the business’s 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 three-month Treasury rate for the last month of the taxable
year.
Any congressional action that raises taxes would require a three-fifths
(supermajority) vote in both the Senate and the House of Representatives.
Representative Phil English’s Proposal
H.R. 4707. The Simplified USA Tax Act of 2006 was introduced on February
8, 2006, and referred to the House Committee on Ways and Means. This proposal
would replace our income tax system with a consumption tax system. 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 business 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 tax on value-
added in order to calculate the amount that the business would remit 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. Deductions 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.
Senator Arlen Specter’s Proposal
S. 812. Flat Tax Act of 2005 was introduced on April 15, 2005, and referred
to the Senate Finance Committee. This act is modeled after the Hall-Rabushka
proposal, which was previously discussed. The Specter flat rate consumption tax
would replace the federal individual and corporate income taxes and the federal
estate and gift taxes.

---

CRS-8
This proposal has two components: a wage tax and a cash-flow tax on
businesses. It is essentially a modified VAT, with wages, salaries, 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 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
2005, the basic standard deduction would have been the following:
! $20,000 for a joint return;
! $20,000 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, pension contributions, and the
cost of personal and real property used in the business. Purchases from other firms
would include capital goods. If the business’s 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 three-month Treasury rate for the last
month of the taxable year.
This tax reform act would have become operational on January 1, 2006.
Representative John Linder’s Proposal
H.R. 25. (A companion bill, S. 25, has been introduced in the 109th Congress
by Senator Saxby Chambliss.) The Fair Tax Act of 2005 was introduced on January
4, 2005, and referred to the Committee on Ways and Means. This proposal would
repeal the individual income tax, the corporate income tax, all payroll taxes, the self-
employment tax, and the estate and gift taxes and levy 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 Social Security Administration would provide a monthly sales tax
rebate to registered qualified families. The 23% national retail sales would not be

---

CRS-9
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.
Senator Saxby Chambliss’s Proposal
S. 25. (A companion bill to H.R. 25, which is the preceding bill.) The Fair Tax
Act of 2005 was introduced on January 24, 2005, and referred to the Senate Finance
Committee. This act would “promote freedom, fairness, and economic opportunity
by repealing the income tax and other taxes, abolishing the Internal Revenue Service,
and enacting a national sales tax to be administered primarily by the states.”
Senator Jim DeMint’s Proposal
S. 1921. The Savings for Working Families Act of 2005 was introduced on
October 26, 2005, and referred to the Senate Finance Committee. This act would
repeal the individual income tax, the corporate income tax, and the estate and gift
taxes, effective January 1, 2007. This act would impose an 8.4% national retail sales
tax. Each qualified family would receive a family consumption allowance; that is,
a sales tax rebate. The family consumption allowance would equal 8.4% of the
poverty level. The Social Security Administration would provide the sales tax rebate
on a monthly basis to duly registered qualified families. States would have the option
of administering the national retail sales tax, and in return, receive an administration
fee.
This act would impose a business tax, which would be an 8.4% subtraction-
method value-added tax. Each business enterprise would remit 8.4% of the
difference between its gross sales and its purchases from other businesses. If a
business’s gross sales were less than its purchases from other businesses, then this
“loss” would be carried over as a deduction in future years.
Senator Ron Wyden’s Proposal
S. 1927. The Fair Flat Tax Act of 2005 was introduced on October 27, 2005,
and referred to the Senate Finance Committee. This proposal would reform the
current income tax base rather than changing to a consumption base. This act has
three stated purposes: (1) to make the federal individual income tax system simpler,
fairer, and more transparent, (2) to make the federal corporate income tax rate a flat
35% and eliminate special tax preferences that favor particular types of businesses
or activities, and (3) to partially offset the federal budget deficit through the increased
revenues resulting from these reforms.
The progressive individual income tax would have three rates: 15%, 25%, and
35%. The individual income tax would provide a federal income tax credit for state
and local income, sales, and property taxes. The individual income tax would
provide for an earned income tax credit for childless taxpayers and a new earned
income child credit; repeal the individual alternative minimum tax; increase the basic

---

CRS-10
standard deduction and maintain itemized deductions for principal residence
mortgage interest and charitable contributions; and reduce the number of exclusions,
exemptions, deductions, and credits. All income including capital gains and
dividends would be taxed equally. This act would be effective beginning with tax
year 2006 but would sunset after tax year 2010.
Representative Rahm Emanuel’s Proposal
H.R. 5176. The Fair Flat Tax Act of 2006 was introduced on April 25, 2006,
and referred to the House Committee on Ways and Means. This proposal would
broaden the tax base of the current income tax. The individual income tax would
have three tax rates: 15%, 25%, and 35%. The current rate differential for capital
gains and dividends would be repealed. The basic standard deduction would be
increased, including tripling the standard deduction for single filers from $5,000 to
$15,000 and raising it from $10,000 to $30,000 for married couples. A “simplified
family credit” would replace the current earned income tax credit, the child credit,
and the dependent care credit. A refundable “college tax credit”of $3,000 per year
to students for four years of college and two years of graduate school would replace
five existing education tax incentives. The home mortgage deduction would be
available to all homeowners regardless of whether or not they itemize their
deductions. A “universal pension account” would replace 16 existing IRA-type
accounts with a single portable retirement account for all workers. The individual
alternative minimum tax for individuals would be repealed.
The corporate tax rate would be 35% of taxable income. The Secretary of the
Treasury would be required to report “recommendations regarding the elimination
of federal tax incentives which subsidize inefficiencies in the health care system ....”5
When sufficient information is available, brokers would be required to report
customers’ basis in securities transactions. Penalties for promoting abusive tax
shelters would be increased. The criminal monetary penalty limitation for the
underpayment or overpayment of tax due to fraud would be increased. A sunset
provision states that “All provisions of, and amendments made by, this act shall not
apply to taxable years beginning after December 31, 2010.”6
Representative Michael C. Burgess’s Proposal
H.R. 1040. The Freedom Flat Tax Act was introduced March 2, 2005, and
referred to the House Committee on Ways and Means. This proposal would allow
taxpayers to select a flat tax as an alternative to the current income tax system. The
flat tax was based on the concepts of Hall-Rabushka and is similar to the Armey flat
tax proposal. The individual’s selection of the flat tax would be irrevocable. In the
first two years, the flat tax rate would be 19%, and in subsequent years it would fall
to 17%. An individual engaged in a business activity may elect irrevocably, as an
alternative to our current income tax system, to be taxed on business taxable income
that equals gross sales less the cost of business inputs for business activity, wages,
5 H.R. 5176, Fair Flat Tax Act of 2006, Section 204.
6 Ibid., Section 302.

---

CRS-11
and retirement contributions. For the first two years, a 19% rate would apply to
business taxable income, but after the first two years, this rate would decline to 17%.
This act would have become effective for tax year 2006.
Representative Chaka Fattah’s Proposal
H.R. 1601. The Comprehensive Transform America Transaction Fee Act
of 2005 was introduced on April 13, 2005, and referred to the House Committee on
Ways and Means. This act would require the Secretary of the Treasury to conduct a
study and produce a comprehensive analytical report on the implementation of a
transaction fee as a replacement for all existing federal taxes on individuals and
corporations. This transaction fee would apply to all non-cash transactions
(including checks, credit cards, transfers of stocks, bonds, and other financial
instruments) and all high-dollar cash transactions. The fee would not apply to cash
transactions of less than $500, and salaries and wages paid by employers to
employees, and transactions involving individual savings instruments through
financial institutions. The fee would be double, or higher than, the standard
transaction fee on cash withdrawals from financial institutions. The fee would be
collected by the seller or financial institution servicing the transaction. The fee
would be set at least at the level to replace revenues generated under the Internal
Revenue Code. A higher fee could be levied to pay for one or more of the following:
elimination of the national debt over 10 years, a federal revenue sharing program
with the states to support 50% of the K-16 education costs, a plan to meet the
promised levels of certain provisions listed under the National Security Intelligence
Reform Act of 2004, a federal health care program providing insurance coverage for
the estimated 45 million uninsured Americans, an increase in the military basic pay
rate to a level comparable with that of federal civilian pay, a federal revenue sharing
program supporting community and economic development investments in new
markets (rural and urban areas) at a level equal to 10% of current federal tax
revenues, a plan to increase the pay for National Guard and Reserve soldiers to that
of active duty military for periods of extended deployments abroad, and a Social
Security and Medicare solvency plan ensuring that revenues continue to exceed
expected outlays. The Secretary of the Treasury would submit to Congress the
results of the study in a comprehensive analytical report not later than one year after
the enactment of this act.7
Status of Other Relevant Legislation
in the 109th Congress
H.R. 4725 (Representative Bob Goodlatte). The Tax Code Termination Act
was introduced on February 8, 2006, and referred to the House Committee on Ways
and Means. On December 31, 2009, this act terminates the tax code except for Social
Security taxes and Railroad Retirement taxes. This act states that “Congress ...
declares that any new federal tax system should be simple and fair ....” This act
7 For an analysis of the transaction tax, see CRS Report RL32266, Transaction Tax: General
Overview, by Maxim Shvedov.

---

CRS-12
establishes a new federal tax, which has a low tax rate and eliminates the bias against
savings and investment, and requires that the new federal tax system be approved by
Congress not later than July 4, 2009.
S. 2122 (Senator Johnny Isakson). The Date Certain Tax Code
Replacement Act was introduced on December 16, 2005, and referred to the Senate
Finance Committee. This act establishes within the legislative branch a National
Commission on Tax Reform and Simplification that shall review and submit to
Congress a report on (1) the present structure and provisions of the Internal Revenue
Code; (2) whether tax systems imposed under the laws of other countries could
provide more efficient and fair methods of funding the revenue requirements of the
government; (3) whether the present income tax system should be replaced with a flat
tax, a national sales tax , or any other specified tax system; (4) whether the Internal
Revenue Code can be simplified, absent wholesale restructuring or replacement; and
(5) the transition costs (including the length of time recommended for a smooth
transition) associated with any changes to the present federal tax system. This act
authorizes appropriations for the Commission. Any new federal tax system would
require approval by Congress no later than July 4, 2008. If a new federal tax system
is not approved by July 4, 2008, then Congress would be required to vote to
reauthorize the Internal Revenue Code of 1986.
For Additional Reading
CRS Report RL32603, The Flat Tax, Value-Added Tax, and National Retail Sales
Tax: Overview of the Issues, by Gregg A. Esenwein and Jane G. Gravelle.
CRS Report 98-529, Flat Tax: An Overview of the Hall-Rabushka Proposal, by
James M. Bickley.
CRS Report RL32266, Transaction Tax: General Overview, by Maxim Shvedov.
CRS Issue Brief IB91078, Value-Added Tax as a New Revenue Source, by James M.
Bickley.
CRS Report RL33438, A Value-Added Tax Contrasted with a National Sales Tax, by
James M. Bickley.
CRS Report RS22367, Federal Tax Reform and Its Potential Effects on Saving, by
Gregg A. Esenwein.
CRS Report RL33025, Fundamental Tax Reform: Options for the Mortgage Interest
Deduction, by Pamela J. Jackson.
CRS Report RL30351, Consumption Taxes and the Level and Composition of
Saving, by Steven Maguire.

CRS Report RL33378, Would Tax Reform Alter the Economy’s Growth? by Marc
Labonte.

---