Rand Paul's tax reform plan is utterly bizarre. I don't even mean that as a criticism. It's not that the plan is bad, though it is; it's just downright weird. It calls for a 14.5 percent flat tax, which is substantially lower than just about every other Republican flat tax plan. That's normal enough, if a bit extreme, but then Paul takes a strange turn, altering his proposal in a way that suggests he's borrowing it from a completely baffling source: current California Gov. Jerry Brown's eccentric, ideologically unclassifiable 1992 Democratic presidential primary campaign.
The result is a confused jumble that cuts rich people's tax burdens dramatically but abandons the very features that conservatives think make flat taxes good for the economy. I've read a lot of politicians' tax plans in my time — a truly unreasonable number, really. The origin story and specific details of Paul's plan make it among the strangest I've ever seen.
How Paul's proposal works
Paul wants to replace just about every federal tax: income taxes, corporate taxes, payroll taxes, estate and gift taxes, etc. He even throws in unilateral repeal of all duties and tariffs for good measure. In their place, he introduces two taxes:
- A 14.5 percent flat tax on all personal income: wages, capital gains, dividends, interest, etc., leaving only deductions for charitable donations and mortgage interest, as well a $15,000 standard deduction and a $5,000 personal exemption. The plan keeps the Child Tax Credit and the Earned Income Tax Credit.
- A 14.5 percent tax on corporations that lets them deduct all their expenses, save for wages.
The latter, as Cato's Daniel Mitchell notes, is a value-added tax (VAT), just like Canada, Australia, New Zealand, and all EU countries have. It's specifically what's called a subtraction-method value-added tax; Japan is the most notable country with one of those today.
Of course, 14.5 percent is way lower than the top personal and corporate rates today. It's also lower than most conservative flat tax proposals. Steve Forbes wanted a 17 percent tax in 1996 and 2000; Rick Perry wanted a 20 percent one in 2012. However, they also exclude capital income from taxation, which Paul explicitly does not.
The main beneficiaries are the rich
An analysis by the right-leaning Tax Foundation found that Paul's plan would cost $3 trillion over 10 years, before accounting for effects on economic growth. It also found that while all income groups under $200,000 see after-tax income go up, on average, by at most 3 percent, people making over $1 million get a 13 percent boost.
If you factor in the Tax Foundation's extremely generous and pretty implausible growth estimates, the poorest Americans would gain 11 percent — but millionaires would get a whopping 27 percent income boost.
So it's really expensive and regressive. What's the argument for it then?
The basic argument is that capital and business would be taxed less, boosting growth and helping everybody; the lower rate on non-capital income would also, on this view, have growth effects. This is the traditional argument for flat taxes: they're a form of consumption tax, and economists think consumption taxes help growth by exempting savings and investment from taxation. Paul writes that his plan would be "an economic steroid injection," by which I assume he means it'd help, rather than just helping temporarily before causing long-run irreversible damage, like actual steroids.
The problem is that while the VAT side of the Paul plan is definitely a consumption tax, the income tax side isn't, because it subjects capital gains and dividend income to taxation rather than just wages. This is very odd. In a traditional flat tax, the business tax would let companies deduct wages, and then have individuals pay taxes on wages and nothing else. It's a slightly altered version of a VAT: businesses pay a VAT on everything but wages, and then individuals pay a tax on their wages. The tax base is the same as a VAT's or a sales tax's: consumption.
But Paul's individual tax is not, in any sense, a consumption tax. He's broken the entire conceptual model behind flat taxes. It's a big enough change that it's worth questioning if the proposal even deserves to be called a "flat tax," in the traditional sense.
Recent empirical work has suggested that taxing savings and investment doesn't hurt growth as much we thought. For example, a big study found that in Denmark, providing $1 in tax incentives to save only increased savings by $0.01 — one measly cent. That suggests the reasoning behind a real flat tax might be flawed. It's less of a problem for Paul's weird quasi-flat tax.
What does this have to do with Jerry Brown?
In 1992, Jerry Brown — who was Bill Clinton's main rival in the late stages of the primaries, mostly running to his left — proposed abolishing the payroll tax for Social Security as well as personal and corporate income taxes, and replacing them with a 13 percent flat tax on personal income (with deductions only for rent, mortgage interest, and charitable donations), and a 13 percent VAT.
That's right: Rand Paul has taken Jerry Brown's tax plan and then raised the tax rates in it. Brown's plan was more regressive than Paul's as well. Brown would've eliminated personal exemptions and the standard deduction, which makes the flat tax far more regressive. He would've eliminated the Earned Income Tax Credit, which Paul keeps; Paul also retains the Child Tax Credit, which helps many low-income families, and didn't exist yet in 1992. While in the past Paul has proposed slashing those credits by making them nonrefundable, they're still fully refundable under this plan. Paul does eliminate the estate tax, unlike Brown, but on the whole, his plan can be fairly characterized as to the left of Brown's.
For one thing, while Paul's plan cuts taxes for all income groups on average (albeit more for rich people), the working class would actually be worse off under Brown's plan. The conservative National Center on Policy Analysis's study of Brown's plan found that people making between $5,000 and $40,000 would pay higher taxes, but millionaires would see an average cut of $98,065. Improbably, NCPA claimed that the tax plan would be "fully self-financing" even without economic growth effects; the left-leaning Citizens for Tax Justice estimated that the plan would increase the deficit by $200 billion a year, or $2 trillion in the 10-year time frame.
How do Rand Paul and the Democratic governor of California have the same tax plan?
But wait, how are these proposals so similar? Well, for one thing, the same person crafted both of them. Brown's plan was crafted initially by Arthur Laffer, the conservative economist whose titular curve argues that big tax cuts can pay for themselves. Paul, too, credits Laffer — along with Heritage Foundation economist Stephen Moore and failed flat tax presidential candidate Steve Forbes — with helping craft his plan.
It's strange to imagine Brown, who's championed progressive taxation in his past four years as governor, backing a far-right tax proposal like this. By all indications, it didn't feel any less strange at the time. The Brown plan was a frequent target of attacks from other Democratic contenders. "This proposal is a disaster," Clinton said. "We don't need any more … brain-dead politics. Jerry's tax is an example of that." Then-Sen. Tom Harkin (D-IA) quipped that it was "like something proposed by the Flat Earth Society."
Brown, presumably realizing he'd made a huge mistake, even hired eminent left-wing economist Robert Pollin, now at UMass Amherst, to come in and fix Laffer's version of the plan. In an April 2, 1992, op-ed for the Wall Street Journal, Pollin (billed by WSJ as a member of the steering committee of the "Union for Radical Political Economics") and the socialist writer Alexander Cockburn defended Brown's plan, but suggested adding a 13 percent surtax for people making over $100,000, which would be a huge change.
Paul won't face pressure from fellow Republicans to make his plan more progressive, of course. But he'll have to come up with a decent answer to the question: why in the world are you proposing a higher-rate version of an old Democratic candidate's tax plan?