It's hardly worth mentioning Fred Thompson's recent tax proposals, although lauded in the Wall Street Journal the other day, given that the dang doggone ol' boy (as this Washington-Hollywood smoothie likes to style himself) is going nowhere fast. He makes my 16-year-old cat Shadow, who sleeps almost all the time, seem like a whirling dynamo by contrast. But I'll briefly discuss ol' Fred's tax plans anyway, as they raise broader points of interest.
What with proposing to end the AMT, extend the Bush tax cuts, and on and on, Fred appears to envision reducing Federal revenues by as much as 5 to 10 trillion dollars for 2008-2017 alone. (This is a wild guess, but the Bush tax cuts alone come in at $2.3 trillion according to the Congressional Budget Office.) This verges on the criminally insane given the overall U.S. fiscal picture and the political unlikelihood of commensurate outlay reductions.
The bad idea I want to emphasize here, however, is his proposal to add a simple flat tax system with fewer deductions to the Code, but not to replace the current system - he would instead make it elective: you get to use whichever system you prefer.
Tax Policy Rule # 12 (I don't have a list, it's just that this one isn't important enough to be Rule # 1): Taxpayer elections are almost always a bad idea. They add complexity while losing revenue, since taxpayers have an incentive to look at all the options and then pick the one under which they pay the least. Plus, the pattern of tax liability you get is bound to be incorrect, given its being a mix-and-match between different systems. No matter which system you prefer, the result is "wrong" for people who pick the other system.
The Wall Street Journal, in its Nov. 28 editorial lauding the plan, was characteristically ignorant and naive. They put it as follows: "Anyone who prefers the current tax code can stick with it. The rest of us can have a better choice."
Does the Journal really think that taxpayer elections will be based on personal affinity as opposed to which system enables one to pay less tax? That is not a very plausible or sophisticated view of taxpayer behavior.
Yes, as the Journal notes, providing the election may ease the politics of adopting a flat tax, which may seem good if that is the tax system you prefer. But it eases enactment by not really enacting the flat tax, given that the other system remains out there, influencing behavior and running up tax planning costs. Making something easier to adopt by not really adopting it is not a very brilliant strategy.
Okay, just for completeness, are taxpayer elections always bad? No. To over-simplify, suppose there were 2 kinds of elections: those that induced the taxpayer to choose whichever option reduced tax liability, and those that induced the taxpayer to choose whichever option lowered her tax planning and compliance costs. The latter type of election would be good, the former bad. In practice, of course, the two effects will generally be mixed together, so it's a question of how much you get of each. But the election Thompson proposes certainly seems likely to be the bad kind, as taxpayers would have strong reason to track, e.g., their home mortgage interest deductions and such (not all that administratively costly a thing to do) in deciding which option they want to use.