Flat-tax proposals would be rough on Nevada’s middle class

By Karoun Demirjian

Tuesday, Oct. 25, 2011 | 3:34 p.m.

Rick Perry’s doing it. So is Herman Cain. Even Mitt Romney has said he likes the idea.

The flat tax is having a Republican renaissance, as presidential candidate after presidential candidate rolls out an economic plan built around the simple message of a one-size-fits-all tax plan.

But local economists say the flat tax may be dumbing down economic recovery too much to provide real solutions for the Silver State.

When it comes to taxes, Nevadans like to keep it simple. No income tax. No corporate income tax. Sales and property taxes are a little steep, but straightforward.

Flat tax “sells better here than it does in most places,” UNLV economics professor Bill Robinson said. “Nevada is a more traditionally anti-government, and the flat tax always seems to resonate more with people who believe in smaller government.

“But all flat-tax plans are somewhat regressive,” Robinson continued. “It’s in the details. And politicians don’t usually like to talk details.”

Current national front-runner Herman Cain started the trend toward flat taxation with his “9-9-9” plan: 9 percent sales tax, 9 percent income tax and 9 percent corporate tax, with deductions for only charitable giving.

“It is fair, simple, transparent and efficient,” Cain says of the plan on his website. “It taxes everything once and nothing twice.”

Now, former Texas Gov. Rick Perry, who has fallen out of first place, is following up with a flat-tax plan of his own: a 20 percent flat option.

Perry says the plan would “cut taxes and spending, balance the budget, and grow jobs and the economy.” He’s also gotten the endorsement of the dean of Republican flat-tax aficionados, Steve Forbes, who ran for president on a 17 percent flat tax platform in 1996.

But local economists say there’s a catch in these plans — the middle class.

“I think most of us like the idea of the federal income tax being a little simpler,” UNR Economics Department Chairman Elliott Parker said. “But ... most of us would have to give up something ... having a flat tax means having the rich pay less and everybody else pay more.”

The federal tax structure is too complex to boil down to a few words, but the basic principle of the current system is a progressive tax code: Those at the lowest end of the income spectrum don’t pay as much of their income to the federal government, and those at the higher end of the spectrum pay disproportionately more: about 35 percent of their income, under the extended Bush tax cuts.

The extent of this system has upset many in the GOP presidential field, who have complained that too many citizens aren’t paying any taxes.

“Absolutely every American should pay something, even if it’s a dollar,” GOP candidate Michele Bachmann said in last week’s Las Vegas debate.

But presidential hopefuls pushing for flat taxes are looking for far more than a dollar from most in the middle class.

Cain’s 9-9-9 plan, for example, absolves the poor of any responsibility to pay income tax, but still hits them with a federal sales tax — the first of its kind — of 9 percent. It hits the middle class twice: with the sales tax and the income tax.

Perry’s 20-percent plan doesn’t impose a sales tax and exempts the first $12,500 in income from taxation for any individual (and his or her dependents) who earns less than half a million dollars a year. He also preserves the mortgage interest, charitable contribution, and state and local tax deductions.

“The criticism of a flat tax is that it tends to be regressive, but you can handle that with an upfront exemption. Then it turns into a progressive tax,” said Stephen Miller, chairman of the economics department at UNLV.

But compared with other tax proposals, Perry’s upfront exemption of $12,500 is low. Forbes’ plan would have included a $33,000 exemption to his 17 percent flat-tax plan. Miller also cited Connecticut, where the state flat tax of 4 percent exempts the first $25,000 in income. A lower exemption “means more people are going to pay the tax. It’s not as progressive as a higher deduction would be,” Miller said.

Preserving the mortgage interest deduction — a feature of Perry’s plan but not of Cain’s — is likely a point in Perry’s favor in Nevada, where the loss of a mortgage interest tax deduction would come as a heavy blow for those who have experienced financial losses on their homes.

But deductions can be a slippery slope.

“Once you open the door for one, then it’s hard to make the arguments against others,” Robinson added. “Should we have a child care deduction? Why not medical expenses? ... We’ve built a tax system which is grossly unfair, but while everyone who benefits from the unfairness of it may philosophically like the idea of a fairer system, they’re going to be personally opposed to when their unfair piece goes away.”

And if a flat tax is laden with too many deductions across the board, that brings about the problem of revenue neutrality: You can’t bring in less money than you were before.

“You can’t reduce the deficit and cut average taxes at the same time,” Parker said. “Do we really want the poor and the middle class to pay much higher rates of taxes than they currently do? I’m sure the wealthy would think that would be fair. But I don’t know if most voters, if they understood it, would.”

The potential for a shortfall in tax revenue has been a major criticism of Cain’s plan, as well as Perry’s, though both address the complaint by promising a combination of cuts in the federal budget, reductions in entitlement spending (privatization of Social Security is on the table), and new regulatory policies say believe will create jobs — and people who fill those jobs will become taxpayers.

But Miller, Robinson and Parker all agree that the GOP field seems to be avoiding the one big economic problem that could hinder Nevada from economic recovery: foreclosures, specifically, a way to push banks to write down mortgage principal so that homeowners can make good on their loans.

Specific initiatives to heal Nevada’s homegrown ills don’t appear in most of the GOP’s economic proposals, whether they’re based on a progressive or a flat-tax system.

But depending on the particulars of the proposal, a flat tax could widen Nevada’s above-average income disparities.

Median Nevada income is $51,001 per household, based on 2010 figures. But the state has a higher-than-average number of financially comfortable retirees who come here specifically to avoid steep tax rates in other states. For them, either of these flat-tax plans would likely yield lower net tax rates. Nevada also has a larger-than-average complement of service industry workers, who sit squarely in the middle class, where under these plans, many will see their net tax rates increase.

But as the Republican Party focuses ever more acutely on tax reform as its main jobs engine, economists predict more and finer-tuned flat-tax plans will be proposed.

“We’re probably going to hear more of these,” Miller said.