Even flat tax advocate Daniel J. Mitchell of the Heritage Foundation believes the flat tax has only a "one in three" chance of being enacted.
However, Mitchell's acknowledgement did little to assuage the concerns of the two other flat tax panelists at The Bond Buyer's First Annual New York Public Finance Conference in New York City yesterday.
Both William G. Gale, senior fellow at the Brookings Institution, and Arthur Miller, vice president and municipal market strategist at Goldman, Sachs & Co., argued that, as proposed, a flat tax would cause more harm than good.
In fact, according to Gale, the potential problems with the flat tax go well beyond common concerns about fairness: a flat tax could actually end up trading one set of loopholes for another.
In a flat tax world, Capitol Hill tax lobbyists would shift their attention to distinctions between income and capital gains - the latter being exempt from taxes under most proposals, Gale predicted.
Businesses would likely employ creative accounting in order to minimize the amount of cash inflow reported as regular income.
And a flat tax could even have unintended consequences for divorce settlements, he said.
"Right now alimony payments are deductible, and alimony receipts are taxable income," Gale explained. "But under a flat tax the person who pays the alimony would have to pay taxes on it while the person who receives the alimony would not.
"So the flat tax, as written by Rep. Dick Armey, (R-Tex.), would effectively renegotiate every divorce agreement in the country."
While this problem could easily be rectified, the alimony question "indicates that ... flat tax proponents did not think through all the details," he said. "Before I sign on to the biggest change in the history of U.S. tax policy, I'd like to see a few of the i's dotted and t's crossed."
Moreover, because a flat tax has never been tested, Republican revenue predictions are not dependable, according to Gale.
"It's a mistake to compare an actual tax system to one that only exists on paper," he said. "What we really ought to do is hire some country like Albania - have them ... work out the kinks."
Given the complexity of the U.S. economy, simplifying the tax system would not necessarily improve it, Miller added.
"The only way to have a fair tax system is to have a complex system," he said.
In defending the flat tax, Mitchell argued that it would promote economic growth by reducing the cost of doing business.
"Tax rates are too high," he said. With combined federal, state, and local taxes nearing 50%, "you don't have to be a rabid supply-sider to think that just maybe (the current tax code discourages) people from being entrepreneurial."
Mitchell also downplayed the flat tax's potential impact on states, municipalities, and the municipal bond market.
New economic activity generated by lower tax rates will more than compensate municipalities for higher borrowing costs, he argued. In addition, the impact on outstanding bonds would be minimal.
A flat tax only levels the investment playing field, he said. A municipal bond paying 5% before a flat tax will still pay 5% afterwards.
While outstanding bonds may drop in value, the loss would not be as significant as some fear, he claimed.
In fact, Mitchell said that if passage of a flat tax caused a massive municipal market correction, he would personally view that as an opportunity to buy municipals.o
