Governor Rick Perry of Texas has announced a plan, which he outlines in the Wall Street Journal, to replace the corrupt and inefficient internal revenue code with a flat tax. Let’s review his proposal, using the principles of good tax policy as a benchmark.

1. Does the plan have a low, flat rate to minimize penalties on productive behavior?

Governor Perry is proposing an optional 20 percent tax rate. Combined with a very generous allowance (it appears that a family of four would not pay tax on the first $50,000 of income), this means the income tax will be only a modest burden for households. Most important, at least from an economic perspective, the 20-percent marginal tax rate will be much more conducive to entrepreneurship and hard work, giving people more incentive to create jobs and wealth.

2. Does the plan eliminate double taxation so there is no longer a tax bias against saving and investment?

The Perry flat tax gets rid of the death tax, the capital gains tax, and the double tax on dividends. This would significantly reduce the discriminatory and punitive treatment of income that is saved and invested (see this chart to understand why this is a serious problem in the current tax code). Since all economic theories — even socialism and Marxism — agree that capital formation is key for long-run growth and higher living standards, addressing the tax bias against saving and investment is one of the best features of Perry’s plan.

3. Does the plan get rid of deductions, preferences, exemptions, preferences, deductions, loopholes, credits, shelters, and other provisions that distort economic behavior?

A pure flat tax does not include any preferences or penalties. The goal is to leave people alone so they make decisions based on what makes economic sense rather than what reduces their tax liability. Unfortunately, this is one area where the Perry flat tax falls a bit short. His plan gets rid of lots of special favors in the tax code, but it would retain deductions (for those earning less than $500,000 yearly) for charitable contributions, home mortgage interest, and state and local taxes.

As a long-time advocate of a pure flat tax, I’m not happy that Perry has deviated from the ideal approach. But the perfect should not be the enemy of the very good. If implemented, his plan would dramatically boost economic performance and improve competitiveness.

That being said, there are some questions that need to be answered before giving a final grade to the plan. Based on Perry’s Wall Street Journal column and material from the campaign, here are some unknowns.

1. Is the double tax on interest eliminated?

A flat tax should get rid of all forms of double taxation. For all intents and purposes, a pure flat tax includes an unlimited and unrestricted IRA. You pay tax when you first earn your income, but the IRS shouldn’t get another bite of the apple simply because you save and invest your after-tax income. It’s not clear, though, whether the Perry plan eliminates the double tax on interest. Also, the Perry plan eliminates the double taxation of “qualified dividends,” but it’s not clear what that means.

2. Is the special tax preference for fringe benefits eliminated?

One of the best features of the flat tax is that it gets rid of the business deduction for fringe benefits such as health insurance. This special tax break has helped create a very inefficient healthcare system and a third-party payer crisis. It is unclear, though, whether this pernicious tax distortion is eliminated with the Perry flat tax.

3. How will the optional flat tax operate?

The Perry plan copies the Hong Kong system in that it allows people to choose whether to participate in the flat tax. This is attractive since it ensures that nobody can be disadvantaged, but how will it work? Can people switch back and forth every year? Is the optional system also available to all the small businesses that use the 1040 individual tax system to file their returns?

4. Will businesses be allowed to “expense” investment expenditures?

The current tax code penalizes new business investment by forcing companies to pretend that a substantial share of current-year investment outlays take place in the future. The government imposes this perverse policy in order to get more short-run revenue since companies are forced to artificially overstate current-year profits. A pure flat tax allows a business to “expense” the cost of business investments (just as they “expense” workers wages) for the simple reason that taxable income should be defined as total revenue minus total costs.

Depending on the answers to these questions, the grade for Perry’s flat tax could be as high as A- or as low as B. Regardless, it will be a radical improvement compared to the current tax system, which gets a D- (and that’s a very kind grade).

Here’s a brief video for those who want more information about the flat tax.

Last but not least, I’ve already received several requests to comment on how Perry’s flat tax compares to Cain’s 9–9‑9 plan.

At a conceptual level, the plans are quite similar. They both replace the discriminatory rate structure of the current system with a low rate. They both get rid of double taxation. And they both dramatically reduce corrupt loopholes and distortions when compared to the current tax code.

All things considered, though, I prefer the flat tax. The 9–9‑9 plan combines a 9 percent flat tax with a 9 percent VAT and a 9 percent national sales tax, and I don’t trust that politicians will keep the rates at 9 percent.

The worst thing that can happen with a flat tax is that we degenerate back to the current system. The worst thing that happens with the 9–9‑9 plan, as I explain in this video, is that politicians pull a bait-and-switch and America becomes Greece or France.

My Washington Post op-ed on federal infrastructure yesterday elicited a large and vigorous response. The comments on the WaPo site and emails to my inbox were about 80 percent in opposition to my views.

Here are some critiques of my article and my responses:

Critique: My view of devolving infrastructure funding to the states is unrealistic because only the federal government has enough “resources” to do big projects.

Response: The federal government has no magical source of money. All “federal dollars” ultimately come from taxpayers who live in the 50 states. It is true that the federal government can run larger deficits that state governments, but that’s a reason not to give the Feds responsibility for spending activities because they tend to go hog wild.

Critique: Maybe the federal government screws up, but so do state governments and private companies.

Response: Of course. But as the op-ed noted, when the Feds screw-up they botch it for the entire country, often for many decades. The federal government is a monopoly, and monopolies breed inefficiency. By contrast, the states compete with each other and learn from each other to an extent. And when private companies screw up repeatedly, they go belly up.

Critique: Maybe the federal government screws up, but we should just try to make it work better.

Response: The histories of the Corps and Reclamation illustrate patterns of failure for more than a century. And we’ve explored similar patterns with other federal agencies at www​.down​siz​ing​gov​ern​ment​.org. Federal problems are often deep-rooted and systematic, and they defy the many well-meaning efforts at reform, such as Al Gore’s “reinventing government” initiative in the 1990s. So it’s time to try something different—like exploring privatization.

Critique: We need the federal government for things like the Interstate Highway System because infrastructure crosses state lines.

Response: Numerous people made this point regarding my op-ed, but I’m afraid they didn’t put their thinking caps on. Private energy pipelines cross state and international borders, and so do the huge systems of the private freight railroads, such as Union Pacific.

Critique: Federal agencies, such as the Corps, often contract-out work to private companies that do the actual construction, so failures like Hurricane Katrina are private failures.

Response: Hurricane Katrina represented a failure of government on many levels, as I’ll address in an upcoming essay on the Corps. The American Society of Civil Engineers concluded that “a large portion of the destruction from Hurricane Katrina was caused by …engineering and engineering-related policy failures.” So that’s the fault of the Corps, not private contractors.

Anyway, the volume of negative, snarky, and knee-jerk responses to my suggesting that the federal government doesn’t work very well is rather depressing. I criticized Rachel Maddow for “thinking big” about federal spending. But the nation is going to have to “think big” about government reforms to avert the looming federal fiscal disaster. Devolution and privatization offer part of the solution both to reduce debt and to revive U.S. economic growth in coming years.

Over at Downsizing the Federal Government, we focused on the following issues this past week:

• Chris Edwards proposes an alternative to Herman Cain’s 9–9‑9 tax reform plan.
• My reaction to Ron Paul’s plan to cut federal spending can be summed up in one word: Hallelujah.
• Chris Edwards wonders if Canada stole the Tenth Amendment to our Constitution.
• Unfortunately, government spending in the United States is 41 percent of GDP.
• The Government Accountability Office throws water on a taxpayer bailout for the U.S. Postal Service.

Follow Downsizing the Federal Government on Twitter (@DownsizeTheFeds) and connect with us on Facebook.

Federal energy subsidies to business are a hot national topic thanks to the Solyndra scandal. Flying below the radar—and deserving more national media attention—are grants and other targeted incentives given to businesses by state governments. There is little doubt in my mind that there are state-subsidized “Solyndras” waiting to be discovered.

The Wall Street Journal took a step in this direction by noting in an editorial that a struggling lithium-ion battery maker subsidized by the Obama administration also received handouts from the State of Indiana. The editorial chides the administration for having “made a habit of investing your cash in their clunkers.” A series of investigations from WTHR-TV in Indianapolis has demonstrated that the administration of Indiana Gov. Mitch Daniels shares that same bad habit (see here).

The Journal editorial’s concluding lines correctly sum up the problem with government subsidies to businesses:

Better to leave commercial financing decisions to private investors and bankers who are likely to take more care with their own money. Politicians write the press releases first and worry about the taxpayer losses later.

As I’ve previously discussed, it was my experience as a state budget official in the Daniels administration that led me to coin the phrase “press release economics” to describe these subsidies. Indeed, WTHR’s investigations of the Indiana Economic Development Corporation showed that the Daniels administration was adept at taking credit for “creating jobs” that never materialized.

It might seem like I’m picking on Daniels, but he’s hardly alone. The Wall Street Journal recently ran an article on similar shenanigans in Texas Gov. Rick Perry’s administration:

In Texas, Mr. Perry in a 2011 report to the legislature credited the Texas A&M Institute for Genomic Medicine with already producing more than 12,000 additional jobs. That’s ahead of the 5,000 promised by 2015.

According to the institute’s director, however, 10 people currently work in its new building. A Houston-area biotech firm that agreed to produce about 1,600 of the project’s jobs has instead cut its Texas staff by almost 400 people, and currently employs 220 people in the state.

What accounts for the discrepancy? To reach their estimate of 12,000-plus jobs created by the project, officials included every position added in Texas since 2005 in fields related sometimes only tangentially to biotechnology, according to state officials and documents provided by Texas A&M. They include jobs in things like dental equipment, fertilizer manufacturing and medical imaging.

Republican governors aren’t the only ones who enjoy playing pretend venture capitalist with taxpayer money. The Mackinac Center for Public Policy’s Capitol Confidential reported this week on state subsidies given to Michigan solar companies by the administration of now-former governor Jennifer Granholm:

Michigan Capitol Confidential took a look back at the nine solar power companies that were approved for state tax credits. Many have fizzled with reports that the companies are laying off employees at a time they were supposed to have been adding jobs.

For example, in 2009 a company from Georgia called Suniva announced it planned to open a $250 million manufacturing plant in Saginaw County. It was to add 500 jobs. Media reports said the company is holding off plans for a Michigan plant after deciding not to pursue a Department of Energy loan.

Energy Conversion Devices and United Solar Ovonics are affiliated companies that have been approved for state tax credits for four different projects that were supposed to add about 5,700 jobs. Both companies announced layoffs this year.

Evergreen Solar opened a solar plant in Midland in 2009. The company announced in August it was filing for bankruptcy.

I’ll end on a (hopefully) positive note. Taxpayers in New York fed up with the state handing out their money to businesses have been fighting a long-running battle to end the practice. The New York State Court of Appeals is currently hearing a lawsuit brought by 50 taxpayers that challenges state grants given to business.

From the Associated Press:

The taxpayer group cited a provision in New York’s constitution that says: “the money of the state shall not be given or loaned to or in aid of any private corporation or association, or private undertaking; nor shall the credit of the state be given or loaned to or in aid of any individual, or public or private corporation or association, or private undertaking.” It has an exception for funds or property used for education and mental health.

Defendants countered that the funding for public purposes through state-designated economic development agencies is supported by law and precedents and doesn’t violate the constitution. “Doesn’t that just invite evasion?” Judge Robert Smith said. “All you’ve got to do is put an intermediary between the state and the recipient?”

Hopefully, Judge Smith’s question foretells a favorable outcome. A win for New York taxpayers could raise the issue’s profile and embolden fed-up taxpayers in other states.

The Government Accountability Office has weighed in on the controversy over whether the federal government “owes” the U.S. Postal Service approximately $50-$75 billion in alleged pension “overpayments” made by the USPS to the government’s retirement system. In short, the GAO concluded that the USPS is not owed the money.

The controversy is interesting because it pits government agencies against each other. The USPS, the USPS inspector general, and the Postal Regulatory Commission say money is owed. The Office of Personnel Management, which administers the government’s retirement system, and the OPM inspector general say that money isn’t owed. The GAO is the most neutral party so its findings should carry more weight with members of Congress. Let’s hope as a transfer from the federal government to the USPS would amount to a taxpayer bailout.

The GAO explains:

Any assets that are transferred from the nonpostal to the postal subaccount of CSRS [Civil Service Retirement System] would increase the federal government’s nonpostal CSRS unfunded liability, which must then be paid by the federal government through tax revenue, borrowing, or both. For example, adoption of the recommendation in the PRC report would result in an asset transfer of about $50 billion to $55 billion, which would then need to be repaid by the federal government and taxpayers.

The GAO also notes that a bailout wouldn’t solve the USPS’s long-term problems:

Any change in the USPS’s share of responsibility for CSRS benefits would provide some temporary relief from the pressures USPS faces because of declining volume, revenue, and inflexible costs, but would not by itself address USPS’s long-term financial outlook. Such a transfer of CSRS funds would not be sufficient to repay all of USPS’s debt and address current and future operating deficits related to USPS’s inability to cut costs quickly enough to match declining mail volume and revenue.

See this Cato essay for more on the USPS’s problems and why it should ultimately be privatized.

My good friend Kathy Ruffing at CBPP takes me to task for testifying that government spending in the United States is 41 percent of GDP, which in my view is a very high and harmful level.

Kathy says that recent U.S. spending data is “exaggerated” because of the recession, and indeed, spending has soared not only here, but in most major countries because of the unfortunate popularity of Keynesian pump-priming theories. My point was that the American smaller-government advantage eroded both during the Bush growth years and during the Obama recession years, as seen in Figure 2 of my testimony. 

Kathy noted that the OECD data I used are different than U.S. national income accounts data published by the Bureau of Economic Analysis. Well, that’s right. Every country has quirks in the way they do their national income data. The advantage of using OECD data is that the economists at the OECD adjust for these quirks and create spending data that is comparable across countries. If Kathy has more accurate international comparisons, I’d love to see them.

Finally, Kathy says that just because American government spending divided by GDP is about 40 percent, that “doesn’t mean that government controls about 40 percent of the U.S.economy.” I don’t agree. She means that government does not produce 40 percent of gross domestic product, which is true. The broader figure of 40 or 41 percent includes not just government production but government transfers. And transfers do entail government control over resources because both the taxing and spending activities involved in transfer programs distort private sector behavior. Thus, the government misallocates resources both when it “produces” useless solar power activities in its own labs and when it subsidizes failed private solar companies. 

Anyway, thanks to Kathy for raising the important issue of the overall size of government because it is something that the policy community should focus more attention on. For data geeks, the OECD has all kinds of cross-country comparison data here. Government spending is Table 25.

The Herman Cain campaign released details of the revenue expected to be collected from his 9–9‑9 tax plan. Here are the estimates for 2010:

• $701 billion from the 9 percent personal income tax.
• $753 billion from the 9 percent retail sales tax.
• $863 billion from the 9 percent business VAT.

Yikes! By far the largest tax haul under the Cain plan would be from the business VAT—a tax which would be hidden from most voters.

By the way, the Cain business tax is not a tax on “corporate income,” as some media stories are identifying it. The new revenue data makes it clear that it is a tax on all value added by all businesses in the nation—corporate, partnership, and proprietorship.

Sorry Mr. Cain, I think your tax plan gives the federal government far too much room to grow in coming decades as entitlement cost pressures increase. I’d suggest dropping 9–9‑9 and going with my 15–15-15 tax plan. After that, you could move on to proposing a detailed plan for spending cuts, as candidate Ron Paul has delivered.