Tax Reform.

• Author: Friedman, Milton

Two principles are basic to every discussion of tax reform.

First, tax reform consists of more than changes in those items that are called taxes. The real cost of government--the total tax burden--equals what government spends plus the cost to the public of complying with government mandates and regulations and of calculating, paying, and taking measures to avoid taxes. Currently, this burden, at federal, state, and local levels combined, exceeds half of national income: 40 percent in direct spending and more than 10 percent in indirect costs. Anything that reduces that real cost--lower government spending, elimination of costly regulations on individuals or businesses, simplification of explicit taxes--is a tax reform.

Second, essentially every tax affects incentives by altering the rate of exchange between various activities--between work in the market and at home (e.g., painting your house yourself or hiring a painter), between work and leisure, between one vocation and another, between buying a product or service from one seller or another, and so on in infinite variety. In short, there is no such thing as a neutral tax. But the lower the tax rate, the broader the base, and the more equal the tax rates, the less distortion it introduces. On these grounds, our present corporate and individual income taxes must surely rate as among the most misshapen monstrosities that ingenious tax-gathers have ever created.

Discussion of fundamental tax reform has recently centered on two proposals: House Majority Leader Dick Armey's flat-rate income tax and House Ways and Means Chairman Bill Archer's flat-rate retail sales tax. Both would greatly simplify the tax system and reduce the cost of tax compliance to taxpayers and of tax collection to the government. Both would eliminate double taxation from the corporate tax and the individual tax, reduce the bias against saving, eliminate the marriage tax, level the playing field for income from diverse sources, and reduce the disincentive of high marginal rates to innovation and enterprise.

Though each has advantages and disadvantages, the differences between the two are trivial compared with the superiority of either to our present system. Unfortunately, neither has a chance of being enacted by...