News Release

By DAVID WILLIAMSON
UNC News Services

CHAPEL HILL -- Echoing what others first suggested about 30 years ago, a University of North Carolina at Chapel Hill business expert says President Bush could do citizens, corporations and the nation a tremendous service by pushing dramatic tax reform.

Among the most welcome and useful changes would be scrapping the entire income tax system and creating a flat tax on consumption instead, said Dr. James F. Smith, professor of finance at UNC’s Kenan-Flagler Business School.

"President Bush campaigned in 2000 on a pledge to reduce personal income taxes, which had reached the highest share of gross domestic product (GDP) since 1943 by 1999," Smith said. "This, coupled with declines in the defense share, was a huge part of why we had budget surpluses for fiscal years 1998-2001. He succeeded in getting his first tax cuts passed in 2001, just in time to help make the recession that began in March that year and ended in November the mildest one ever recorded."

Real GDP (GDP adjusted for inflation) fell only 0.4 percent during the 2001 recession, and the recovery was completed by Dec. 31, 2001, he said. Since then, the U.S. economy has been expanding.

The president convinced Congress to go along with a second tax cut in 2003. That happened in time to help the expansion pick up after being hammered by the Sept.11, 2001 terrorist attacks, corporate scandals and the war in Iraq, Smith said.

"Unfortunately, all these tax changes, several more of which were enacted or extended in two tax bills enacted in the past few months, have added even more complications to the tax code," he said. "It takes a real expert to be able to fill out her or his own tax return these days, and it gets worse every year."

The UNC professor, rated by The Wall Street Journal as the nation’s most accurate economic forecaster in three of the past nine years, made his remarks in the latest issue of the Business Forecast, a newsletter he writes for the business school.

"President Bush has said he wants to make his tax cuts permanent," Smith said. "He has also said he wants to pursue tax reform in his second term. A very good way to do that would be to junk the entire current system of corporate and personal income taxation. A wonderful replacement would be a flat tax on consumption."

All analysts agree that one of the biggest U.S. economic problems is the low savings rate, he said. Since savings must equal investment by definition, that shortfall "means that we must rely on foreigners to finance investment in the United States."

Total retail sales in this country were nearly $4 trillion in fiscal year 2004, which ended Sept. 30, the economist said. Total personal income tax receipts in the same period were $816.3 billion. Thus a flat tax on retail sales would have to be 20.6 percent to replace the income tax. If all services such as work performed by utilities, doctors, dentists, lawyers, educators and others were subject to the same tax, the rate could be reduced to 12 percent or so.

"If one wished to provide a rebate to all households with less than the median income of $50,000, then a flat rate of about 14 percent would work," Smith said. "This would result in a huge efficiency gain for the U.S. economy. We could abolish the Internal Revenue Service and repeal the 16^th amendment to the Constitution, so it would be hard to bring back an income tax. If businesses paid the same flat tax, the rate could probably be reduced to 11 to 12 percent, though business taxes are always passed along to consumers through pricing."

Savings would not be taxed at all, he said. Neither would dividends or capital gains or estates. There would be no loopholes. There would be no special interests lobbying Congress for tax breaks.

The sellers of goods and services would collect taxes. The collected money would be sent on to the U.S. Treasury on a daily, weekly or monthly basis, depending on volume.

"Some experts have estimated that such a tax would add one to two trillion dollars in efficiency gains to the U.S. economy over the first few years," Smith said. "It would also make the level of U.S. economic activity permanently higher and would dramatically reduce or even eliminate the federal budget deficit until 2012 or so."

Some people like such a tax because it would bring the underground economy totally into the system, he said. All consumer spending would be taxed.

The late broadcaster, David Brinkley, used to say that as desirable as such a system is, it would never come to pass because members of Congress get too many donations from people who want a specific tax break of some sort, Smith said. Brinkley may have been right, but many people said the same things about the Tax Reform Act of 1986.

"Just think about never having to fill out any tax forms again," he said. "That smile on your face ought to help make you an advocate of the flat tax on consumption."

- 30 -

Note: Smith can be reached at (919) 593-0308 (cell), 968-9995 or smith.jf@mindspring.com 

Kenan-Flagler contact: Kim Spurr, (919) 962-8951

News Services contact: David Williamson, (919) 962-8596