MOST years, they do not get really angry until early April. But, in an election year, America's taxpayers are starting early. They are fed up with the federal tax code, a tangle of tax breaks and loopholes that only accountants and politicians could love. Many of them have grown so disgusted that they want to scrap it altogether and start again from scratch. Emboldened by their new majority in Congress, the Republican Party's leaders see a golden opportunity: with one blow, they hope, they can simultaneously score a hit with voters and kill a tax system they have always loathed. 

The Republicans are already pushing several different proposals. To help bring some cohesion to their efforts, Newt Gingrich and Bob Dole, the party's House and Senate leaders, appointed a commission last May, led by Jack Kemp, one of the Republicans' leading economic thinkers and a strong advocate of a 'flat tax'. After months of public hearings across the country, the commission was scheduled to unveil its report earlier this week, before a tremendous snowstorm intervened. The outlines of their proposal, however, are already known. 

At its heart will be a plea for America to abolish its entire system of personal and corporate income tax - down to the last itemised deduction - and replace it with a single-rate tax on consumption with generous exemptions for the poor. For good measure, the panel is also expected to suggest making it harder to raise taxes, by requiring a two-thirds vote in Congress to do so. 

However, despite the seeming boldness of its recommendations, the committee has tip-toed through some of the trickiest issues. The present code looks as it does for a reason. It is a finely-tuned instrument for rewarding politically powerful interests: the middle class, home-owners, big corporations. These groups will not surrender their privileges willingly. Moreover, most of the reform plans on offer have been denounced by their opponents as giveaways to the rich, a charge that Bill Clinton will try to make stick in his bid to win re-election. The problem facing Mr Kemp and other tax-reformers is to convince voters angry with the present system without arousing the wrath of those whom it benefits. 

Or, for that matter, those who wish to change it. The Republican Party's leaders, especially those who would be president, are offering several competing plans for reform (the exception is Mr Dole, who has been on the fence awaiting the panel's report). The most noteworthy is Steve Forbes, whose rise in the Republican primary polls rests almost entirely on his backing of a pure flat tax (along with several million dollars in campaign advertising). To steer clear of these political battles, the panel is expected to avoid endorsing any specific tax scheme. It will simply lay down the broad goals that it believes any reform plan should meet. 

In the event, therefore, the Kemp commission's guidelines will not be enough to settle the party's disagreements over exactly how reform should proceed. Supply-siders, who hate impediments to economic growth, want lower tax rates for investment income and the rich. Populists, who hate loopholes, want to force corporations and wealthy individuals to pay their fair share. And libertarians, who simply hate government, want to strip the Internal Revenue Service (IRS) of as much power as possible. If they are to lead a true rebellion against the tax code, the Republicans must overcome these divisions soon, and rally behind a coherent, compelling plan for replacing the current system. 

The trouble with taxes 

That the system needs reforming is clear enough. It is riddled with exemptions for everything under the sun; it stifles investment and entrepreneurship; and it is beastly to comply with. On these points all agree. The only real question is what to do about it. To shed some light on this, it helps to ask what an ideal tax system should accomplish. 

The basic problem with taxes is that they punish whatever is being taxed. As a result, they distort the decisions of families and firms, which leads to all kinds of economic nonsense. One compelling objective of tax policy, therefore, is to make taxes as neutral as possible: rather than punish some productive activities a lot, punish them all a little. 

America's system (and that of most other countries) violates this principle in three ways. It applies different tax rates to different activities. It favours consumption over saving, discouraging investment in productive capital. And it applies high marginal rates to people with high incomes, discouraging effort. A system free of these distortions would also be much cheaper to administer. (Most experts reckon that the cost of complying with the present system is well over $ 100 billion a year.) 

So the benefits of a more neutral tax code seem clear. How to achieve them? One way would be to replace the entire income tax (on both people and corporations) with a simple consumption tax (also known as an expenditure tax), along the lines that Mr Kemp's commission will suggest. By taxing all consumption once and only once, with no loopholes, such a scheme would treat all industries equally, and would eliminate the bias against investment and saving. Despite the furore over competing schemes, most of the reform plans being mooted are in fact variants of such a tax. 

A taxonomy of reforms 

One way to tax consumption without taxing investment, for example, is to use a retail sales tax. This would levy a tax at the point of sale on all retail goods and services. It has been estimated that in order to raise the same amount of revenue that the corporate and personal income taxes provide now, America would have to set this rate at around 15%, provided nothing is excluded. 

However, a pure retail sales tax is easy to evade - it is simply a matter of by-passing the retailer. Taxing goods would be difficult enough; taxing retail services would be even harder. Economists at the OECD reckon that any retail sales tax higher than 10-12% would encourage unacceptable levels of cheating. 

To deal with evasion, governments that rely heavily on sales taxes tend to push the tax further down the distribution chain, through a value-added tax (VAT). This approach has been used in most of Western Europe. Rather than taxing only retailers, based on their sales, the government could tax all businesses, based on their 'value added' (roughly, their sales minus their non-wage costs) minus an extra deduction for capital investment. Because the tax is levied on the total value of the economy's final goods, such a VAT is essentially equivalent to a sales tax. Its beauty, though, is that it is self-policing: every transaction is reported twice (a wholesaler's revenues are a retailer's costs) by two different parties. 

The biggest drawback of both kinds of sales tax is clear: they clobber the poor. Because poor families would pay a tax on all their purchases, they would face the equivalent of, say, a 15% tax on all their income, with no exemptions. Since the poor consume almost all their income, their average tax rate would actually be higher than that of many rich people. Eliminating essential goods such as food and clothing from the sales-tax base would drive the tax rate on all other goods unacceptably high. 

Fortunately, however, there are ways around this. One would be to give cash to the poor to offset the effects of the tax. Another would be to give every taxpayer a generous rebate - say $ 3,000 per family - at the end of the year, which would benefit the poor, who consume less, disproportionately. Even without using subsidies, however, there are at least two other ways to tax consumption in such a way that the poor face a lower average tax rate than the rich. 

The first is through a consumed-income tax. This, as the name implies, is an income tax which exempts savings. Each taxpayer would add up his total income for the year (eg, wages, salaries, dividends and interest), and subtract from this his net new savings (eg, contributions to bank accounts and purchases of shares and bonds). He would then pay a tax on the difference. The base for such a tax would again be consumption, as with a sales tax. But the advantage is that, by collecting the tax from pay-packets instead of at the check-out, the government could apply a higher rate to people with higher incomes, thereby making the system as progressive as it likes. 

The other way to tax consumption is by means of a flat tax on households and businesses. Recall that the economy's total consumption is equal to its total income (from labour and capital) minus its total investment. A consumed-income scheme taxes all of this at the household level; a VAT taxes it all at the business level. A flat tax essentially combines the two approaches. Income from employment is taxed at its destination (households); income from capital, net of investment, is taxed at its source (businesses). The business part of the tax is similar to a VAT. But besides subtracting its input costs and investment from total sales, each company deducts its labour costs as well. Labour income is then taxed at the same rate, at the household level. 

Surprisingly, then, a flat tax of this kind is, in effect, just another variant of the consumption tax. It is harder to understand than a consumed-income tax or a VAT; but it is also far simpler to implement. This is because a flat tax offers the best of both worlds. 

The virtue of simplicity 

Like a VAT, it makes the tax on capital income easier to administer. Businesses do not have to worry about how their decisions affect the taxes of their myriad shareholders, each with different incomes and personal circumstances. There is no need to file countless forms certifying the amount of dividends that companies have paid out to each shareholder. And the IRS is spared the chore of verifying how much people save. 

Like a consumed-income tax, a flat tax is also easy to make progressive. Since labour income is taxed at the household level, the government can offer generous personal exemptions on a big chunk of each taxpayer's wages. It has been estimated that a flat tax raising as much revenue as the present system could combine a rate of 19% with an exemption of about $ 28,000 for each family of four (with other families getting bigger or smaller exemptions depending on their size). This would allow a family's average tax rate (ie, its total taxes as a share of its total income) to increase with its income. 

Whereas the current graduated-income-tax system has multiple tax rates, the flat tax has only two: zero and, say, 19%. These marginal rates translate into the average rates shown in the chart on the left. Although the flat-tax curve is not as steep as that for the current system, the tax burden still rises fairly sharply with income. In other words, the flat tax is progressive. However, this comparison takes no account of loopholes. The chart below shows how much people with different incomes actually pay, on average, under the current system. 

The various consumption-tax schemes on offer would bring broadly similar economic benefits. The scale of these is hard to predict, given the dramatic shifts in resources they might produce. But, unlike the usual tax gimmicks cooked up in Washington, the effects of such a reform would be enduring, the result of fundamental changes in the economy - fewer distortions, higher rewards for saving, and (with some plans) lower marginal rates. 

Because all these approaches are roughly equivalent in economic terms, the most important differences are political. On this score, the flat tax may be America's best bet. To begin with, it is much simpler than the present code. The plan's supporters are fond of holding up the postcard-sized forms on which each taxpayer could file his return. More important, however, it would no longer be possible for politicians to confuse voters with mind-numbing details and competing forecasts. Voters would need to ask only two questions. How much income is excluded? And what is the tax rate? Political debate might then have a better chance of focusing on issues that matter. 

Moreover, by offering a generous exemption for, say, the first $ 28,000 or so of wages, a flat tax would make America's tax system progressive where it most needs to be: at the bottom. The 'rich' would still pay a lot more than everyone else. But the next time a politician promised to pay for a new government programme by jacking up their tax rates even higher, he would have to convince the average voter that it was worth making him pay more as well. 

A bumpy ride 

The flat tax appears to be the most popular proposal among Republican voters. However, the odds of passing a pure flat tax are slim. The main reason is that, no matter how simple the scheme, arguments about taxes tend to become complicated. Opponents of reform are free to dream up whatever criticisms they like: merely saying them out loud is enough to strike fear in the hearts of voters. Reformers, meanwhile, cannot rely solely on simple economic logic to overcome these claims: they must fight jargon with jargon. 

It is enough to make even the most gung-ho voter's eyes roll back into his head. In the case of a flat tax, four snags in particular could prove fatal. 

The rich. A flat tax, opponents say, will benefit the rich, at everyone else's expense. Certainly, many middle-income families would pay more under a flat tax, especially after losing tax breaks - not least, the one for home-mortgage interest. There is nothing inherently fair about the status quo. But the middle class get all those breaks precisely because they are so politically powerful. They will not give them up easily. 

The old. Because it falls on consumption, a flat tax bears heavily on people in retirement. Unlike younger people, the retired tend to consume all their income. Indeed, they consume more than their income, by running down their stock of savings. Any consumption-based tax therefore hits them especially hard. To many people, this is another advantage of the flat tax, since the elderly already receive over-generous benefits from Social Security and Medicare. But they will not allow the taxman to get at their wealth without a fight. 

Investment income. How is it fair, ask flat-tax opponents, for a worker to pay taxes on his $ 35,000 salary, while his neighbour pays nothing on his $ 35,000 in 'unearned' dividend income? Such arguments miss the point. Because all business income is taxed at the source, the second taxpayer has already paid his taxes before receiving his (now lower) dividends. The only 'tax break' he receives is when a business he owns invests in productive capital. 

Payroll taxes. If Republicans wish to scrap the personal and corporate income taxes, which fall most heavily on high-income taxpayers, the argument goes, then they should also replace the payroll tax, which harms lower-income workers. This criticism rests on a peculiar definition of harm. In exchange for their payroll taxes, low-income workers receive pretty handsome Social Security benefits when they retire. As it happens, there are strong economic arguments for reforming Social Security and abolishing the payroll tax, but not because it hurts low-income workers. 

The good old USA 

Although there would indeed be losers from a flat tax, and although some of these deserve genuine consideration, most criticisms of the scheme are exaggerated. Nevertheless, they could easily do it in, especially in the hands of a skilled campaigner such as Mr Clinton. Indeed, in an attempt to throw some cold water on flat-tax fever, Mr Clinton may announce a tax-reform commission of his own, perhaps during his State of the Union address later this month. Even flat-tax fanatics recognise these perils. As a result, they are searching for a more marketable approach. At present, two watered-down plans seem to be the front-runners. 

One of these is the Unlimited Savings Allowance (USA) tax, championed by Senators Sam Nunn (a Democrat) and Pete Domenici (a Republican). Much like the flat tax, the USA tax would eliminate most exemptions and broaden the business tax beyond corporations. It would also eliminate the double taxation of investment income through a form of tax-free savings account. Unlike the flat tax, however, it would retain the current system of graduated tax rates. 

The USA tax is a clear concession to politics. Barry Rogstad, president of the American Business Conference, who helped to design the scheme, admits that a flat tax would be both simpler and better for the economy. But the USA tax, he believes, is about the closest thing to a flat tax that the political process can deliver. 

The other 'moderate' proposal is some form of 'flat-tax lite'. Such a scheme would maintain a single tax rate, along with most of the other mechanics of a flat-tax system. But it would retain some important tax breaks for the middle class, such as the one for mortgage interest. Although it will stress the merits of a clean approach, Mr Kemp's commission, which knows that its recommendations could have a big effect on the Republicans' campaign efforts, will leave the door open for such fudges. 

This seems enticing. By watering down their reform plans, many Republicans hope to capitalise on voters' frustration with the tax code, while wooing a few middle-class voters and dodging Mr Clinton's charges that they favour the rich. It may work - but most likely not for long. If even diehard tax-reformers are willing to sacrifice principles for the sake of appeasing powerful interests, what will happen when a congressional committee gets hold of their brainchild? 

Allowing a few bumps in the flat tax would invite a few more, and then a few more. The system could quickly degenerate into something like the present horror. Lobbyists would descend on Congress by the squadron to convince members that their particular group or activity was truly a deserving one; hundreds of loopholes would allow congressmen to disguise the effects of their patronage; hundreds of thousands of skilled professionals and millions of dollars would be wasted on exploiting every last tax break. In other words, a willingness to compromise could turn out to be the very thing that undercuts the rationale for reform. 

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