STATE TAX EXPECTED TO FOLLOW U.S. LEAD\Systems linked, controller says.

Byline: Gregory J. Wilcox Daily News Staff Writer

Implementing a federal flat tax could force California to follow suit or make drastic changes in its own taxing structure, State Controller Kathleen Connell said Wednesday.

Speaking at a tax reform conference at UCLA, Connell said that any of the various flat tax proposals would have a major impact on the way California's state and local governments collect their revenues.

"If they eliminate the income tax at the federal level it would almost be impossible for us to maintain the current tax system we have," Connell said.

The reason, she pointed out, is that the state income-tax system is closely tied to the federal government's.

If a flat tax is adopted, Connell favors maintaining a deduction for home ownership and holding down any increase in taxes paid by small businesses because these enterprises account for 97 percent of the nongovernment jobs in California.

In the last year about six flat-tax proposals have surfaced, and the issue is getting more attention now because it's a key component of publisher Steve Forbes' presidential campaign.

The proposals surfaced after Congress decided to explore ways to overhaul the cumbersome federal tax system. Many deductions and tax shelters would disappear, but tax rates would be lowered under most flat-tax plans.

The most prominent proposal is the "Freedom and Fairness Restoration Act of 1995" sponsored by House Majority Leader Richard Armey, who would cap the tax rate at 17 percent. He modeled his plan after one by economists Robert Hall and Alvin Rabushka of the Hoover Institute. They call their plan simply "The Flat Tax," characterized by postcard-sized returns for both businesses and individuals.

Unlike the current system, which taxes income, the flat-tax plans basically would tax consumption because income set aside for savings would be sheltered.

Hall, one of the panelists at the day-long conference, said that his plan could increase the nation's economic growth by 6 percent over seven years.

State governments could likewise benefit by implementing their own flat-tax systems, he said.

"There will be a very strong desire on the part of states to emulate a federal flat tax and I think that would be a very good idea," he said.

Connell said that any form of tax reform should be revenue neutral, promote economic efficiency, be perceived as equitable and restore simplicity.

The U.S. Treasury Department has estimated that a tax rate of 22.9 percent would be necessary to achieve revenue neutrality.

Based on that assumption, an analysis by the controller's office concludes that individual taxpayers would be the big winners and businesses the big losers under a flat-tax plan.

On average, individual taxpayers in California would see their federal income tax bill reduced by 24 percent, while the bills for businesses would jump 139 percent. Federal revenues would increase by 6.6 percent.

Connell notes that for individuals the tax burden would shift from the wealthy to the middle class.

Economist Arthur Laffer, a former policy adviser to President Ronald Reagan, said he favors a flat tax because it spreads the lowest possible tax rate across the broadest possible base.

He would even abolish all state and local tariffs except property and sin taxes. This would help individuals at the lower end of the pay scale.

"The whole purpose of introducing a flat rate tax is . . . economic growth," he said. "Economic growth always helps the lower echelon."

But economist Leslie Appleton-Young, vice president of public policy at the California Association of Realtors, said a flat tax would be bad news for her industry, sending it into a 10 year slump.

Housing starts would plunge by 28 percent in the first year of such a plan and sales would plummet by 19 percent. At the end of 10 years those figures would taper offer to 5.2 percent and 5.5 percent, respectively.

"Housing is a loser under the flat tax," she said.