WASHINGTON - A controversial tax reform proposal by Rep. Dick Armey, R-Tex., the new House majority leader, has stirred widespread public interest and a little flimflamming by the Treasury Department.

Last June, Mr. Armey introduced a far-reaching bill to phase in a flat tax rate of 17% for individuals and corporations. The bill seeks to slash taxes, simplify the tax code, reward savings, and cap federal spending programs - all at the same time.

Mr. Armey is currently putting the bill on hold while House Republican leaders pursue their ambitious Contract With America agenda, which includes a $500 tax credit per child for families and proposes rolling back the Social Security tax increases on the wealthy in the 1993 tax law.

But Mr. Armey remains committed to the idea of a flat tax. He told the Washington Times in an interview last month that he believes a flat tax will be in the Republican platform for the 1996 election.

Aides say they have been surprised at the interest and support that Armey's bill has generated, suggesting it has a powerful political appeal that Republicans won't ignore as they train their eyes on the White House. Supporters include the National Taxpayers Union (250,000 members), the Christian Coalition (1.4 million members), and Citizens for a Sound Economy (250,000 members).

Mr. Armey's bill has also drawn supporting editorials and columns from around the country.

Mr. Armey favors replacing the current mishmash of loopholes, deductions, and rates in the tax code with a flat 17% tax on individual wages, salaries, and pensions. Deductions for state and local taxes and interest payments on mortgages would no longer be allowed. But there would be generous personal exemptions that would reduce taxable income before the 17% rate is applied.

Mr. Armey calculates that a family of four with a $100,000 mortgage and $50,000 in income would pay $3,060 in federal taxes under his plan, $884 less than it does now.

Families with more modest incomes would do even better. A family of four earning $34,000 that now pays $1,739 in taxes would pay no taxes at all.

Corporations would also pay a flat tax of 17% on profits, after adjusting for plant and equipment investment and wages paid to employees. The capital gains tax would be eliminated.

All of this apparently frightened the Treasury Department, which leaked an internal analysis of Armey's bill that concluded it would add hundreds of billions of dollars to the deficit. The analysis, which came to light a week before the election, was prepared by Eric Toder, deputy assistant secretary for tax analysis.

According to Stephen Entin, a Treasury official in the Reagan administration, the Clinton Treasury failed to take into account the fact that Mr. Armey's bill would disallow many deductions by businesses and individuals. As a result, the deficit projections were pumped up.

"Our understanding is that some political people told the number crunchers to do this," said one House source.

Normally, Treasury officials try to offer technical analysis that then meets tough scrutiny from accountants, economists, and other experts. They check with congressional aides to go over the details of any bill. Apparently, in the rush to put a political spin on Mr. Armey's proposal, none of this was done.

Bond Buyer is a sister publication of American Banker.

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