Can Tax Reform Save the U.S. Economy? Some Influential Economic Thinkers Offer Their Perspectives

The International Economy, Winter 2012 | Go to article overview

Can Tax Reform Save the U.S. Economy? Some Influential Economic Thinkers Offer Their Perspectives


With U.S. public debt rising as a percentage of GDP, reform of the personal and corporate income tax codes has been suggested as a solution to achieving the twin goals of deficit/debt reduction and higher rates of economic growth.

Two important American economists have reached opposite conclusions on this issue. Martin Feldstein argues that the Tax Reform Act of 1986 "showed how a tax reform that includes lower rates can change incentives in a way that grows the tax base and produces extra revenue." Feldstein argues that the 1986 experience "showed an enormous rise in the taxes paid, particularly by those who experienced the greatest reductions in marginal tax rates." In view of today's budget shortfall, he suggests that the flattening of the tax code after the 1986 tax reform "implies that the combination of base-broadening and rate reduction would raise revenue equal to about 4 percent of the existing tax revenue," potentially "more than $500 billion in savings over the next ten years."

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Alan Blinder concedes that both the U.S. personal and corporate tax codes are "disgracefully complicated messes." He argues, however, that "flattening the rate structure won't make the tax code any simpler. It would, however, make the tax system far less progressive" and thus less fair. Blinder also notes the political difficulty of reforming the tax code: "Every tax 'gimmick' has an engrained constituency. I shake my head in disbelief when I hear politicians claim to be able to raise huge amounts of revenue by closing loopholes. Arithmetically, that's easy. Politically, it's almost impossible." Blinder adds that "many useful steps could be taken to simplify the personal income tax ... but flattening the rate structure isn't one of them ... The corporate income tax is virtually fiat once a corporation passes a paltry $750,000 in taxable income. Is it simple?"

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At a time of expanded public debt and below-trend growth, should enactment of tax reform be a top priority?

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PAUL RYAN

Member, U.S. House of Representatives (R-WI) and Chairman, House Budget Committee

Will tax reform work? Let's put the question another way: For whom does the tax code currently work?

It doesn't work for American families. The code is notoriously complex, as individuals, families, and employers spend over six billion hours and over $160 billion per year trying to negotiate a labyrinth of deductions and credits, a tangle of different rules for characterizing income, and a variety of schedules for taxing that income. Simply put, the code is too costly and too burdensome for hardworking families trying to make ends meet.

It doesn't work for small businesses, either. Many successful small businesses in America file as individuals. Their income is taxed at the top marginal rate, and the proliferation of artificial deadlines in today's tax code has left them exposed to uncertainty and the threat of higher tax rates each year. The expiration of current tax rates, scheduled for the end of next year, would raise the rate that these businesses pay to 44.8 percent, and proposals put forward by the President and leading Democrats would raise this rate to roughly 50 percent.

Nor does the current tax code work for U.S. employers that compete overseas. At 39.2 percent, America's combined federal, state, and local corporate tax rate is the second-highest in the developed world. Other developed nations tax their businesses at an average rate closer to 25 percent, meaning we are forcing American employers to compete at a disadvantage in global markets, or worse, encouraging them to move operations overseas.

For whom does the current code work? A code with high rates and lots of loopholes benefits those powerful interest groups that can afford the best lawyers and lobbyists in Washington. Rather than join together to argue for lower rates, those with political muscle usually take the path of least resistance by pushing for special deductions and carve-outs.

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