Three Versions of Tax Reform
Warren, Alvin C., Jr., William and Mary Law Review
My subject this afternoon is tax reform, which again rose to the top of the U.S. political agenda during last year's presidential campaign. My principal goal in this lecture will be to explore three different versions of tax reform. In order to provide some context for that exploration, I would like to begin by briefly comparing taxation in the United States to taxation in other industrialized countries, focusing on three attributes of a mature tax system.
The first attribute is the overall level of taxation. Although rarely emphasized in American political discourse, the overall level of taxation in the United States is much lower than in other developed countries. In 1994, the most recent year for which comparative figures are available, the total of all taxes, including social security taxes, at all levels of government in the U.S. was 27.6% of gross domestic product.(1) Of the twenty-eight developed countries that made up the membership of the Organisation for Economic Cooperation and Development (OECD), only Turkey and Mexico had lower overall levels of taxation. The OECD average was 38.4% of gross domestic product, while the European Union average was 42.5%.(2)
Turning now from the overall level of taxation to a second attribute, the type of taxes imposed, the United States also differs from most other industrialized nations. Once again, looking at 1994, income taxes provided a comparatively high 44.6% of all American government revenue.(3) Social security taxes provided 25.5%, sales and other consumption taxes 17.9%, and property taxes 12%.(4) Most other developed countries rely significantly less on income taxes and significantly more on consumption taxes. On average, for example, consumption taxes constituted 31.9% of the tax revenue of OECD countries in 1994, almost twice the 17.9% in the United States.(5) To a large extent, this difference is explained by the widespread adoption of value-added taxes over the last thirty-years throughout the industrialized world, with the notable exception of the U.S.
Focusing now particularly on income taxes, the third and final tax system attribute that I want to emphasize is the relationship between the individual and corporate income taxes. The United States continues to have a so-called classical system of income taxation, under which income earned through corporations can be taxed twice, once when earned by the corporation and again on distribution to shareholders. Over the last thirty years, most other developed countries have integrated their individual and corporate income taxes into a single system that is intended to eliminate or reduce this double burden.(6)
This brief international comparison of tax systems can be summarized as follows: first, taxes in the U.S. are lower than in other industrialized countries; second, the U.S. relies relatively more on income taxes and less on consumption taxes than do other industrialized countries; and, finally, the U.S. is one of very few such countries that continues to levy individual and corporate income taxes that are separate and cumulative.
Given that background, let me now turn to three versions of tax reform in the U.S. In each case, I plan to focus on the intellectual foundations of tax reform, the use of those ideas in the political process, and the level of understanding of the ideas by the tax paying public.
I. IMPROVING AN EXISTING TAX BASE
The first version of tax reform that I want to explore is the regular work of improving an existing tax base. Given the relative importance of income taxation in the United States, it is not surprising that "tax reform" in the U.S. generally has meant refinement and improvement of the income tax.
The seminal American formulation of the concept of income for these purposes is the celebrated definition articulated by the University of Chicago economist Henry Simons in the 1930s.(7) Given the centrality of what has come to be called the Haig-Simons definition of income to our first version of tax reform, it is worth quoting the concept in detail:
Personal income may be defined as the algebraic sum of (1) the
market value of rights exercised in consumption and (2) the
change in the value of the store of property rights between the
beginning and end of the period in question. …