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Although some tax increases may be needed to help balance the budget, all reasonable options for cutting spending should be exhausted first.
Tax rate increases would yield less “revenue” than expected due to changes in taxpayer behavior and drag effects on the economy.
Such “revenue” increases as were achieved might serve as a pretext for more Government spending rather than being used to balance the budget.
Furthermore, polling has consistently shown that the majority of Americans prefer spending cuts to tax increases. A survey that SAFE conducted in September 2007 showed a 4-1 margin in favor of spending cuts.
Does this mean the tax system should be kept as it is? No, because the current system has many problems.
Excessive complexity - The Internal Revenue Code grows longer and more complex with every session of Congress. Just think of all the nonproductive effort to interpret and hopefully comply with its provisions (as supplemented by thousands of pages of IRS Regulations, Revenue Procedures, Revenue Rulings, etc.).
Erratic application – Due to the exemptions, deductions and credits that are available, over half of Americans pay more in Federal payroll taxes (to cover their Social Security and Medicare benefits) than in income taxes (to cover general costs of the Government). Indeed, many people pay negative income taxes (receive money back) due to the Earned Income Tax Credit and other “refundable” tax credits.
Double taxation – The earnings of large businesses are typically taxed twice, once at the corporate level and a second time (albeit currently at a reduced rate) when paid as dividends to shareholders.
Alternative minimum tax (AMT) – Originally enacted in an attempt to ensure that wealthy taxpayers could not use “loopholes” to avoid all tax liability, the AMT is becoming applicable to more and more taxpayers because the specified income thresholds were not indexed for inflation. But for the perennial AMT patch (a waste of time and energy for all concerned), millions of additional taxpayers would be forced to calculate their tax twice, once on the regular basis and the second time on the AMT basis, and pay whichever bill is higher.
Noncompliance – There is some cheating with any tax system, but the Federal income tax has worked reasonably well over the years due to a high level of voluntary compliance. Given the foregoing problems, however, voluntary compliance is eroding.
Three options for overhauling the tax system seem worthy of consideration.
Option One: Flat Tax – In addition to overhauling the Internal Revenue Code (option one), replace the graduated tax rate table with a single tax rate (e.g., 17%). As a result of increasing personal exemptions, about half of the population would be removed from the tax rolls. As the result of the exemptions, the effective tax rate would vary from 0% to nearly 17% for very high earners.
Option 2: “FairTax” – Replace Federal income, payroll (and also self employment), corporate and death taxes with a Federal sales tax (“the FairTax”) levied at a rate (perhaps 23% of purchase amounts) designed to raise the same amount as the several taxes eliminated. To temper regressivity, consumers would receive, in equal monthly installments, an annualized FairTax rebate on poverty level (determined by the Government for the household size) expenditures. Thus, a worker who consumed the poverty level amount would pay zero tax.
Option Three: SimpleTax – A thorough overhaul of the current tax system to make it a vehicle to raise revenue vs. fostering social policy goals. Thus, for the individual income tax: broaden the tax base; repeal tax credits, AMT and most exemptions; eliminate double taxation of corporate income and marriage penalty for 2-earner households, reduce tax rates by 5+ percentage points at all income levels.
In our opinion, the SimpleTax is the best of the three options. For detailed discussion, see the following November 2010 memorandum. SimpleTax
6/2/14 – It’s not a slam dunk, but some progress on tax reform may be possible
2/11/13 – More tax revenue would be nice
1/14/13 – A tax overhaul is way overdue
7/16/12 – Raising taxes on high earners
2/27/12 – House Ways and Means should get moving
1/16/11 – SAFE offers DC a “to do” list for 2012
1/2/12 – Happy 2012, and why it’s time to focus on taxes
12/5/11 - Bin the payroll tax cut
11/28/11 – Tax cuts for rank and file now; tax increases for the wealthy in 2013
12/13/10 – DC action: the tax cut deal is overloaded
11/8/10 – Internal Revenue Code 2.0 – part two
11/1/10 -- Internal Revenue Code 2.0
9/20/10 – Raising taxes and a crackdown on cheating won’t solve the fiscal problem8/9/10 – Sorry, but there are no “painless” ways to raise taxes
1/19/09 – Never mind the “tax cut”
10/10/08 – Famous last words: “my plan will cut taxes”
6/16/08 – To win “Budget Hero,” raise taxes
6/2/08 – Message to Congress: cap taxes now
5/26/08 – A line in the sand on taxes
11/19/07 – Let’s stop tinkering with taxes and reboot the system
10/15/07 – Refundable tax credits: not the answer for healthcare