- 07 Mar, 2021
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Taxation
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The following excerpt was taken from, “How to Judge a Tax PlanPreview the document,” by William McBride. Tax Foundation Report No. 286, December 15, 2011. Available for download here: https://taxfoundation.org/how-judge-tax-plan/ (Links to an external site.).
Tax reform has become the central issue in the presidential primaries and will likely remain an important issue in the general election. While the plans and proposals will vary considerably in their scope and intent, it is important that they all be judged against a standard set of guideposts or principles that define a sound tax system.
The ideal tax system should do only one thing: raise a sufficient amount of revenue to fund government activities with the least amount of harm to the economy. By all accounts, the U.S. tax system is far from that ideal.
Since 1937, Tax Foundation economists have judged every tax measure against the immutable principles of economically sound tax policy, which say that: Taxes should be neutral to economic decision-making; they should be simple, transparent, and stable; and they should promote economic growth. See, for example, Adam Smith’s formulation in The Wealth of Nations, that taxes should a) be in proportion to income, b) remain stable, and c) minimize compliance costs and distortions of economic behavior.
The largest group of questions used to evaluate any tax plan deals with fairness and neutrality since this aspect of our current tax code is widely perceived, perhaps correctly, as the code’s most egregious failing. More specifically, it is important to ask:
Does the plan make taxes less of a factor in decision-making and reduce social engineering?
How to think about this: Whether the decision is to purchase a home, replace the windows on that home, build a factory, or hire new workers, taxes should play as small a role in decision-making as possible. Unfortunately, our tax code is rife with measures that attempt to induce taxpayers into all manner of activities, from buying hybrid vehicles to investing in historic buildings.
Not only do these measures distort individual and business decisions; they distort the economy as well. For example, businesses have an incentive to take on more debt than necessary because interest expenses are deductible, whereas equity financing is not. Individuals may choose tax-free health care benefits over taxable wages, thus causing over-consumption of health care. The mortgage interest deduction diverts billions of dollars to the housing industry and away from more productive uses, such as investment in ideas and entrepreneurs.
Moreover, the proliferation of these tax incentives has made the IRS an extension of, or rather a substitute for, every other cabinet agency, from Energy and Education to Transportation and Housing and Urban Development. Were we starting from scratch, these would not be the roles we would assign to a tax collection agency.
While some economists may justify the use of taxes to address “market failures” in specific circumstances, such as a tax on emissions to reduce the externalities (costs external to the transacting parties) of pollution, taxes should otherwise simply raise sufficient revenue to pay for necessary government functions.
Does it improve the stability of revenues?
How to think about this: Whatever the size of government the American people decide they want, the ideal tax system should do one thing only: raise a sufficient amount of revenue to fund government activities with the least amount of harm to the economy. As Jean Baptiste Colbert famously wrote, “The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least amount of hissing.”
However, our current tax system is anything but stable and harmless to the economy. While federal tax revenues have averaged about 18 percent of GDP over the past four decades, they have been particularly volatile in recent years, fluctuating between 15 and 20 percent of GDP. In part this is due to the business cycle, but it is also due to our progressive tax rate system and our over-reliance on tax collections from wealthier Americans, who have highly variable incomes from business and investment sources.
For example, recent IRS data for 2009 indicates the volatility of millionaire incomes and the taxes they generate for the government. Comparing the 2009 data to the pre-recession data for 2007 shows that not only did the number of millionaires fall by 40 percent, but the overall income of millionaires fell by 50 percent.
The result for the U.S. Treasury was that 54 percent of the total drop in tax revenues during this period was due to the falling tax collections from millionaires.
Thus, a fiscally sound tax system should have a broad base that is not restricted to volatile sources of income.
The Tax Foundation is an independent tax policy nonprofit organization. Since 1937, the Tax Foundation’s research, analysis, and experts have informed tax policy at the federal, state, and global levels. For over 80 years, the Tax Foundation’s goal has remained the same: to improve lives through tax policies that lead to greater economic growth and opportunity.
As part of its mission, the Tax Foundation provides tax policy research and analysis on the 2020 Democratic Presidential Campaign Tax Proposals https://taxfoundation.org/2020-tax-plans/ (Links to an external site.). For this discussion board, please select ONE candidate’s campaign tax proposal and evaluate the proposal in terms of its likely 1) revenue adequacy and 2) economic efficiency or neutrality. In your evaluation, be sure to specifically address the two questions posed above.
The responses should directly reference and cite relevant content outside resources obtained on your own.