Tax Policy Reform: Facts, Figures & Recommendations (Issues 2006)

Taxes

By Daniel J. Mitchell, Ph.D.

The goal of tax policy should be to raise the amount of money needed to fund legitimate functions of government while doing the least amount of damage to the economy and respecting the principle of treating taxpayers equally. This is why a low-rate, consumption-based system like the flat tax is the ideal approach. A flat tax has a low tax rate and eliminates the current tax code’s pervasive bias against saving and investment. It also eliminates special preferences and penalties that lead individuals and businesses to make choices based on tax considerations rather than on economic benefits. This is why a flat tax will boost growth. Since a flat tax also is based on the principle that all taxpayers are treated equally regardless of how they earn their income, how they spend their income, or the level of their income, the system is both morally and economically superior to the current Internal Revenue Code.

Recommendations

Make the Bush tax cuts permanent. While far from perfect, the Bush tax cuts have moved tax policy in the right direction. Income tax rates have been slightly reduced, with the top tax rate falling from 39.6 percent to 35 percent; the double taxation of dividends on capital gains has dropped to 15 percent; and the death tax will disappear in 2010.
Fundamentally reform the tax code. Tax cuts are just one step toward the ideal of scrapping the colossal federal tax code. Either a flat tax or a single-rate national sales tax would be fairer, would lower compliance costs, and would spur economic growth. One of the current system’s blights is the alternative minimum tax (AMT), a "Catch-22" system that forces an ever-larger number of taxpayers to recalculate their tax burdens and, if it results in a higher tax liability, pay more tax.
Eliminate the death tax. The estate tax is one of the most inefficient and immoral features of the current tax system. Its sheer complexity results in high compliance costs—by some estimates, as much money as is raised by estate taxes. Many small businesses and family farms are destroyed by its penalty, which distorts incentives and hurts families. Although the 2001 tax cut kills the death tax in 2011, the penalty is resurrected the following year.
Institute dynamic scoring of tax proposals. Congress routinely debates changes in tax policy largely without considering their economic or dynamic effects. Absent an understanding of how tax and fiscal policy influences economic behavior, the static "cost" estimates produced by official revenue estimators (the staff of the Joint Committee on Taxation, the Congressional Budget Office, and the Treasury Department’s Office of Tax Analysis) are often shockingly wrong and nearly always misleading. The current static approach creates an artificial and incorrect bias in favor of tax rate increases and against pro-growth tax rate reductions.
Lower the corporate income tax rate. The United States now has the world’s second highest corporate tax rate, second only to Japan’s. America’s corporate tax rate is higher than the rate in every European nation—even socialist welfare states like France and Sweden. This creates a significant competitive disadvantage for U.S.-based companies. But even if the United States were the world’s only nation, the corporate tax rate should be reduced.
Abolish "worldwide" taxation. The greedy hand of the Internal Revenue Service reaches out to tax labor income, capital income, and corporate income earned in other nations—even though this income already is subject to foreign tax. This "worldwide" taxation places U.S. companies at a competitive disadvantage, reducing their share of the global market. Some argue that worldwide taxation is a good idea because it discourages U.S. companies from operating abroad, but this policy neither limits competition from factories in low-tax countries nor restricts imports. Instead, it impedes U.S. companies’ ability to capture a bigger share of foreign markets, thereby leading to fewer exports from the United States and fewer jobs here. Territorial taxation—the common-sense notion of taxing only income earned inside national borders—is good tax policy, and reducing the tax burden on foreign-source income is a simple step in this direction that would help the economy by resulting in more jobs, better jobs, and improved competitiveness for U.S. companies.