Taxes

Our tax system is complex, confusing, inefficient, and unfair. The tax code is riddled with tax expenditures, or "tax breaks," including loopholes, deductions, exemptions, credits, and preferential rates. Because these tax breaks provide financial assistance to specific activities and groups, many are actually a lot like government spending in disguise. Worse, they create market distortions that are damaging to economic growth and productivity.

Many economists believe it would help the economy to do away with some or all of these tax breaks, and in return lower marginal tax rates and reduce the deficit. Tax reform done right would promote economic growth, reduce the complexity and burden of compliance, increase the system’s transparency and make it more equitable by treating individuals and businesses in similar circumstances more equally. For more background about the tax system, see Revenues.

Many worthwhile ideas have been proposed for reforming individual and corporate income taxes, in addition to proposals for new types of tax regimes.

Policy Options

Individual Income Tax Reform

One prominent reform strategy is to eliminate most or all of the $1.5 trillion in annual individual income and payroll tax expenditures. In the current system, two taxpayers with the same level of income could face very different tax bills because one taxpayer takes advantage of more tax breaks — or tax expenditures — than the other one. Some of the most expensive tax expenditures are also the most popular, including tax breaks that cover employer-provided health benefits, retirement plans, and mortgage interest. For that reason, tax reform should be phased-in gradually to give people time to adjust to the changes.

Six popular tax provisions account for more than half of annual tax expenditures

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Eliminating individual tax expenditures could allow for a number of other changes to the tax system, including lower tax rates, while also producing additional revenues to help reduce our long-term debt. It could also improve the efficiency of our economy and improve taxpayers’ confidence in the fairness of the overall system.

Corporate Income Tax Reform

The corporate tax system is also flawed in ways that harm economic growth. Corporate tax expenditures implicitly subsidize some economic activities and sectors of the economy at the expense of others and thereby distort economic decision-making. Businesses are taxed differently based upon how they are organized (i.e., as corporations, Subchapter S corporations, limited liability companies, partnerships, etc.) and whether they use debt or equity to finance investments. In addition, under U.S. corporate tax laws, multi-national corporations can be put at competitive disadvantages due to differences in tax systems around the globe.

As with the individual tax code, many leading economists have agreed that major reforms to our corporate tax code are needed. Many have suggested similar solutions that include lowering the overall corporate tax rate while doing away with some or all of corporate tax breaks, which would remove market distorting special provisions and promote economic growth. Others have argued for deeper reforms such as reducing the corporate tax rate to 15 percent and taxing more capital income at the individual level.

For more on the corporate tax system and reforms proposed by a bipartisan pair of economists, Eric Toder and Alan Viard, see A Proposal to Reform the Taxation of Corporate Income.

Other Tax Reform Proposals

Other proposals would create new types of taxes to replace existing taxes or to supplement them. Two prominent examples include:

  • Consumption taxes: One major reform would replace the current income tax system with one that taxes consumption. There are many forms that a consumption tax could take. Most proposals exempt income used for savings and investments. To protect lower-income taxpayers, some proposals would exempt income used for housing, food, medical care ,and other defined purposes up to a specified level. Other proposals would tax the consumption by lower-income families at reduced rates.
  • Carbon taxes: Some have suggested introducing carbon taxes to achieve two goals: raising revenue and discouraging the use of carbon-intense energy, which would ultimately have positive environmental effects. A carbon tax could also enable the government to reduce other taxes, such as the corporate income tax, the payroll tax, or individual income taxes, while still generating additional revenue for deficit reduction.

Additional resources:

FISCAL ISSUES ILLUSTRATED

This series of infographics helps put some of today's most pressing fiscal debates in context.

THE TAX REFORM OPPORTUNITY

Video: Our tax code is complex, unfair, and insufficient. Learn more about the opportunity we have to reform and improve tax policy.