Transcript America’s Changing Role in the World Economy

Why We Need Tax Reform –
and Why We Probably Won’t Get It
Robert Coen
Professor Emeritus of Economics
Northwestern University
Woman’s Athletic Club
Chicago, IL
January 23, 2013
Effective Personal Income Tax Rate, 1947-2011
Ratio of Personal Income Tax Revene to Personal Income (%)
14
Average (red line) = 9.7
12
Percent
10
8
6
4
2
0
50
55
60
65
70
75
80
85
90
95
Year
Source data: Commerce Department, National Income Accounts
00
05
10
The Changing Personal Income Tax
Single Taxpayer
Year
Number of
Brackets
1st bracket
------------------------Rate
Income<
Top bracket
--------------------------Rate
Income>
1955
24
20%
$16,745
91%
$1,674,475
1988
2
15%
33,856
28%
33,856
2007
6
10%
8,468
35%
378,435
Income levels are adjusted for inflation and stated in 2011 dollars.
In each of these years, tax revenue = 9.7% of personal income
Source: The Tax Foundation
Effective Personal Income Tax Rates by Household Income, 2007
Income
quintile
Effective
tax rate
Average
pre-tax
income
Lowest
-6.8
18,400
4
-3
Second
-0.4
42,500
8
0
Third
3.3
64,500
13
5
Fourth
6.2
94,100
19
13
Highest
14.4
264,700
56
86
9.3
96,000
100
100
19.0
1,873,000
19
40
All
Top 1%
Source: Congressional Budget Office
Share of
pre-tax
income
Share of
taxes
Why Are Effective Rates Much Lower Than Statutory Rates?
Some types of income not subject to tax: Employer-provided health insurance
Contributions to retirement programs
Interest on state-local bonds
Basic income level exempted from tax:
Personal exemptions
Standard deduction
Some uses of income deductible:
Charitable contributions
Medical expenses
State-local income, property taxes
Tax credits for some uses of income:
Energy-efficient windows,
appliances, heating
Refundable tax credits =“negative tax”:
Earned income tax credit (1975)
Child tax credit (1998)
Some types of income taxed lightly:
Capital gains
Shortcomings of Tax Loopholes
Hidden form of spending – “tax expenditures”
Alternative is direct expenditure (subsidy),regularly reassessed
Open-ended cost
Difficult to get rid of, may outlive usefulness
Incentive effects vary (undesirably?) across taxpayers
Invite “creative behavior” to avoid taxes
Convert ordinary income to capital gain
Substitute home equity loan for other consumer borrowing
Abuse and verification issues
Erosion of tax base requires higher, distorting tax rates
Waste of (limited!) human talent in legal and accounting professions
Direct Spending and Tax Expenditures by Category, 2011
Billions of dollars
Direct
Tax
National Defense and Veterans Benefits
International Affairs
General Science, Space, and Technology
Energy, Natural Resources and Environment
832.8
45.7
29.5
57.7
13.1
36.3
10.3
13.3
Agriculture, Commerce and Housing
Transportation
Community and Regional Development
Education, Training, Employment, Social Services
8.1
93.0
23.8
101.2
418.3
6.0
4.3
167.7
Health and Medicare
Income Security
Social Security
General Government
858.2
597.4
730.8
25.5
202.6
198.4
31.0
72.8
3,603.1
1,175.5
Total outlays
Sources: Office of Management and Budget, Joint Committee on Taxation
Strengths of Tax Loopholes
Allow private preferences to allocate subsidies
Effective and Statutory Corporate Income Tax Rate, 1948-2011
Ratio of Corporate Income Tax Revenue to Corporate Profits (%)
70
60
Percent
50
40
30
20
10
50
55
60
65
70
75
80
85
90
95
00
05
10
Year
Effective rate
Source data: Commerce Department, National Income Accounts
Staturtory rate
Income Tax Reform of 1986
Goals
Reduce tax rates to improve economic efficiency and growth
Maintain tax revenue by eliminating some tax expenditures
Personal Tax
Reduced number of brackets from 15 to 2
Reduced top rate from 50 to 28 percent
Eliminated deduction for interest paid, except on home mortgages
Eliminated deduction for state-local sales taxes
Eliminated favored rates for long-term capital gains
Corporate Tax
Reduced top rate from 46 to 34 percent
Repealed tax credit for equipment investment
Tightened depreciation rules
Undoing of 1986 Reforms
1991
1993
1997
2001
2003
Top personal rate raised from 28% to 31%,
Brackets increased from 2 to 3
Top rate personal rate raised to 39.6%
Brackets increased from 3 to 5
Top corporate rate raised to 35%
Capital gains rate reduced to 28%
Refundable child tax credit of $500
Capital gains rate reduced to 20%
Personal rate to fall gradually from 39.6% to 35%
Brackets to increased from 5 to 6
Child credit raised to $1K
Estate tax reduced, to be eliminated in 2010
Accelerated reductions in top rates
Dividends and KG rates reduced to 15%
Numerous grants of accelerated depreciation
Numerous new tax credits – biofuels, etc.
Alternative Proposals for Tax (Re)Reform
Romney: Personal tax cuts
1st bracket from 10% to 8%
Top bracket from 35% to 28%
Eliminate taxes on capital income
Reduce corporate rate from 35% to 25%
Pay for by eliminating unspecified tax expenditures
TPC estimated 2015 cost at $480b
Estimated Cost of 10 Largest Personal Tax Expenditures
Billions of dollars
Annual average
2010-14
Exclusion of employer contributions for health care
Deduction of mortgage interest
Reduced tax rates on capital gains and dividends
Exclusion of pension contributions – defined benefit plans
Earned income credit
Deduction of state-local taxes
Exclusion of pension contributions – defined contribution plans
Exclusion of capital gains at death
Deduction of charitable contributions
Exclusion of untaxed social security and railroad retirement
Total of largest 10
Source: U.S. Congress, Joint Committee on Taxation
131.9
96.8
80.6
60.6
53.8
47.5
42.4
38.4
36.5
34.6
623.1
Estimated Cost of 10 Largest Corporate Tax Expenditures
Billions of dollars
Annual average
2010-14
Deferral of income of controlled foreign corporations
Exclusion of interest on state-local debt
Deduction of income from domestic production activities
Inventory property sales source rule exception
Accelerated depreciation of equipment
Inclusion of income from business debt discharged by reacquisition
Tax credit for low-income housing
Expensing of R&D expenditures
LIFO inventory accounting
Reduced tax rate for first $10mil of taxable income
Total of largest 10
Source: U.S. Congress, Joint Committee on Taxation
14.1
9.1
8.6
7.6
7.4
5.8
5.4
5.1
4.0
3.2
70.3
Alternative Proposals for Tax (Re)Reform
Obama’s Deficit Commission (Simpson-Bowles, Dec. 2010):
Reduce personal rates to 12%, 22%, 28%
Cut corporate tax cut to 28%
Pay for by:
Taxing dividends and capital gains like other income
Eliminating personal and corporate tax expenditures, except:
Child and earned income credits
Mortgage interest (within limits)
Employer-provided health insurance (with cap)
Charitable giving (>2% of income, 12% refundable credit
Exclusion of state-local bond interest
Retirement savings
Increasing gas tax to 15¢ per gallon
Alternative Proposals for Tax (Re)Reform
Simply reduce or eliminate specific tax expenditures
Use increased revenue to reduce budget deficit
Adopt a “flat tax”
Popular with conservatives, e.g., Steve Forbes, Paul Ryan
Single rate for individuals and businesses
Simplified base for each
Ultimate in simplification – postcard tax return
The Postcard Tax Return for Individuals
See The Flat Tax, by R. Hall and A. Rabushka
The Postcard Tax Return for Businesses
See The Flat Tax, by R. Hall and A. Rabushka
“Flat Tax” Is a Consumption Tax, Not an Income Tax!
Sources of income:
Wages and salaries
Gross capital income
Gross business revenue – wages and salaries – purchases
Uses of income:
Consumption
Investment
Wages and salaries + Gross capital income – Investment = Consumption
Base of personal
Base of business
flat tax
flat tax
Should we have a consumption tax?
More popular form is value-added tax
Consumption tax is regressive – need to consider entire tax system
Effective Federal Tax Rates by Household Income, 2007
Income
Quintile
Personal
Income
Tax
Social
Insurance
Taxes
Corporate
Income
Tax
Excise
Taxes
All
Federal
Taxes
Lowest
-6.8
8.8
0.4
1.6
4.0
Second
-0.4
9.5
0.5
1.0
10.6
Third
3.3
9.4
0.8
0.8
14.3
Fourth
6.2
9.5
1.1
0.7
17.4
Highest
14.4
5.7
4.6
0.4
25.1
9.3
7.4
3.0
0.6
20.4
19.0
1.6
8.8
0.1
29.5
All
Top 1%
Source: Congressional Budget Office
Impact of All Federal Taxes on the Distribution of Household Income,
1979 and 2007
Income
Quintile
1979
Pre-Tax After-Tax
2007
Pre-Tax After-Tax
Lowest
6
7
4
5
Second
11
12
8
9
Third
16
17
13
14
Fourth
22
22
19
20
Highest
45
42
56
53
Top 1%
9
8
19
17
Source: Congressional Budget Office
Why Is Tax Reform So Difficult?
It’s really expenditure reform, tax expenditures become entrenched
Growing income inequality leads to more lobbying for tax expenditures
Legislators prefer to hide subsidies in lost revenue
Many tax expenditures support worthy goals – child care, reduction of
poverty, education, energy conservation, research, risk taking
Emphasis on reducing tax rates is out of touch with fiscal needs
Taxes as Percent of GDP, 2010
Denmark
Sweden
Italy
Norway
France
Netherlands
Germany
UK
Canada
Switzerland
Japan
US
Source: OECD
48
46
43
43
43
39
36
35
31
28
28
25
Sweden
Canada
Switzerland
UK
US
Norway
Netherlands
France
Germany
Denmark
Japan
Italy
Source: OECD
Annual GDP
Growth Rate
20001-11
Taxes as
Percent of GDP
2010
2.4
1.9
1.8
1.7
1.6
1.5
1.3
1.2
1.2
0.7
0.6
0.4
46
31
28
35
25
43
39
43
36
48
28
43
END