Choosing the Nation's Fiscal Future (2010) / Chapter Skim
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8 Revenue Options
8 Revenue Options
Pages 143-172
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From page 143... ...
Just how additional revenue is raised is an important policy question. At higher tax rates, substantial flaws in the current tax system would be magnified.
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From page 144... ...
, even as tax legislation reduced or increased income tax rates, increased payroll tax rates, and made other changes. The business cycle has substantial effects on the federal budget; and the deep 2008-2009 recession, following major tax cuts early in this decade, has reduced revenues as a share of GDP below historical levels.
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From page 145... ...
The payroll taxes are earmarked to finance rising current and future health and retirement benefits; corporate income taxes are not earmarked. Therefore, the ostensibly equal exchange of corporate income tax for payroll tax receipts -- the latter linked to higher health and retirement spending -- arguably left the federal budget worse off for the long term.2 Complexity of the Tax Code The individual income tax is imposed on wages and salaries, returns from savings, small business profits, and other sources of income under a graduated rate structure.3 In 2009, statutory or explicit tax rates ranged from 10 to 35 percent.
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From page 146... ...
These figures suggest that eliminating tax expenditures and broadening the tax base would allow tax rates to be cut nearly in half (Burman et al., 2008a:13)
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From page 147... ...
estimates that the cost of complying with federal income taxes is roughly $200 billion annually.6 Second, tax simplification would improve the ability of individuals and businesses to make sound economic decisions: that is, to make decisions that work best for their own finances and for the performance of the economy, rather than to try to benefit from special provisions in the tax code. For example, the large and growing number of tax rules on pensions, savings vehicles, and investment earnings complicate, if not confuse, family financial planning.
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From page 148... ...
This would allow lower marginal tax rates without losing revenues, so that economic decisions would be less driven by their effect on taxes owed and be more likely to raise income throughout the economy.9 Neutral Treatment of Different Sources of Income Variations in the way different categories or sources of income are taxed tend to distort wage, price, and profit signals in the economy, thereby diverting resources into lower productivity uses. This is particularly so for variations in taxing different sources of income of one type, such as business profits and capital income.
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From page 149... ...
for which there is a tax preference. The economic distortions in the tax code are magnified when marginal tax rates are high or differ among otherwise similar economic options.
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From page 150... ...
As marginal rates rise, these efficiency losses rise more than proportionally, roughly as the square of marginal tax rates. Because of this distortion, tax reform efforts in the past, such as the bipartisan Tax Reform Act of 1986, focused on reducing marginal tax rates.
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From page 151... ...
. Perhaps the most striking changes in tax policies in the OECD countries have been the dramatic reductions in income tax rates since the 1980s.
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From page 152... ...
, one of the likely effects would be lower wages for average American workers, implicitly compensating for the higher taxes paid here.16 At the same time, tax competition to attract capital reduces tax rates on corporate income, capital gains, dividends, and high incomes in general, and thereby perhaps unintentionally constrains tax systems to be less progressive. The conflicting concerns of legitimate international tax competition and a race to the bottom on taxes on capital raise complex issues that will be important for all tax policy decisions in the coming decades.
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From page 153... ...
Furthermore, there is no clear and simple benchmark -- such as maintaining the current distribution of burdens -- that can be used as a starting point for public debate. In this chapter generally, the committee models either the current tax law or a simplified alternative with tax rates chosen to replicate the level and distribution of revenues of the current law and then increases revenues by simply increasing all tax rates proportionately.
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From page 154... ...
. If income and payroll tax rates were simply raised while retaining the current tax structure, the adverse effect on growth would likely be more severe than if a simplified tax structure were adopted; see, e.g., Congressional Budget Office (1997)
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From page 155... ...
earnings above cap in current law; rises to 3% in 2060. High Spending Current tax cuts expire and income tax Higher individual tax rates and Revenue: rates rise higher than above.
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From page 156... ...
"Unacceptable" is defined differently by different experts, but the committee concluded that to avoid damaging effects on growth, the top income tax rate should not exceed 50 percent for people with the highest incomes.19 With the revenue required for the "high" scenario, that level would be reached by about 2020 under the current tax structure. At that time, we assume that policy makers would add to the current income tax a VAT similar to that in Europe.
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From page 157... ...
(Table E-1 in Appen 60 50 40 Tax Rate 30 20 10 0 2009a 2012 2020 2030 2040 2050 2060 2070 2080 High Intermediate-1 Intermediate-2 Low FIGURE 8-4 Current tax structure: top personal income tax rates for the committee's four scenarios. aUnder current law.
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From page 158... ...
The current tax structure discussed in the preceding section and the broader-based or simplified tax structure discussed here represent two "bookends," with many possibilities in between.25 Assumptions The committee's illustrative version of a simplified tax would replace the current six tax brackets for individuals with two. With few deductions or credits, individual income tax rates could be lowered and still yield the same revenue because the tax base would be broader.
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From page 159... ...
In other words, it would raise the same amount of money as under the current tax system, and it would generally retain the same relative burdens on various broad income groups as would occur under current tax law projected to 2012. Some analysts prefer more precisely mirroring the current-law distribution of the tax burden: for the same total revenue yield, this approach would require more tax brackets.
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From page 160... ...
It is currently the most costly tax expenditure in the system. Capping the level of employer-paid health insurance that is excludable from personal income taxation would raise revenue and help limit this source of medical inflation.
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From page 161... ...
Under the simplified tax structure, personal income tax rates generally decrease over time because of the broader tax base of simplified taxation and the elimination or reduction of costly tax expenditures, including interest paid on home mortgages and, especially, employer-sponsored health insurance. With growth in real income, these tax expenditures would 30 25 Tax Rate, Percentage 20 15 10 5 0 2012 2020 2030 2040 2050 2060 2070 2080 2nd: High 2nd: Inter-1 2nd: Inter-2 2nd: Low 1st: High 1st: Inter-1 1st: Inter-2 1st: Low FIGURE 8-5 Personal income tax rates for the first and second brackets under a simplified tax structure for the committee's four scenarios.
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From page 162... ...
First, the economy is growing. Growth in real incomes puts taxpayers into higher personal income tax brackets -- particularly with the six brackets in the current tax structure -- and also affects the amount of payroll tax paid.32 With only two brackets for regular income and no AMT, this "real bracket creep" generally raises proceeds of the simplified income tax far less than under the current structure.
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From page 163... ...
REVENUE OPTIONS Low (Current Tax Structure is Current Law) 60% 40% 20% 0% First Quintile Second Third Fourth Fifth Quintile Top 10% Top 5% Quintile Quintile Quintile Current Law Current Tax Structure Simplified Tax Structure Intermediate-1 60% 40% 20% 0% First Quintile Second Third Fourth Fifth Quintile Top 10% Top 5% Quintile Quintile Quintile Current Law Current Tax Structure Simplified Tax Structure Intermediate-2 60% 40% 20% 0% First Quintile Second Third Fourth Fifth Quintile Top 10% Top 5% Quintile Quintile Quintile Current Law Current Tax Structure Simplified Tax Structure High 60% 40% 20% 0% First Quintile Second Third Fourth Fifth Quintile Top 10% Top 5% Quintile Quintile Quintile Current Law Current Tax Structure Simplified Tax Structure FIGURE 8-6 Distribution of the percentage share of combined federal taxes by relative income in 2050 for the committee's four scenarios.
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From page 164... ...
The level and path of payroll taxation vary with the scenario, as do other details that also affect the distribution of payroll tax payments.33 And the VAT added in the high scenario under the current tax structure also has distributional effects -- it is less progressive than either form of personal income taxation. In practice, there is no doubt that tax rates and other parameters of the tax system that affect tax distributions would be adjusted multiple times over the decades covered in these simulations and projections.
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From page 165... ...
Under the current tax structure, many single-earner families in the lower quintiles get a tax break by the "head of household" filing status, which is not included in the simplified tax structure. In the simplified tax approach, real income growth makes more and more filers at the low end of the distribution subject to income taxation.
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From page 166... ...
For the implementation of both tax structures, the capital gains rate is adjusted proportionately to the rates on ordinary income, but the resulting reduction in progressivity is greater with the simplified tax structure.37 Although the simplified tax structure moves the federal tax system somewhat away from its current progressivity, it would remain highly progressive. In 2050, for instance, the first quintile would pay 1.2-1.3 and 1.5-1.7 percent of combined taxes under the current and simplified structures, respectively, for the different scenarios; for the middle quintile, taxes would be 10.4-10.8 and 11.2-12.2 percent, respectively; and for the top 5 percent the share of all taxes would vary between 38.1 and 39.4 percent for the current tax structure and between 33.7 and 36.5 percent under the simplified tax structure.38 If these distributional results were judged to differ more than is desired from the current progressivity of the tax burden, the tax liabilities could be adjusted by using somewhat more elaborate procedures than the committee used to fine-tune the tax parameters, such as the exemptions, standard deductions, numbers of tax rate brackets and their tax rates.
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From page 167... ...
In any tax regime, high marginal tax rates tend to distort economic decisions, tend to lower growth, and -- especially for personal and corporate income taxation -- tend to reduce incentives for work and investment. But unavoidably difficult tradeoffs in values are implicit in the choice between the current tax structure and a simplified tax structure for personal income taxation.
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From page 168... ...
Higher revenue levels, accompanied perhaps by bold changes to establish a simplified tax structure for the personal income tax or introduce a VAT, would require different tradeoffs and a new consensus. The options presented here suggest, in broad outlines, the kinds of changes in tax structure that may be required if a decision is made to achieve fiscal sustainability by raising revenue levels to match higher future spending, taking into account the effects of such changes on efficiency, growth, and the distribution of tax burdens NOTES 1.
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From page 169... ...
19. Only 4 of 30 OECD countries now have top income tax rates that exceed 50 percent.
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From page 170... ...
170 CHOOSING THE NATION'S FISCAL FUTURE 20. For simplicity and because its revenue yield is dwarfed by that of the personal income tax, we have not explored increasing the proceeds from the corporate income tax by broadening its base -- without raising the statutory rate.
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From page 171... ...
Moreover, the high scenario would raise the current tax cap so that additional upper-level earnings would be subject to taxation at a higher rate. Although payroll tax increases first become effective in 2012, they would be phased in very gradually, so that, for a given revenue level above "low," the distributional differences between the current and simplified tax structure almost exclusively reflect the change in income tax structure.
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From page 172... ...
35. For a given scenario -- such as high -- the differences in the distribution of combined taxes between the current and simplified taxes very likely would reflect the different structures of the personal income tax.
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