This is How Tax Reform Can Make Us All Rich

This summer, members of the Senate Finance Committee brought tax reform to the national agenda. While it is unlikely significant legislation will be implemented in the near future, the discussions raised important questions about the role tax policy should play in revenue creation, the use of tax policy to generate desired social behaviors, and the relationship between U.S. corporate tax rates and their foreign counterparts. While each of these topics raises hearty debate from those of all political orientations, it is clear that tax reform should play a crucial role in revenue creation. The outcomes from the 1986 Tax Reform Act, arguments for and against the use of tax reform to raise revenue, and Obama's position on the issue must be considered to formulate the appropriate policy.

The 1986 Tax Reform Act was the most recent significant reform to the United States tax code. The act lowered individual and corporate rates and simultaneously broadened the tax base through the elimination of a variety of exemptions, deductions, and credits. Via a redistributive effect, the corporate tax system increased revenues and the individual system decreased revenues. The act was declared revenue neutral. However, upon closer inspection, the reform created politically-motivated inconsistencies in which individuals, namely voters, received benefits such as individual rate reductions, increases in the standard rate deduction, and the expansion of the Earned Income Tax Credit. Simultaneously, the elimination of the top two tax rates and the repeal of the investment tax credit increased corporate tax revenues. Thus, while it can be said that the 1986 Tax Reform Act was revenue neutral, it shifted the base and redistributed tax burdens across the economy so that some people benefited more than others. Lessons from 1986 teach today's policymakers that the goal of tax reform should be to make the code fair and efficient by enforcing the lowest possible rate among the largest possible base.

Democrats typically support revenue-generating taxation whereas Republicans prefer revenue-neutral policy. However, recent debate has sparked a potential compromise between the two parties whereby tax reform would be revenue neutral in the long term. Building on this concept, the Obama administration recently released a tax reform proposal that generates revenue creation in the short term, but guarantees tax neutrality in the long run. The proposal recommends that the corporate tax rate be lowered from its current 35% to 28%, preceding a one-time tax repatriation holiday used to fund a national infrastructure bank. The proposed bank would finance infrastructure projects, thereby creating jobs and stimulating the economy. While there is much to be praised about this proposal, it is possible that the focus on corporate taxation may limit the potential for comprehensive tax code reform.

Overall, supporters of positive revenue tax policy advocate that tax policy can promote fairness across income levels. On a technical note, the failure to secure sources of revenue increases before lower tax rates result in revenue loss. Broadening the tax base will not always occur after lowering rates, and revenue-neutral policy may not achieve its intended goals. Nevertheless, supporters of revenue-neutral tax policy advocate for reliance on the free market in the economy rather than government intervention. Historical accounts of tax policy and current discussion reveal the need for comprehensive reform. Policymakers should craft revenue-generating policy in the short term to boost our slowly growing economy. In the long term, policy should raise revenue for reallocation, but allow the invisible hand to guide marketplace transactions.