Objectives of Tax Reform

1. REFORMING TAXATION: ADVANTAGES OF A SAVING- CONSUMPTION NEUTRAL TAX BASE,AND PRINCIPLES TO GUIDE REFORMStephen J. Entin Institute for Research on the Economics of Taxation

2. Neutrality (Growth) Simplicity Fairness Visibility Objectives of Tax Reform 2

3. How to Achieve Objectives • Choose a better tax base. • Consumption versus Income. • (Better put: a Neutral Tax Base vs. Income.) 3

4. Income is the earned reward for providing labor and capital to produce goods and services that other people value. Income is proportional to effort. So the fairest tax is proportional to income, i.e., one flat rate. Exempting the very poorest is a kindness, but it is fair for everyone who can to pay something toward the cost of government. Income 4

5. Income is a Net Concept • Income is revenue less the cost of earning revenue. • Deductions for costs are necessary to measure income properly. 5

6. Saving Is a Cost of Earning Income • No saving => no interest, no dividends. • You can't have your principal and eat it too. • Therefore, the best measure of income is consumption. We should tax what we spend. 6

7. Neutral Taxes: • Do not fall more heavily on saving and investment than on consumption, • Are unbiased against growth, • Are simpler than the income tax, and • Are fair and straightforward. 7

8. By Comparison the Income Tax: • Hits saving and investment harder than consumption by taxing saving and its earnings, encouraging consumption by penalizingsaving (a tax base error). • Compounds the damage by taxing people more heavily the more they work, save, and produce by imposing graduated tax rates (a tax rate error). 8

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11. Taxing Capital Income Hurts Workers • Savers can always switch to consumption, which is nice for them. • But when they do, investment slumps, and workers lose their jobs. 11

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14. Steps Toward a Fair, Flat, Unbiased Neutral Tax Step 1. Treat all saving and investment as a cost of earning income. Step 2. End double taxation of corporate income. Step 3. Kill the Death Tax. 14

15. Step 1. Treat Saving and Investment as a Cost of Earning Income • Treat all saving like pensions and IRAs: either defer tax until the saving is spent, or tax the saving up front and not tax the returns. • Immediately expense all investment; do not drag out depreciation over time. (This still tax above normal profits, which is OK.) 15

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18. Tax-advantaged saving in an IRA, 401(k), or pension yields about two-thirds more income in retirement than ordinary saving! 17

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20. Step 2. End Double Taxation of Corporate Income • A neutral tax would not tax corporate income twice. • It would tax it either at the corporate level or the shareholder level, but not both. 19

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22. Step 3. Kill the“Death Tax" A neutral tax would not tax estates because estates are accumulated saving that has already been taxed or will be subject to an heir's income tax. 21

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26. Four Types of Neutral Taxes: • Personal Expenditure tax (on income less saving, i.e., saving is tax-deferred). • Flat tax (no deferral, returns are exempt). • Sales tax (on income spent, not saved). • Value Added Tax (on output less investment; which equals income less saving or sales tax). 28

27. Elements of Neutral Taxes • All treat saving neutrally vs. consumption. • All employ expensing instead of depreciation. • All are territorial. • All have the same basic tax base. • Differ mainly as to point of collection. 29

28. Why it Matters History tells us that: • When we have moved toward a neutral tax with lower rates, the economy has boomed. • When we have increased tax biases the economy has faltered. • When we have wasted tax cuts on non-growth-related rebates, nothing good has happened. 25

29. Tax ReformThe Good,the Bad,and the Ugly • JFK • ERTA 1981(+TEFRA’82&DEFRA’84) • Tax Reform Act of 1986 • Bowles-Simpson Deficit Commission • Wyden-Coats 35

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34. Recap • Tax reform is about: • Getting the tax base right. • Setting rates that cover the amount of government that people want to have. • Raising revenue with less damage to the economy. • Informing voters of the price they pay for govern-ment so that they can make informed decisions about how much government activity to support. • Cut spending to pay for it. THWRN,TBWSECTR 34

35. Objective: Neutrality/Growth • Neutral taxation is best for growth. It can yield: • More saving, investment, and growth. Potentially: • Trillions of dollars of added capital. • Millions of added jobs and higher wages. • Thousands of dollars in added family income. • U.S. would become a jobs and investment magnet. 30

36. Objective: Simplicity • Neutral taxes are much simpler, even if collected on individual tax forms: • No double taxation. • No limits on savings plans. One universal plan, not dozens. • No separate taxation of capital gains. • No depreciation schedules. • No foreign tax and tax credit. • No phase-outs of exemptions, credits, deductions. 31

37. Objective: Fairness • Consumption is a fairer tax base than income; it respects the effort of people who work and save. • Neutral taxes can be made progressive to shelter the poor. • There is no need to tax saving and investmentmore harshly than consumption to achieve progressivity. • The simpler, clearer neutral tax would be seen to be fair. 32

38. Objective: Visibility • Only people pay taxes. • Businesses and things don't pay tax. • Taxes are best levied on individuals. • Voters need to see what government costs. • Everyone who can do so should pay something toward the cost of government. • Simplicity is no excuse for dropping tens of millions of people from the tax rolls. 33

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41. Please consider:Economics is not thedismal science --if you have a morbid sense of humor --and a large tru$t fund. 39

42. On the other hand ---(Sorry, I’m an economist, it’s our mantra) ---- 40

43. Politicalscience(sic)is rather depressing, --and actual politics is surely theGreat Dismal swamp!!! 40

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