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Donald Marron

Seven ways to reform a broken tax system

Tax reform should include a redesign of income tax.

By Guest blogger / February 2, 2011

Our tax system is broken, writes Donald Marron. Reforming income tax is one thing that will start to fix the problem.

Photo illustration / Newscom

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This morning I appeared at a Senate Budget Committee hearing, “Tax Reform: A Necessary Component for Restoring Fiscal Sustainability.” My full testimony, “Cutting Tax Preferences Is Key to Tax Reform and Deficit Reduction,” is available here.

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Here’s my opening statement:

America’s tax system is broken. It’s needlessly complex, economically harmful, and often unfair. It fails at its most basic task, raising enough money to pay our government’s bills. And it’s increasingly unpredictable, with large, temporary tax cuts not only in the individual income tax, but also in corporate, payroll, and estate taxes.

For all those reasons, our tax system cries out for reform. Such reform could follow many paths. Some analysts recommend the introduction of new taxes—such as a value-added tax, national retail sales tax, or pollution taxes—to supplement or replace our current system. Those ideas are worth serious discussion, but in today’s testimony I would like to focus on a more traditional approach to reform: redesigning our income tax.

I would like to make seven main points:

1. Tax preferences pervade the tax code. These preferences total more than $1 trillion annually, almost as much as what we collected from individual and corporate income taxes combined. These preferences narrow the tax base, reduce revenues, distort economic activity, complicate the tax system, force tax rates higher than they would otherwise be, and are often unfair.

2. The first step in any income tax reform should be to broaden the tax base by reducing or eliminating tax preferences. Doing so would help level the playing field among different economic activities, reduce the degree to which taxes distort economic behavior, and make taxes simpler to file and administer.

3. Policymakers can use the resulting revenue – potentially hundreds of billions of dollars each year – to lower tax rates, reduce future deficits, or both. Lowering tax rates would further reduce the economic distortions created by the tax system and would encourage economic growth. Reducing future deficits would help tame our federal debt, which threatens to grow to unsustainable levels in coming years and thus poses a significant risk to our economy.

4. Many tax preferences are effectively spending programs run through the tax code; that poses a challenge for how we talk about tax reform and the size of government. Any cuts to these spending-like preferences will increase federal revenues, but will reduce government’s influence over economic activity. Advocates of smaller government are often skeptical of proposals that would increase federal revenues. When it comes to paring back spending-like tax preferences, however, an increase in revenues may actually mean that government’s role in getting smaller.