An Alternative Vision for Tax Reform

12/17/2012 12:00:00 PM
Inside the beltway, the term "tax reform" has become a code word for a specific kind of reform: we abolish nearly all tax deductions, and put all of that revenue into lowering the marginal tax rates. There is some merit to this idea, because lower marginal tax rates would mean higher GDP because marginal incentives to work would be larger.  However, this has taken on some mythical proportions among a lot of advocates for the idea. People seem to have become deluded into thinking that this version of tax reform would actually lower their taxes. It wouldn't. That's the point.

Rather than lower taxes on people, this version of reform actually just reallocates how they pay the taxes. Instead of paying a high rate and claiming deductions, they pay a low rate and can't claim any deductions, with the result that they are no wealthier than before. The economic gains from this system flows only to individuals who choose to work more hours as a result of the change. Bottom line: if you plan to stick to a 40 hour work week regardless of the marginal tax rates, you don't benefit from this tax reform.

Now that we've established that tax reform doesn't actually lower anyone's taxes at all, lets also discuss the fact that this tax reform doesn't help the government's fiscal problems at all. The point of "tax reform" is to be revenue neutral, so by definition it doesn't increase revenues. Neither does it inherently decrease expenditures, with the result that it doesn't do anything to decrease the deficit.

So, the beltway types have been hiding two truths about tax reform from you: it won't lower your taxes, and it won't reduce the deficit. Now their failure is complete.

I have an alternative proposal for tax reform. Start by eliminating all tax deductions except for the standard deduction. Then take all that revenue and use it to increase the standard deduction. This version of tax reform is more progressive than the usual proposal. In addition, it gives us a tool for managing the deficit: when we want to stimulate the economy we can increase the standard deduction, and when we want to decrease the deficit we can decrease the standard deduction.

And for some sagely advice to the beltway: the only reason to ever lower marginal tax rates is if there is a budget surplus.