President Obamas avowed to commitment to folks paying their fair share in taxes is generally understood to refer only to the rich, who already pay 90% of all taxes. The Framers of our Constitution would of course have been been disturbed by the spectacle of one half the American population forming a vast coalition of rent-seekers to manipulate the machinery of government in order to capture the wealth of the other half of the population — essentially the progressive taxation system (and political party system) we have today.
The idea of flattening and broadening the burden of government taxation is eminently fair — all Americans should pay their fair share. We need to get back to the principles of self-reliance an individual responsibility on which this great nation was built. Such a tax reform would also be smart economics. A new op-ed out this morning in the Wall Street Journal by Dr. Martin Feldstein (former chairman of Reagans Council of Economic Advisers) looks at the impact of the 1986 tax reforms on personal income and tax revenue:
Taxpayers who faced a marginal tax rate of 50% in 1985 had a marginal tax rate of just 28% after 1986, implying that their marginal net-of-tax share rose to 72% from 50%, an increase of 44%. For this group, the average taxable income rose between 1985 and 1988 by 45%, suggesting that each 1% rise in the marginal net-of-tax rate led to about a 1% rise in taxable income.
This dramatic increase in taxable income reflected three favorable effects of the lower marginal tax rates. The greater net reward for extra effort and extra risk-taking led to increases in earnings, in entrepreneurial activity, in the expansion of small businesses, etc. Lower marginal tax rates also caused individuals to shift some of their compensation from untaxed fringe benefits and other perquisites to taxable earnings. Taxpayers also reduced spending on tax-deductible forms of consumption.
Dr. Feldstein goes on to explain:
The substantial sensitivity of taxable income to the taxpayers marginal net-of-tax share has important implications for the effect of tax-rate reductions on total tax revenue. For a 10% across-the-board reduction in all tax rates, a traditional static analysis implies that revenue would fall to 90% of its previous level. But reducing a current 40% marginal tax rate by 10% to 36% raises the net-of-tax share to 64% from 60%, a rise of 6.7%. If that causes the taxable income of those at that tax level to rise by 6.7%, their taxable income would fall to only 96% of what it had been. In short, the behavioral response of taxpayers in this highest bracket would offset 60% of the static revenue loss.
Feldstein then points to the Joint Select Committee on Deficit Reduction, which is required to propose $1.5 trillion in cuts for the next ten years or sequesters will go into effect. He signals that his proposal flatten, reduce, and broaden the tax base would produce enough increased economic activity and revenue to wipe out a third of the deficit reduction target:
Combining that base broadening with a 10% cut in all tax rates would be revenue neutral in a traditional static analysis. But the experience after the 1986 tax reform implies that the combination of base broadening and rate reduction would raise revenue equal to about 4% of existing tax revenue. With personal income-tax revenue in 2011 of about $1 trillion, that 4% increase in net revenue would be $40 billion at the current level of taxable income, or more than $500 billion over the next 10 years.
The Joint Select Committee should insist on counting that revenue as the starting point for a serious deficit reduction plan.
Simplifying the task base would also reduce the enormously waste Americans spend each year just to get through the irretrievable labyrinth of the Internal Revenue Code. To paraphrase Senator Phil Gramm, our current system forces one half of us to pull the wagon while the other half gets to sit in it, and leaves everyone worse off. Isnt it time we all got out off the wagon and helped to pull it?
– Mario Loyola