As Tax Day Approaches, We Can Surely Do Better
As Tax Day approaches, we are once again reminded that the tax code is a mess. Much of the income we earn avoids being taxed thanks to deductions, credits, and exclusions, while plenty of other income is taxed twice. Work, saving, and investment are taxed, not rewarded. And certain types of activities are treated preferentially for no good reason. On top of this, the IRS officially estimates the cost of compliance for individuals to be $33.6 billion annually while researchers have pinned the burden even higher, between $67 billion and $99 billion per year.
The United States can do better. Our tax code could instead meaningfully promote economic growth. To be clear, plausible growth effects from tax reform will not alone solve our country's fiscal woes, nor will it end poverty or propel our GDP into the stratosphere. But a large scale tax restructuring that removes impediments to work, the bias against saving, and the myriad of uneconomic "favors" in the code would over time yield a measurably larger economy and higher wages.
Many Republican presidential of the candidates this cycle - those few remaining as well as those who have dropped out - have unveiled major tax reform plans. While the budgetary impact of these plans will undermine their positive growth effects, there remains, at least at the campaign level, an understanding among many politicians that a better tax code will yield a stronger economy.
To make the leap from campaign rhetoric to policy action, lawmakers will need more than just the qualitative declarations that lower marginal tax rates are better for encouraging labor supply and capital investment.
They will need concrete economic models that quantify the specific economic effects of various reform options. These results are critical, as lawmakers will face real political tradeoffs in the pursuit of tax reform-tradeoffs between tax efficiency and fairness, as well as tradeoffs between optimal tax policy and the political sway of special interest groups.
The good news is that public finance economics and economic models developed by macroeconomists can inform policymakers about the potential growth effects of tax reform. Thirty years ago, the last time Congress enacted major tax reform, these models hardly existed, but today the field has matured. The Tax Foundation, a leading think tank in Washington, has put its model to good use in the last year by publishing timely analyses of presidential candidates' tax plans, assessing the expected revenue gain/loss of the plans; the distributional effects on high-, medium-, and low-income households; and, importantly, the potential macro-dynamic consequences of the plans.
In addition to the Tax Foundation model, the Congressional Joint Committee on Taxation and the Congressional Budget Office employ similar models. These models never yield the exact same predictions because economists differ in their views about the assumptions underlying these models and how the models are structured. But they consistently tell us that reducing barriers to work and savings is positive for the economy.
Naysayers claim that these models are too uncertain and that the assumptions are too rosy. Congressman Sandy Levin has asserted, "Macro-dynamic scoring risks undermining both the accuracy and integrity of the scorekeeping process." But in actuality, to ignore the very real effects - positive and negative - that changes in the tax system have on the decisions we make is to turn a blind eye to a key responsibility of policymakers: mitigating barriers to economic growth.
The think tank community, the academic tax research community, and the government agencies assisting policymakers all need to continue to advance the science of building these models and make them accessible to policymakers. Doing our part, the American Enterprise Institute has launched the Open Source Policy Center, a fully transparent and user accessible suite of tax models to help further advance efforts towards tax reform.
This year, file your taxes and feel free to complain bitterly to your friends. Let's hope next year things will be better!