Pro-Growth Tax Reform Can Be Progressive

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For the first time in years, fundamental tax reform is at the center of public debate. Republican presidential candidate Herman Cain's popularity has surged, fueled by voter interest in his 9-9-9 tax reform plan. But Cain's plan has been widely criticized for being insufficiently progressive - for shifting too much of the tax burden onto low-income Americans. His plan would likely grow the economy, but its impact on tax progressivity understandably raises concerns for many voters.

It sounds like a painful tradeoff. For struggling Americans facing tax hikes in the here and now, the promise of greater prosperity in future decades offers little consolation.

Luckily, we can escape this false choice. There is a tax plan that offers the best of both worlds: growth and progressivity. It's called the Bradford X tax.

Though it's not yet widely known, the X tax is a progressive consumption tax that has the potential to attract broad bipartisan interest because it incorporates features that both left and right hold dear.

Adopting the X tax would shift the federal tax system away from taxing income toward taxing consumption - a surefire way to accelerate economic growth. Although much of the benefit would not show up for several years, one economic study estimates that replacing the income tax system with an X tax could boost GDP by around 6 percent in the long run.

Consumption taxes promote economic growth because they avoid a central flaw of income taxes: their penalty on saving and investment. Income taxes put heavier burdens on those who save for tomorrow than on those who spend today, because savers, in addition to being taxed on the income they save, are taxed on the returns they earn on their saving. Although both income and consumption taxes discourage work, consumption taxes are more efficient because they don't also discourage saving. This distinction makes consumption taxes more conducive to economic growth.

So what's the downside? Most consumption tax proposals are either regressive or revenue losers. 9-9-9 is an example of the former, while Rick Perry's plan is an example of the latter.

The X tax, though, allows for the best of both worlds. It has all the benefits of consumption taxation - higher growth, no disincentive to save - without regressively redistributing the tax burden.

Two features of the X tax (proposed by the late Princeton economist David Bradford) make it a consumption tax. First, individuals pay tax on their wages only, not on any income from saving. Second, firms are allowed to immediately write off their investments, rather than depreciating them over a period of years. As a result, the tax treatment is the same for those who consume today as it is for those who consume tomorrow.

Where does the progressivity come from? The X tax sets higher tax brackets for workers with higher wages, and lower brackets for low-wage workers. It also allows for exemptions and tax credits to ease the burden on low-income individuals. Firms pay a tax rate equal to the rate on the highest-paid workers. These features allow for almost any desired degree of progressivity.

In this era of economic malaise, it is little wonder that many Americans are excited by the prospect of pro-growth tax reform. Republican presidential candidates are right to call for consumption taxes, but voters listening to the current debate may think such an approach requires that we give up on tax progressivity. It doesn't.

What it does require is a willingness to think outside the box. If we turn to the X tax, we can maintain progressivity in the tax code while boosting economic growth.

Alan Viard is a resident scholar at the American Enterprise Institute (AEI) and is the co-author of an upcoming book on the Bradford X tax.  Chad Hill is a Jacobs Associate and the program manager for economic policy studies at AEI. 

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