The need for tax reform is on the forefront of both American politicians and citizen’s minds. Economists debate what changes will make improvements to the economy. Both viewpoints acquiesce that finding a fiscal balance and reducing the national debt is necessary to boost the American economy and employment rates. The economic effects of tax policy are extensive, and most economists can agree that the United States cannot sustain itself by means of the current tax strategy. However, deliberations concerning the definition of productive government spending are heated and polarizing. Deliberating without reform will result in irreparable damage to the private sector, crippling economic growth and bankrupting the country.
Tax reform, a contemporary crisis, is also historically relevant. The Revolutionary War marked a distinguished time of tax restructuring. American colonists fought for independence from British taxation without representation. In 1773, the Boston Tea party occurred- a revolt in which colonists dumped tea into the Boston Harbor rather than pay taxes on it. The first sales tax was applied on Americans in 1812 to support the on-going war effort with Great Britain. The Internal Revenue Service was established with the Tax Act of 1862, giving the revenue commissioner the right to levy income and property in order to enforce tax laws while also stabilizing policy and voting rights for the people. The Tax Act of 1862 also implemented the marginal income tax system, similar to the same structure Americans use today.
There are several factors influencing the debate on how to simplify and balance the fairness of taxation while also supporting the need of government programs to be adequately financed. The growing burden for health care and other costs generated by retiring Baby Boomers is an issue that needs to be addressed without delay. Programs such as Medicare and Social Security are approaching bankruptcy. (Congress) Historic levels of debt and deficits caused by financing new government policy, defense, and general economic downturn also need to be reversed. The United States has the most unequal income distribution among industrial countries. (Wolff) The public reach different conclusions on the equality of the tax system.
A recent political issue was the continuation of Bush’s Economic Growth and Tax Relief Recovery Act that was due to expire in December of 2011. This Act was implemented in 2001 as a ten year plan to cut tax rates on all economic levels of income and to give tax credits for savings and education. Letting it expire as planned would be the largest tax increase in American history. (Halbert) Disputers of this act recognized it would cause up to a two trillion dollar deficit in interest and repayment. Not implementing these tax cuts could be beneficial in the long-term. They also voiced that an increase on lower and middle class households when the bill expired would not only afflict how much taxes the poor are liable for paying but also support disinterest in investments and working in a time of forecasted financial stress. Supporters of the bill argued the short-term cash stimulus for all would overlap the deficit and there would be balance. They provided some evidence that a small tax increase does not eradicate incentives for working and saving. Most economists agree that maintaining the current tax cuts on the middle class could increase disposable income, stimulate the economy, and therefore improve employment figures. Alternatively, tax cuts on the rich unburden business owners providing more earnings that may yield higher employment percentages. Another option, letting the bill expire with no reform, would increase tax rates for all immediately, while continuing the bill would increase tax rates long-term. The tax cuts were extended for two years and the bill will be readdressed in 2013.
The merits of tax cuts as an economic stimulus are questionable. If the economy is down and unemployment is up, tax cuts can be used to stimulate the economy. However, the long-term results of tax cuts are less money for government programs resulting in government debt and eventually higher taxes to repay the balance.
One reform solution is drastically dissimilar than the current system and offers a more controversial substitute. Modeled from a European style, the Consumption Tax is an alternative to income tax. The pros of instating a Consumption Tax system are that it would support long-term savings growth by exempting savings accounts, investments, and capital gains from taxes. It would force people that net untaxed money to also supply tax earnings. Oppositionists to the Consumption Tax affirm the tax would greatly increase lower and middle-class tax rates. Because most lower and middle-class households do not pay income taxes (Ohlemacher), swelling tax increases to products in stores will be of greater burden to them. This would be a way of collecting more equal revenue from all tax payers. Conversely, it may also inhibit the economy, discouraging the public to spend money. Another disadvantage to the Consumption Tax is that the amount of tax proceeds will not be predictable which may hinder government operations and perhaps cause unnecessary debt. Also, current policy already promotes savings by offering tax cuts to investments in 401K plans or IRAs; therefore, there is concern changing procedure in this way will be regressive.
Another proposed reform solution is a flat-tax method. The flat-tax differs from the graduated income tax of today in that there would not be multiple tax brackets for taxpayers. All wage-earners grossing income over the poverty rate would be required under federal law to pay a certain unwavering percentage of their taxable income. That percent of taxes paid would not fluctuate based on income. With the flat-tax in effect, complex and difficult tax forms would be eliminated as well as credits and deductions. While this strategy is perhaps desirable, some economists suggest a flat-tax would favor the prosperous and saddle disadvantaged Americans with a higher tax load.
The Negative Income Tax is a strategy that incorporates both the guiding principles of flat-tax and income tax. Under the negative tax plan, the law would require a flat-tax rate percentage of all wage-earners; however, deductions would still be calculated in the return. If the added deductions are in excess of total earned income, the return would qualify the tax-payer for a tax refund and a cash reimbursement of a percentage of the negative tax balance. (Chapo) The Negative Tax could eliminate welfare programs such as food stamps and unemployment by redistributing revenue from well-off Americans to unemployed or underemployed tax-exempt Americans. Critics of the negative income tax plan express the plan could endorse tax fraud, support unemployment, and produce worse financial consequences than the existing system, especially if the average American becomes tax-exempt.
Government spending can be economically pertinent. Efficient spending can generate high economic growth while wasteful overheads can cause decline. Tax revenue is shown to be most effective when spent in progressive areas such as on education and research. (McInnis) These taxes help support training programs that increase the number of qualified workers. Lower poverty and crime rates will reflect higher employment. Innovation in the private sector will produce taxable profit.
Because the United States is so conflicted with opinions on the best way to reform our tax system, finding common ground seems unlikely. Yet, acting quickly to fortify the American economy is critical and may impel Congress to sanction new legislation hastily. New tax laws could eventually be derived from an amalgamation of innovative suggestions or a blend of the flat-tax and sales tax initiatives. From the time it was created, the complex nature of convoluted U.S. tax code has influenced many proposals to change and improve the bill. It is essential to the sustainability of our nation for tax collection to be reformed in a profitable way.
Chapo, Richard. “Tax Alternatives: The Negative Income Tax.” EzineArticles Submission. Web. 14 Oct. 2010.
Congress. “Transcript of George W. Bush’s State of the Union Address.” Featured Articles From CNN. 02 Feb. 2005. Web. 9 Oct. 2010.
Halbert, Gary D. “The Largest Tax Increase in US History.” InvestorsInsight.com – Financial Intelligence, Advice & Research / Investment Strategies & Planning for Individual Investors. 12 Jan. 2010. Web. 12 Oct. 2010.
McInnis, Hon. Scott. “Congressional Record, House of Representatives.” Google Books. 13 Dec. 2001. Web. 12 Oct. 2010.
Ohlemacher, Steven. “Half of US Households Escape Fed Income Tax” Yahoo! Finance – Business Finance, Stock Market, Quotes, News. 7 Apr. 2010. Web. 11 Oct. 2010.
Wolff, Edward. “Wealth and Income Inequality in the USA.” Multinational Monitor. May 2003. Web. 10 Oct. 2010.