Tax Reform

1
Tax Reform

• Martin Feldstein
• Harvard University and
• National Bureau of Economic Research

2
The Tax Structure Has Become Much Better

• Reduced individual marginal tax rates
• Top rate down from 91 in 1960, 70 in 1980
• Reduced corporate tax rate
• Rate down from 52 in 1960, 46 in 1980
• Fewer tax deductions and exclusions
• Major changes in Tax Reform Act of 1986
• Lower tax on dividends and capital gains

3
Favorable Effects of Previous Personal Tax Reforms

• Lower tax rates improve
• Work incentive
• Form of compensation
• Saving incentive
• Lower tax on corporate income, dividends and
  capital gains improve
• Saving incentive
• Form of investment (corporate vs other) and
  finance (bias against dividends and in favor of
  debt finance)

4
Priorities for the Future

• Reduce marginal tax rates that distort individual
  incentives
• Reduce corporate income tax distortions that now
• Reduce saving by lowering net return
• Reduce dividend payout because of double taxation
• Increase corporate use of debt finance

5
Fundamental Reforms Would Achieve These Goals

• Value added tax (or national sales tax), Flat
  tax, Consumed Income tax
• BUT
• Distributional problems eliminate pure VAT and
  pure Flat Tax
• VAT and Consumed Income Tax involve major
  transition problems

6
Two Possible Piecemeal Reforms Could Also Achieve
Those Goals

• Tax husbands and wives separately
• Integrate corporate and personal income tax rates

7
Taxing Husbands and Wives Separately

• Lowers marginal rate on 2nd earners
• Common practice in most other countries
• Can be done in revenue neutral way
• Can be applied to wage and salary income only or
  to all income

8
Integrate Corporate and Personal Income Taxes

• Gross-up and credit method has been widely used
  in other countries
• Total earnings imputed to individual taxpayers
• Corporate tax regarded as withholding at source
• Individual receives tax refund if personal rate
  less than credit rate
• Credit rate is 35 with complete integration but
  could be less to achieve revenue neutrality
• Could be combined with other corporate tax
  reforms, e.g., investment expensing

9
Favorable Effects of CIT Integration

• Lowers tax rate on equity investment and saving
• Reduces anti-dividend bias in current law
• Reduces current bias in favor of debt finance