The Future of the Income Tax

The federal income tax has been under attack by the economics profession for more than a decade. The attack comes from two directions: supply-siders who believe that progressive income taxation impairs economic incentives,' and more traditional economists who would substitute a progressive expenditure tax for the income tax.2 At one time, support for the expenditure tax was confined to a few members of our profession, including such distinguished names as John Stuart Mill, Irving Fisher, Nicholas Kaldor, and James Meade. Today, it is fair to say that many, if not most, economists favor the expenditure tax or a flat rate income tax. This group has joined the opponents of progressive taxation in the attack on the income tax. Despite an incessant barrage from both groups, no country in the world is planning to abandon the income tax or is even considering a personal expenditure tax. A wave of tax reform, beginning with the U.S. reform in 1986, has been sweeping the world, aimed at improving the income tax, not at eliminating it. Tax preferences formerly regarded as sacrosanct are being removed and there is a distinct movement toward comprehensive income taxation.3 However, individual income tax rates are being cut, tax progressivity has been declining almost everywhere, and reliance on the income tax has been diminishing. It will come as no surprise to this audience that I approve of the base-broadening feature of the current tax reform movement, but I believe that the reduction in the redistributive effect of the income tax has gone too far. In this paper, I shall show that the progressivity of the U.S. tax system-never very pronounced, except during and immediately after the two world wars-has been declining for more than two decades and that the Tax Reform Act of 1986 reversed this decline, but only slightly. Consequently, we have a long way to go to improve the equity of the tax system. I believe this can be done without punitive tax rates that will hurt economic incentives. I begin with a brief review of recent changes in the U.S. distribution of income and follow this with an analysis of the effect of taxes on the income distribution. I next examine arguments for and against the income tax, with particular emphasis on its effects on economic incentives and its merits when compared with the expenditure tax. I then evaluate the income tax as it emerged from the 1986 tax reform and conclude with tJoseph Pechman passed away on August 19, 1989. His Presidential address was delivered at the onehundred second meeting of the American Economic Association, December 29, 1989, Atlanta, Georgia. *Joseph A. Pechman, Economic Studies Program, The Brookings Institution, 1775 Massachusetts Avenue NW, Washington, DC 20036. I have benefited from the comments and suggestions on an earlier draft of this paper by Henry J. Aaron, Richard Goode, Jane G. Gravelle, Robert W. Hartman, Donald W. Kiefer, Herbert E. Klarman, Robert D. Reischauer, Clifford M. Winston, and H. Peyton Young, but they should not be held responsible for the views expressed in this paper. I am indebted to Richard Kasten for various simulations. I am also grateful to Stephen J. Kastenberg for research assistance and to Diane A. Shugart, Valerie M. Owens, and Sara C. Hufham for secretarial assistance. 'Some of the more extreme supply siders argued that large tax cuts pay for themselves (see, for example, Laffer, 1981), but I believe it is fair to say that this view has been totally discredited. For a more reasonable supply-side view, see the Economic Report of the President 1982. 2See, for example, Michael J. Boskin (1978), David E. Bradford (1980), Charles L. Ballard, Don Fullerton, John Shoven and John Whalley (1985), Paul Courant and Edward Gramlich (1982), Martin Feldstein (1978), Robert Hall and Alvin Rabushka (1985), John Kay and Mervyn King (1983), Charles McLure (1987), Mieszkowski (1980), and Lawrence Summers (1981). It is interesting that the recent popularity of the expenditure tax among economists was stimulated by a tax lawyer, William D. Andrews (1974). 3See Pechman (1988).