Opportunities and Risks in Individual Tax Reform: Testimony Before the US Senate Committee on Finance

This testimony before the US Senate Committee on Finance on individual tax reform makes five main points. First, the current tax reform effort is occurring at a time when low- and middle-income families are facing deep financial challenges. Economic disparities are vast and have been widening for decades. The US also has one of the lowest levels of economic mobility relative to our competitors. Our debt as a share of GDP is projected to grow to unprecedented levels in coming decades, largely because of the retirement of the Baby Boom and increasing life expectancy. This growth in debt will be a drag on economic growth. For all these reasons, tax reform should increase revenues and enhance progressivity. Doing so would boost economic growth and make the tax code fairer at the same time. At a bare minimum, tax reform should maintain the current level of revenues and progressivity—and these both should be measured consistently and without resort to budget gimmicks like a “current policy” baseline. Second, individual tax reform should focus on leveling the playing field for the next generation and supporting work. Doing so would blunt economic inequality, broaden opportunity, and increase productivity by ensuring that jobs are awarded more often based on effort and talent, and less based on connections and the luck of one’s birth. Some worthwhile proposals that would advance these goals are expanding the EITC, especially for workers without dependents; increasing refundability of the child tax credit, particularly for young children in the poorest families; and restructuring child care benefits so they provide the largest benefits to those spending the largest share of their income on child care. These proposals could make significant headway in offsetting the much lower earnings growth that low- and middle-income families have experienced over the past few decades compared to those who are more fortunate. They should be paid for by raising taxes on the wealthy, including by strengthening, not repealing, wealth transfer taxes. Third, individual tax reform should focus on reducing transactional complexity, which arises from taxpayers reorganizing their affairs to minimize taxes. Doing so would accomplish the trifecta of tax reform: it would make the code fairer, more efficient, and simpler. To further this goal, Congress should consider proposals like rationalizing the NIIT and SECA taxes so all labor and capital income are subject to the Medicare tax on high incomes in some form, repealing stepped-up basis, narrowing the gap between the tax rates on ordinary income and capital gains, and taxing carried interest as ordinary income. Fourth, individual tax reform should seek to make tax incentives more efficient and fair, generally by restructuring them into refundable credits, and leveraging the empirical insights of behavioral economics. Doing so could generate more social benefits at a lower cost. One particularly promising area for reform is tax incentives for retirement savings. Finally, the first principle of tax reform should be to do no harm. Unfortunately the tax plans offered so far by the President and in the House Republican Blueprint do just that. They lose massive amounts of revenue. The corresponding increase in debt would depress economic growth substantially over time. They are both sharply regressive, providing vast tax cuts to the wealthy and a pittance to everyone else. They create a giant new loophole for the wealthy in the form of a special rate cap on pass-through business income, which tax experts on the left and right agree is a terrible idea. And, to the extent that they include any proposals intended to support low- and middle-income households, they do so in relatively ineffective ways. Sooner or later, these plans’ massive tax cuts will have to be paid for, and low- and middle-income families are likely to be left footing the bill.