Tax Reform

The U.S. tax system is complex, confusing, inefficient and, according to some, unfair. The tax code is riddled with tax expenditures or "tax breaks," which include loopholes, deductions, exemptions, credits and preferential rates. Because these tax exemptions provide financial assistance to specific activities and groups, many of them are actually very similar to government expenditures in disguise. Worse, they create market distortions that are detrimental to economic growth and productivity.

Many economists believe it would be beneficial to the economy to eliminate some or all of those tax breaks to make the code more efficient and reduce the deficit. Well-done tax reform would promote economic growth, make our tax outlook more sustainable, reduce complexity and compliance burden, and increase the transparency and fairness of the system by treating people and businesses in similar circumstances more equitably. .

POLICY OPTIONS

This page outlines a number of useful policy ideas that have been proposed to reform personal and corporate income taxes, as well as proposals for new types of tax regimes. For more information about how the US tax system currently works, see our Income page.

Personal income tax reform

An important reform strategy is to eliminate most or all of spending on personal income and payroll taxes. Under the current system, two taxpayers with the same income level could face very different tax bills because one of them can take advantage of more tax breaks than the other. The Tax Cuts and Jobs Act eliminated certain tax expenditures, but many of the most important ones remain. Some of the most expensive tax expenditures are also the most popular and were designed to meet certain policy objectives, including those that cover retirement plans, employer-provided health benefits and credits for parents of dependent children. For that reason, major changes to our tax code must be implemented gradually to give people time to adjust.

Eliminating some or all individual tax expenditures could allow for a number of other changes to the tax system, while also producing additional revenue to improve our long-term fiscal prospects. It could also improve the efficiency of our economy and increase taxpayer confidence in the fairness of the overall system.

Corporate income tax reform

The Tax Cuts and Jobs Act not only reduced the top corporate income tax rate from 35% to 21%, but also introduced a number of changes to the way the tax is administered. Corporate tax expenditures implicitly subsidize some economic activities and sectors of the economy at the expense of others and therefore distort economic decision-making. For example, businesses are taxed differently depending on their organization (i.e., as corporations, Subchapter S corporations, limited liability companies, partnerships, etc.). Similar to the individual tax code, many have suggested that an ideal system would eliminate some or all corporate tax exemptions, thereby avoiding the distortions generated by special provisions and instead promoting economic growth.

Other tax reform proposals

Other proposals would create new types of taxes to replace or supplement existing taxes. Two notable examples are:

• Consumption taxes: A major reform would replace the current income tax system with one that taxes consumption. There are many forms a consumption tax could take. Most proposals exempt income used for savings and investment. To protect low-income taxpayers, some proposals would exempt income used for housing, food, health care and other defined purposes up to a specified level. Other proposals would tax the consumption of lower-income families at reduced rates.
• Carbon taxes: Some have suggested introducing a carbon tax to achieve two goals: increasing revenues and discouraging the use of high-carbon energy, which would ultimately have positive environmental effects. A carbon tax could also allow the government to reduce other taxes while generating additional revenue to reduce the deficit.