Tax reform for progressivity: A pragmatic approach

Internal Revenue Service federal building Washington DC USA
Editor's note:

The report below is a chapter from the book, “Tackling the tax code: Efficient and equitable ways to raise revenue.” Read the full book here.

The Problem

In the coming decades, federal spending will need to grow just to enable the government to continue to provide the services it does today. One important weakness in the tax system that funds this spending is insufficient tax compliance: In 2020 the IRS will fail to collect more than $630 billion, or nearly 15 percent of tax liabilities. Illegal tax evasion generates unfair differences in tax payments across otherwise similar individuals and firms.

The tax code also presents many legal opportunities for tax avoidance. Taxpayers differ in their ability to benefit from these opportunities, generating further inequities. Tax avoidance can also lead taxpayers to engage in socially unproductive activities (e.g., avoiding realization of capital gains in order to benefit from stepped-up basis).

The Proposal

Sarin, Summers, and Kupferberg propose several reforms to the tax system both to combat illegal evasion and to decrease the opportunities for legal tax avoidance.

  • Decrease illegal tax evasion by investing in the IRS, better targeting audits, and increasing information requirements.
  • Decrease legal tax avoidance by:
    • Minimizing individual tax shelters, including the payroll tax loophole, pass-through deduction, and tax deductions more generally.
    • Reforming the corporate tax code with an increased tax rate and broadened base.
    • Overhauling capital gains taxation by taxing capital gains at ordinary levels, removing the stepped-up basis for inherited capital gains, and closing the carried interest loophole.

The authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. Neither is currently an officer, director, or board member of any organization with a financial or political interest in this article.