The Misguided Max Tax

Robert D. Reischauer and
Robert Reischauer Headshot
Robert D. Reischauer Distinguished Institute Fellow; President Emeritus - Urban Institute
William G. Gale
William G. Gale The Arjay and Frances Fearing Miller Chair in Federal Economic Policy, Senior Fellow - Economic Studies, Co-Director - Urban-Brookings Tax Policy Center

February 23, 1998

WASHINGTON—The latest fad in the seemingly endless stream of budget proposals involves limiting total tax payments. Bill Archer, chairman of the House Ways and Means Committee, wants to cap Federal revenue at 19 percent of gross domestic product. Some have gone even further, pushing for a constitutional amendment that would limit Federal taxes to 25 percent of income. The “Max Tax,” a variation on this theme, would let each taxpayer choose between filing under the current system and simply paying 25 percent of gross income.

These proposals may seem simple and fair. But they would constrain public policy in unwise and dangerous ways, give away needed Federal money and provide a huge tax break for the wealthiest households.

It’s true, as advocates for tax limits like to point out, that the Federal Government has more revenue today relative to the size of the economy than at any time since the end of World War II. But there are good reasons that this is the case.

First, lawmakers increased tax rates in 1990 and 1993 to reduce the deficit. And guess what? For the first time since 1969, we will have a budget surplus. A tax limit like the Max Tax, which would reduce revenue by more than $100 billion, would throw this accomplishment away.

Second, since the 1960’s payroll taxes have risen to match the rising costs of Social Security and Medicare. This largely explains the higher overall tax burdens facing individuals. Yet even these higher taxes will not meet the challenge that these two programs face when the baby boomers begin to retire in a decade.

Third, both the economy and stock market are booming. When incomes, corporate profits and capital gains soar, Government revenue rises more than proportionately, because the tax system is progressive.

But tax limits would be a windfall for the wealthy. If the Max Tax had been the law in 1994, those individuals with adjusted gross income below $50,000 a year—that’s 90 percent of all taxpayers—would have received cuts averaging only $150. Those with incomes exceeding $200,000—the top 1 percent of taxpayers—would have received cuts averaging $40,000. Should we reduce progressivity in the tax system when the richest among us are receiving a disproportionate share of the wealth?

It would be unwise and risky to limit taxes through a constitutional amendment or some arbitrary statutory cap. If the nation needed to expand the defense budget significantly, we would want to consider raising taxes; otherwise, we may find ourselves recklessly financing any buildup through soaring deficits, as we did in the 1980’s.

Moreover, a cap on taxes would be difficult to design and implement. Clear and accepted definitions of “taxes” and “income” would be needed, but none exist. For example, would it make sense when calculating a tax limit to equate income and payroll tax payments even though some portion of the latter will be returned to the taxpayer in the future as Social Security benefits?

Tax lawyers and financial planners would have a field day designing ways to game the new system. Under a tax limit, they would create mechanisms to shift corporate income, which would still be taxed at a 35 percent rate, to upper income households that would face a 25 percent rate on unlimited amounts of gross income.

The next step in tax reform should be to simplify the tax code. This does not require a constitutional amendment, a depletion of Federal revenue or a huge tax cut for the wealthy.