Tackling the tax code: Efficient and equitable ways to raise revenue

The federal government faces increasing revenue needs driven by the aging of the population and emerging challenges. But the United States collects less revenue than it typically has in the past and less revenue than other governments do today. In addition, how the government raises revenue—not just how much it raises—has critical implications for economic prosperity. This chapter provides a framework for assessing tax policies and understanding their implications for growth and economic inequality.

Despite our founding vision as a land of opportunity, the United States ranks at or near the bottom among high-income countries in economic equality and intergenerational mobility. Our tax code plays a key role. Inherited income is taxed at less than one-seventh the average tax rate on income from work and savings. This chapter proposes a major step toward leveling the playing field by requiring wealthy heirs to pay income and payroll taxes on inheritances they receive above a large lifetime exemption. As part of this shift, the proposal would repeal the current estate and gift taxes and would tax accrued gains (beyond a threshold) on transferred assets at the time of transfer. It would also substantially reform the rules governing family-owned businesses, personal residences, and the timing and valuation of transfers through trusts and similar vehicles. The Urban-Brookings Tax Policy Center estimates the proposal would raise $340 billion over the next decade if the lifetime exemption were $2.5 million, and $917 billion if it were $1 million, relative to current law.
The proposal would almost exclusively burden the most affluent and most privileged heirs in society, while the additional revenues could be used to invest in those who are not as fortunate. As a result, the proposal would soften inequalities, strengthen mobility, and more equitably allocate taxes on inheritances among heirs. It would also enhance efficiency and growth by curtailing unproductive tax planning, increasing work among heirs, and reducing distortions to labor markets and capital allocation. Furthermore, the proposal is likely to increase public support for taxing inherited income. While the burdens of estate and inheritance taxes both largely fall on heirs, inheritance taxes are more self-evidently “silver spoon taxes” and appear to be more politically resilient as a result.

The U.S. income tax does a poor job of taxing the income from wealth. This chapter details four approaches to reforming the taxation of wealth, each of which is calibrated to raise approximately $3 trillion over the next decade. Approach 1 is a 2 percent annual wealth tax above $25 million ($12.5 million for individual filers). Approach 2 is a 2 percent annual wealth tax with realization-based taxation of non-traded assets for taxpayers with more than $25 million ($12.5 million for individual filers). Approach 3 is accrual taxation of investment income at ordinary tax rates for taxpayers with more than $16.5 million in gross assets ($8.25 million for individual filers). And Approach 4 is accrual taxation at ordinary tax rates with realization-based taxation of non-traded assets for those with more than $16.5 million in gross assets ($8.25 million for individual filers). Under both the realization-based wealth tax and the realization-based accrual tax, the tax paid upon realization would be computed in a manner designed to eliminate the benefits of deferral. As a result, all four approaches would address the fundamental weakness of the existing income tax when it comes to taxing investment income: allowing taxpayers to defer paying tax on investment gains until assets are sold at no cost.

We propose a tax instrument that is not currently used to any significant degree by the United States: a financial transaction tax (FTT). An FTT—if carefully designed and implemented—would raise substantial revenues in a progressive manner. We propose an FTT of 10 basis points that would apply to trading in stocks, bonds, and derivatives. We do not believe an FTT at this level would hinder market functioning or impede price discovery, and in fact it would be less than the recent declines in transaction costs that have occurred in many markets. The Urban-Brookings Tax Policy Center estimates that the proposal would raise approximately $60 billion in annual revenue once it is fully phased in. Because the United States does not have recent experience with a nontrivial FTT, some aspects of its effects—including the precise amount of revenue that would be raised—remain uncertain. For this reason, we propose a staged implementation over four years, with the FTT starting at 2 basis points, to allow policymakers to monitor market functioning, address avoidance techniques that will undoubtedly arise, and, if necessary, more carefully calibrate the level of the tax.

To raise revenue in a progressive, efficient, and administrable manner, this chapter proposes a new national consumption tax: a broad-based credit-invoice value-added tax (VAT). The proposal comes with several qualifications: the VAT should complement, not substitute for, new direct taxes on the wealth or income of affluent households; to ensure the policy change is progressive, the VAT should be coupled with adjustments to government means-tested programs to account for price level changes, and with a universal basic income (UBI) program; to avoid having the VAT depress the economy, revenues should be used to raise aggregate demand in the short run and the Federal Reserve should accommodate the tax by allowing prices to rise. A 10 percent federal VAT that funded a UBI equal to 20 percent of the federal poverty line would be highly progressive (with net income rising among the bottom forty percent and not changing in the middle quintile) and would still raise more than 1 percent of GDP in net revenue. VATs are a proven success, existing in 168 countries. VATs have been proposed by both Democrats and Republicans in recent years. Concerns about small businesses, vulnerable populations, and the states can be easily addressed.

The corporate tax remains a nearly indispensable feature of the U.S. tax system, since 70 percent of U.S. equity income is untaxed at the individual level by the U.S. government. Yet taxing multinational companies presents policymakers with conflicting goals. Although lower tax rates and favorable regimes may attract multinational activity, such policies erode the corporate income tax as a revenue source. Unfortunately, the Tax Cuts and Jobs Act of 2017 did not resolve this policy dilemma. Despite big reductions in corporate tax revenue due to lower rates, the 2017 tax law does not adequately address profit shifting or offshoring incentives within the tax code, nor does it improve the competitiveness of United States–headquartered multinational companies. This chapter proposes a rebalancing of U.S. international tax policy priorities. Starting from current law, there are several simple changes that can raise corporate tax revenue and adequately address profit shifting and offshoring; these changes can be implemented almost immediately within the architecture of current law. In the medium run the United States should partner with other countries to pursue a formulary approach to the taxation of international corporate income. By dramatically curtailing the pressures of tax competition and profit shifting, such an approach allows policymakers to transcend the trade-off between a competitive tax system and adequate corporate tax revenues. There is widespread international recognition of these problems; the current Organisation for Economic Co-operation and Development/Group of 20 process can serve as a steppingstone toward a fundamental rethinking of how we tax multinational companies in the 21st century.

This chapter proposes reforms to business taxes that would address some of the challenges facing the current system. These challenges include historically low revenue collections, instability, distortions, failure to address positive spillovers from research and development, and failure to address the increased returns to corporations that derive from their monopoly power. The proposal would raise the corporate tax rate from 21 percent to 28 percent, require large pass-through businesses to file as C corporations, and close other loopholes. In addition, it would expand incentives for new investment by allowing businesses to expense all their investment costs and get a nearly 50 percent larger credit for their research and development spending. The proposal would raise the long run level of GDP by at least 5.8 percent, adding at least 0.2 percentage point to annual GDP growth over the next decade. The combination of tax increases and additional growth would raise $1.1 trillion over the next decade and 1.1 percent of GDP in steady-state. The middle quintile of the income distribution would see a 3.5 percent increase in its after-tax income after taking into account the uses of the money raised. The overall gain to society in the long run would be about a 5.0 percent increase in well-being.

Trends in demographics, national security, economic inequality, and the public debt suggest an urgent need for progressive approaches to raising additional revenue. We propose a suite of tax reforms targeted at improving tax compliance, rationalizing the taxation of corporate profits earned domestically and abroad, eliminating preferential treatment of capital gains, and closing tax loopholes and shelters of which wealthy individuals disproportionately avail themselves. We estimate that these proposals have the potential to raise over $4 trillion in the coming decade. These proposals are comparable on the basis of both potential revenue raised and progressivity with newer and more radical proposals, like wealth taxation and mark-to-market reforms, that have been the focus of much recent attention. Importantly, our agenda is likely to enhance rather than reduce efficiency, is far less costly in terms of political capital, and hews more closely to basic notions of fairness than alternative approaches.