The progressive tax system, and the nation’s fiscal system more broadly, have historically played an important role in expanding opportunities for all Americans while reducing inequality. But the same dynamic forces of technological change, financial innovation, and globalization that have contributed to rising income inequality also present new challenges for progressive taxation. Financial engineering, for example, has made it easier for the financially sophisticated—typically the wealthy—to take advantage of new financial instruments that shelter their gains from tax. And as capital is able to move ever more quickly and easily across borders, corporate income becomes increasingly elusive of taxation. These forces, together with deliberate policy changes, have led to an erosion of progressivity—the principle that higher incomes should face higher rates of taxation—and a dramatic reduction in the average tax rate facing very high-income households. More than half of that decline is the result of declining effective corporate tax rates, as high-income households own disproportionate amounts of capital.
The tax code is not only a means of raising revenue to pay for government services. It also impacts an astonishing array of economic and social activities, from homeownership to education and child care to support for low-income workers. Taxes contribute, as part of the problem or as part of the solution, to many of the challenges our nation faces. The present tax treatment of health insurance, for example, pushes health spending upward while offering many of the uninsured little help in getting coverage. The tax treatment of retirement savings provides a windfall for high-income Americans who would likely have saved anyway, while offering scant encouragement to saving by low- and moderateincome Americans, many of whom face the prospect of an insecure retirement. America’s factories and cars continue to emit vast amounts of the carbon dioxide that drives climate change, a problem that would be remedied, in part, if the tax code imposed a cost for burning carbon-emitting fossil fuels.
There is broad agreement about many of the shortcomings of our current tax system, but little consensus about the solution. To make progress, lawmakers will, at a minimum, have to come together in good faith and agree on a broad approach. In an effort to define a common approach, this strategy paper offers six broad principles that reflect the new challenges facing our tax system in the twenty-first century. We believe these principles should command wide assent as policymakers consider tax reforms, whether incremental or far-reaching:
- Fiscal responsibility requires addressing both taxes and spending.
- Rising inequality strengthens the case for progressivity.
- The tax system should collect the taxes that are owed.
- Tax reform should strengthen taxation at the business level.
- Taxes for individuals should be simplified.
- Social policy can and should often be advanced through the tax code—and it must be well designed.
The remainder of the paper will discuss each of these principles in detail.