This paper examines the fiscal outlook and tax reform options in the United States. The major conclusions include: the United States faces a substantial fiscal shortfall in the medium- and long-term; both spending cuts and tax increases should contribute to the solution; tax increases need not do significant harm to economic growth; and there are sensible ways to both reform tax structure and raise revenues, including tax expenditure reform, the creation of a value-added tax, the creation of a carbon tax, or an increase in the gasoline tax.
The Great Recession and its aftermath have left the United States with a difficult fiscal situation, with a weak economy that would benefit from short-term stimulus, but also with projected medium- and long-term budget shortfalls, even after the economy recovers, that indicate the need for fiscal consolidation. Addressing these medium- and long-term problems will likely require a combination of spending cuts and revenue increases. While tax reform would be a laudable goal even in the absence of a fiscal problem, building a better tax system becomes even more imperative when revenue requirements rise and the equity and efficiency of the tax code are put under even greater scrutiny and pressure.
In this paper, we consider how tax reform could be designed to simultaneously address three goals: promoting economic growth, improving equity, and raising revenue. We begin in section 2 by summarizing the medium-term and long-term fiscal outlook and reviewing the arguments for higher revenues as part of a fiscal solution.
In Section 3, we discuss how to broaden the income tax base by reducing and reforming tax expenditures. Public attention often focuses on raising revenues by raising income tax rates, but in the presence of the current narrow income tax base, this could create significant avoidance and prove economically damaging (Altshuler, Lim, and Williams 2010). Relative to rate increases, broadening the income tax base is more conducive to economic growth; it reduces the distortions created by the tax system and the inefficiencies involved in economic choices, it is fairer and simpler since different types of income and expenditure are treated the same way, and it could raise substantial revenue even when accompanied by lower rates.
In Section 4, we explore how a VAT could be designed as part of the solution to the U.S. fiscal problem. A VAT could raise significant revenue and, if the proceeds are focused on deficit reduction, would raise national saving. Distributional issues raised by the VAT can be addressed in a number of ways.
In section 5, we discuss how taxes on carbon emissions and/or a higher tax on gasoline would reduce externalities, make markets more efficient, and raise significant revenues. As with a VAT, the distributional issues could be addressed via other policies. Section 6 is a short conclusion.
Research Associate, Economic Studies
William G. Gale
The Arjay and Frances Fearing Miller Chair in Federal Economic Policy
Senior Fellow - Economic Studies
Director - Retirement Security Project
Co-Director - Urban-Brookings Tax Policy Center