December 28, 2010


The Tax and Spending Compromise (Gary Becker, 12/26/10)

I view the maintenance of the Bush tax cuts as only the first important move of the American tax code toward a more effective income tax structure. That structure would have a broad-based low rate flat tax on personal incomes, with little, if any, taxation of corporate incomes, and with dividends and capital gains taxed as ordinary income. As the majority report of the recent National Commission on Fiscal Responsibility and Reform proposed, the income base should be greatly broadened by eliminating the deductibility of interest on mortgages, and a variety of other special deductions that result from the political influence of various special interests.

I showed in a post last month (see 11/07/10) that even a one-half percent increase in the American long-term rate of economic growth would have a large effect in 20 years on both per capita incomes, and on the size of the US debt relative to its GDP, as long as the rate of growth in government spending was not allowed to increase along with the growth in incomes. Control over the rate of growth of spending is essential even with faster economic growth in order to try to prevent the debt to GDP ratio from becoming a major problem.

A broad-based flat income tax could have a relatively modest tax rate- perhaps about 25%- and still raise as much revenue as the tax structure that would exist if the Bush tax cuts were allow to lapse. A flat consumption tax would be even better than a flat income tax since such a consumption tax would not distort the incentive to save. However, this type of consumption tax is unlikely to be introduced as a substitute for the income tax. It could play a role as a supplement to the income tax if that combination were necessary to prevent a narrow-based progressive income tax system from being imposed.

The difficulty of replacing the tax on income with a tax on consumption is no reason not to try.

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Posted by Orrin Judd at December 28, 2010 8:17 AM
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