Broadening the Tax Base and Its Effect on Fiscal Policy

Abstract

The Tax Reform Act of 1986 signed by President Ronald Reagan, and the Economic Growth and Tax Relief Reconciliation Act of 2001, signed by President George W. Bush are the most significant tax reforms the United States has seen in the past thirty years. While both bills have gained notoriety for “broadening the tax base” by eliminating tax preferences and deductions, neither approach has been clearly proposed as an answer to the current fiscal cliff. Half the political base blames the “Bush tax cuts” for current fiscal deficits because of the massive decrease in tax rates without compensating for lost revenue. The other half admires the “Reagan tax cuts” for broadening the tax base while lowering rates, but do not seem to believe those principles can translate to today’s economy. Indeed, experts do not agree that past, proven principles can help stabilize the current economy. The current United States debt level and yearly deficit should trigger appropriate tax policies to create greater revenue from the tax code. In this paper, I propose that the primary focus of tax reform should be lowering the budget deficit through increased tax revenue. There are primarily two ways in which the tax code can generate revenue: (1) increase the individual income tax rates, or (2) broaden the tax base by making more income subject to taxation. Broadening the tax base is a more viable option than simply raising individual income tax rates because of the inherent fairness and efficiency that accompanies base broadening. Reform through base broadening eliminates taxpayer’s ability to take deductions and equitably places more taxpayers on the same footing from a taxation perspective. As in the 1980’s, broadening the base will result not only in decreasing the national debt and yearly deficit, but could potentially give a greater number of Americans larger take-home pay. Both political parties have pandered to interest groups causing tax reform to be arithmetically easy, but almost politically impossible. Tax reform is political by nature because any change to existing policy and legal structures comes from political bodies changing legislation. While the Tax Reform Act of 1986 and the Bush tax cuts of 2001 and 2003 dealt with many complex issues such as government spending, corporate tax rates, and gift and estate tax rates, both approaches relied on politics, not arithmetic, nor policy to produce tax reform. This paper will attempt to compare the two acts while narrowing its analysis on individual income tax rates and the effects broadening the tax base has on fiscal policy. Part I sets out taxation and broadening the base. Part II shows the history and politics of the respective tax reform acts. Part III compares the two reforms of Reagan and Bush. Part IV analyzes the effects prior reforms could have on the current United States economy if implemented today, with a special focus on broadening the tax base. Part V sets out the potential solutions for tax reform with an emphasis on President Obama’s and former 2012 Republican Presidential candidate Mitt Romney’s tax plans. Ultimately, this paper concludes that broadening the tax base is the best way of addressing, at least in part, the current United States debt.