Reconnecting Taxes and Budgets

Abstract

The last major reform of the federal tax system took place in 1986. Much of that reform has since been erased by proliferating tax preferences for individuals and corporations. The percentage of individual income not subject to taxation, for example, has increased to its highest level since the early 1980s. The economic distortions of the current tax system are, according to most experts, substantial. Its complexity imposes costly compliance burdens on individuals and corporations, and the noncompliance “tax gap” has been estimated at more than 15 percent of total tax liability. While fairness is an elusive concept, few would argue that the tax system has become noticeably fairer over recent decades. More important in terms of budget policy, the federal tax system suffers from a problem that predates the Tax Reform Act of 1986. It does not raise sufficient revenues to finance the defense and domestic programs in the federal budget. Despite the often intense debates over taxation during our early history, budgets were usually balanced. From 1789 to 1930, deficits were routinely incurred during wars and financial upheavals, but nearly 70 percent of annual budgets were in surplus. The Great Depression and World War II produced a long series of consecutive deficits, but the balanced-budget standard was revived in the late 1940s and 1950s. With only a handful of exceptions over the past half-century, however, budget deficits have been the norm, and this fiscal imbalance is unlikely to improve anytime soon. Indeed, the urgent task for the federal government is to keep deficits and debt at “sustainable” levels in the decades ahead.