As Benjamin Franklin once wrote, "in this world nothing is certain but death and taxes." Yet the types and levels of taxation that occur are anything but certain. Rather, they have varied greatly in the past, and may well change dramatically over the coming 30 years.
In 1978, when Research was founded, the top marginal income tax rate in the United States was 70 percent, and since rates were not indexed for the era's surging inflation, "bracket creep" had emerged as a public menace. Capital gains, meanwhile, bore a maximum rate of almost 50 percent, the highest level in the industrialized world.
But a sea change in tax policy was just getting underway. On June 6, 1978, California voters passed Proposition 13, a ballot initiative that capped property taxes in the state. Shortly thereafter, Rep. William Steiger (R-Wis.) successfully pressed legislation that slashed the cap-gains maximum rate to 28 percent. A decade of tax reductions, reforms and revolts had begun, having a lasting impact on American politics.
In 2008, taxation remains an area of intense political contention, and the nation faces near-term decisions about the structure of the tax system. Tax cuts implemented by the George W. Bush administration are slated to expire at the end of 2010, posing difficult choices between allowing a reversion to higher rates (and delivering a shock to the economy) or extending the cuts (and allowing federal deficits to burgeon further).
Current Reform ProposalsLawrence B. Lindsey, former director of the Bush White House's National Economic Council, hopes this stark dichotomy will inspire a broader tax overhaul. In his recent book What a President Should Know ... But Most Learn Too Late (Rowman & Littlefield), Lindsey advises the next president to "use the expiration of the tax cuts as well as the need for changing the alternative minimum tax as an opportunity to substantially reform the entire tax system."
Lindsey proposes replacing most income taxes with a value-added tax, or VAT. This might take the form of a "20-20 plan," combining a 20 percent VAT with a 20 percent flat tax on all income above a certain threshold (such as $75,000 for single filers, $150,000 for married couples). Such an approach, he argues, would make taxes vastly simpler and more efficient, without placing undue burdens on any particular segment of the population. Lindsey also writes favorably about a carbon tax.
Other ideas for tax reform abound. The "FairTax," a proposal that has some grassroots support and was endorsed by recent presidential hopeful Mike Huckabee, would replace all federal income, gift and estate taxes with a national retail sales tax. Another approach that would shift taxation toward consumption was suggested by the late economist David Bradford. Known as the "X tax," this would make all savings tax-free, but would tax spending at graduated rates based on income.
Flat taxes have been pushed by former House Majority Leader Dick Armey and former presidential candidate Steve Forbes, among others. Such proposals, which would replace progressive taxation with a uniform rate while removing deductions, are sometimes promoted as allowing taxpayers to file their returns on a postcard.
Tax simplification has been a theme of other reform efforts as well. In 2005, a presidential commission unveiled two plans that would reduce the number of brackets and repeal the alternative minimum tax, among other measures. In the 2008 presidential campaign, John McCain has spoken of reviving the commission's proposals and submitting a simplification program to Congress for an up-or-down vote. Barack Obama has proposed reducing paperwork by having the Internal Revenue Service send pre-filled forms to taxpayers with information from their employers and financial institutions.
Pressure for ChangeThere are, in short, many reform ideas being bounced around as alternatives to the current tax system. Over the course of three decades, it is likely that at least some significant experimentation will occur. The present tax code is widely disliked. Its prime beneficiaries seem to be accountants and tax attorneys who make a living by navigating through its complexity. The income tax itself has existed, other than during the Civil War, only since 1913. For all its seeming permanence, it could end up on history's scrapheap, if public opinion coalesces around a VAT or other consumption tax instead.
Meanwhile, the nation faces a daunting long-term fiscal picture, in which Medicare and other entitlement costs threaten to overwhelm the federal budget. Congressional Budget Office projections show Medicare as a share of gross domestic product more than doubling by 2030, and more than tripling by 2050. While entitlement reform may avoid the worst of such scenarios, we can expect to see stepped-up efforts by government to generate tax revenues. The one scenario that need not be taken seriously for three decades from now is that taxes will have become extremely low or nonexistent.
With all the above in mind, we now turn toward a speculative exercise in future history.
Taxes in 2038Contrary to what Lawrence Lindsey hoped, the end of 2010 did not bring a radical change in the tax system. American politics rarely moves that fast. Rather, the new president, not known as a tax cutter, and the Congress shifted rates upward approximately halfway to where they would have been without the Bush tax cuts. But public discontent with the system was growing, and the 100th anniversary of the income tax added fuel to the fire.
It was not until 2018 that the "Consumption Plus" tax was enacted. This system was reminiscent of the 20-20 plan Lindsey had proposed, except its rates were higher, combining a 23 percent VAT with a 28 percent flat tax on income above an inflation-adjusted threshold. In addition, the legislative package increased the carbon tax that had been in place since 2015, while providing credits for vehicles fueled with carbon-negative algae biodiesel.
Now, in 2038, this basic system is still in place, although the VAT has been increased to 24.997 percent. (A constitutional amendment limits it to "below 25 percent.") The flat tax on "premium income" and the carbon tax have also been hiked. However, some of the wealthy have become adept at using tax derivatives that let them exchange their tax exposure portfolios with those of foreign speculators. There are concerns that nobody really understands the systemic risks involved in this new market.
In any event, taxation will be a major issue in the upcoming 2040 presidential election. The octogenarian Republican incumbent, Bruce Willis, vows to hold the line against proposals for new taxes on space development, seabed mining, algae farming and cosmetic surgery. However, the likely Democratic nominee, Chelsea Clinton, has said "It's time to balance the budget, and the lunar colonists should pay their fair share."
Here are some notable events in the history of American taxation:1787 United States Constitution gives Congress "power to lay and collect taxes."1791 Treasury Secretary Alexander Hamilton sets up system of tariffs and excise taxes.1815 War of 1812 ends before proposed wartime income tax can be enacted.1828 Regional tensions flare as Southerners decry "Tariff of Abominations."1862 Union begins collecting income tax to pay for Civil War.1881 Supreme Court declares now-expired income tax was unconstitutional.1913 Sixteenth amendment to Constitution authorizes federal income tax.1917 Top marginal rate on income hiked to 73 percent as U.S. enters World War I.1926 Top rate, after several reductions, is at 25 percent.1936 Amid Depression, top rate is 79 percent, and estate and gift taxes are instituted.1945 World War II raises top rate to 91 percent, and it stays there in peacetime.1964 Tax cut, initiated by late President John F. Kennedy, brings top rate to 70 percent.1974 Individual retirement accounts are introduced.1981 President Ronald Reagan presses legislation reducing top rate to 50 percent.1986 Tax reform law closes loopholes, sets top bracket at 28 percent.1990 President George H.W. Bush lifts top rate to 31 percent.1993 Tax hike, putting top rate at 39.6 percent, pressed by President Bill Clinton.2001 President George W. Bush begins tax cuts that will bring top rate to 35 percent.
Kenneth Silber is a senior editor at Research. His work on science, economics and history has appeared in a variety of publications, including The Wall Street Journal