What Will Taxes Be Like?

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.