13: Tax Reform

Replace the individual income tax with a new flat-rate tax applied to income after deducting all savings and replace the business tax code with a flat business tax on domestic sales of goods and services.

Other Information:

Tax Reform -- Summary: The existing tax system is manifestly indefensible, especially in its complexity and its drain on economic vitality. The complexity of the tax system plagues taxpayers in all walks of life. Low-income citizens must navigate the enormously complex Earned Income Credit. Those who save must sort through multiple tax rates and tax regimes for different kinds of returns on those savings, and there is a multitude of phaseouts of various credits, exemptions, and deductions. As if this were not bad enough, Congress created a parallel income tax called the Alternative Minimum Tax, so millions of taxpayers must figure their taxes two different ways before they can know what to pay. Yet these difficulties suffered by taxpayers are relatively minor compared to some of the tortuous rules and exceptions inflicted on businesses large and small. The drain inflicted on economic vitality is even worse than the tax code's complexity. High marginal rates discourage all manner of productive activity. The U.S. corporate income tax rate is the second-highest in the industrialized world and much higher than the average tax rate of our international competitors. The current tax system actively discourages citizens from saving enough for retirement, emergencies, or the large purchases in life, thus driving them toward consumer debt. In turn, it artificially depresses the level of national savings and makes domestic investment more dependent on foreign investment. For decades, Congresses have tweaked and twisted a fundamentally flawed system into knots, each time creating two new problems while attempting to solve one old one. The income tax was a poor choice from the outset, and Congress after Congress has consistently made it worse. The federal tax system need not be so complex or damaging to our economy, nor should it be. A stronger economy means higher wages for American workers and better returns for America's savers. A stronger economy means better opportunities for college graduates and better economic security for families. It means that American companies and workers can compete more effectively in the global economy. And a stronger economy is a more resilient economy, able to withstand and overcome the inevitable economic shocks of tomorrow. A stronger economy also plays a vital role in improving federal finances. It means sustained, normal levels of tax revenues and a lower level of spending to meet the needs of those who are temporarily distressed because of unemployment. A stronger economy offering better wages and better job opportunities is also the most powerful antidote to persistent poverty, and less poverty reduces the demands for anti-poverty spending. Without a stronger economy, we will not solve our long-term problems of federal overspending and overborrowing. Thus, tax reform to spur economic growth is a critical component of the Heritage plan. In broad terms, to promote growth, the federal tax system must be: * A single, low rate system to collect needed revenues without unnecessarily distorting economic decision making. * Simpler and far more transparent. A simple, transparent tax is needed so that taxpayers can anticipate and plan for the tax consequences of their actions and easily understand the full extent of their tax burden. It also provides greater confidence that other taxpayers are not exploiting tax complexities to underpay their taxes. * Neutral between savings and investment. Unlike the current system, it must not impose multiple levels of taxation on saved income. Treating savings neutrally gives individuals greater control of their economic futures while ensuring that the economy has the raw financial material to grow and encourages Americans to invest their savings in the most productive ventures. * Levied in a way that minimizes tax distortions and perverse incentives. This allows prices and market forces—not intentional or inadvertent government meddling—to decide how best to grow the economy. It also helps to keep the tax system simple. * Capable of collecting revenues equivalent to 18.5 percent of the economy. The modern average of tax revenue under normal economic conditions is approximately 18.5 percent of GDP. This is the upper limit that Americans have over many decades indicated to politicians they are prepared to accept. Thus, the tax system should be capped at collecting no more than this amount both to ensure a strong economy and to restrain the growth of government. Using these essential elements, the Heritage plan will transform the current tax system into a modern flat tax that taxes individual income only once and replaces all federal income taxes, all payroll taxes, the death tax, and virtually all excises. Specifically, for individuals, the current system will be replaced with a new flat-rate tax applied to income after deducting all savings. Taxable income will be reduced by the net amount contributed to savings, and savings will be taxable only when spent. This eliminates the current-law bias against saving and ensures that individuals pay taxes only on what they withdraw from the economy and not on savings that they make available for investment in the economy by others. Today's business tax code will be replaced by a flat business tax on domestic sales of goods and services with deductions for labor costs and purchases from other businesses, including expensing of capital purchases. All business activity, including corporate, will be taxed under the new flat business tax.

Objective(s):

13.1: Single Rate

13.2: Revenue Stream

13.3: Simplification

13.4: After-Tax Dollar Savings

13.5: Deductions & Credits

13.6: Tax Relief

13.7: Low-Income Seniors

13.8: Social Security and Medicare Trust Funds

13.9: Business Tax

13.10: Transitioning

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