Why Tax Our Patience?

Whe

n Washington talks taxes, the dickering usually focuses on whose payments should go up and whose should come down. But as April 15 approaches, many frustrated Americans, especially small-business owners, would be thrilled if someone just made the tax forms easier to file. As Congress weighs the impact of the controversial tax cuts proposed by President Bush, TIME's JYOTI THOTTAM asked a group of tax-policy experts to move beyond the current debate and imagine a simpler, more efficient federal tax system. Our Board of Economists — David Bradford of the Woodrow Wilson School at Princeton University and New York University School of Law, Philip Jefferson of Swarthmore College, Dan Mitchell of the Heritage Foundation, Trudi Renwick of the Fiscal Policy Institute and Max Sawicky of the Economic Policy Institute — produced a host of creative ideas and some surprising moments of consensus.

TIME: What are some of the fundamental tax reforms you would like to see?

DAVID BRADFORD: As a Treasury official in the Ford Administration, I became convinced that the way toward a simpler, more transparent system was to base the tax on consumption. The plan we developed would replace the income tax on individuals and corporations. Everything that came into the individual household was taxed, and everything that went out in the form of savings was excluded from tax, with no tax on companies. Since then I have concluded that an indirect approach, with a tax on companies and a graduated tax on individuals, would be easier to implement. The key difference between income tax and consumption tax has to do with the treatment of savings and investment. In a consumption tax, companies expense capital investment immediately. In an income tax, they depreciate it over time.

This approach yields enormous simplification of the rules related to capital gains, interest deductions and the treatment of complex financial transactions. It appalls me that all this brilliant talent is going into the design of ways of gaming our tax system.

TRUDI RENWICK: How would you deal with a mortgage-interest deduction?

BRADFORD: You shouldn't have an interest deduction in my ideal system. It would slowly go away as you move from one system to the other, if the politicians could stand the heat.

DAN MITCHELL: There are two big issues. No. 1, should you have what is called a consumption base? A consumption base is what you find in the flat tax. It is implicit in the national-sales-tax proposals. The second big issue is, do you then have one rate? Then it is a question of how to design it. I would want it to have a low rate, I would want government to be smaller, and I think bringing in less revenue is the only effective means of controlling the size of government.

TIME: And would your perfect tax system be progressive?

MITCHELL: Yes, everyone who supports single-rate tax reform also supports a generous family-based personal exemption, which creates effective progressivity without sacrificing the principle of treating all taxpayers equally. But there is a trade-off. The more income you exempt from taxes for lower-income and lower-middle-income people, the higher your rate has to be — or the more revenue you are going to take away from the government.

MAX SAWICKY: I would like to see less economic inequality than we have now. A bigger revenue system is a better revenue system if one is focused on inequality. I also admire David Bradford's work, and that's how I got into writing about the cash-flow version of the consumption tax, with a few bells and whistles that would make it aggressively progressive, such as defining bequests from estates as consumption. That leads me to the idea of a lifetime income tax, which simply taxes all income once when consumed and finally when it is transferred, at death or through gifts. And I agree with Dan that the tax should be territorial. What that means is, there would be a rebate of taxes on exports and full tax on imports.

RENWICK: There can be great debates on the national level as to what to do with tax reform, but often they fail to take into account the consequences for state and local tax systems. The current tax proposals in Washington are an example. The proposal to exempt dividends from taxation would have disastrous effects for New York State and turn its $9 billion deficit into a $10 billion deficit because it would make it very difficult for the state to tax dividends. We struggle at the state level trying to capture the income of corporations. I would like to see a movement toward combined reporting, in which corporations have to report on all their activities in all their affiliates, where you would be able to look at corporate income and allocate it across the 50 states. Each state would then have the right to tax it and capture the taxes on the income that is made in its borders.

PHILIP JEFFERSON: I would definitely want the consumption tax to be progressive. I would apply higher marginal tax rates so that those who have a higher level of consumption would be contributing proportionately more in taxes. The implication here is that we want to encourage savings. I would also want to provide generous exemptions for low-income individuals and households.