Lecture 5: Toward an Optimal Tax System, Part 2: What Might Full-Blown Tax Reform Look Like, and What Can We Hope to Accomplish by Improving the Tax System?

What benefits might we expect from a complete tax overhaul? The Tax Cuts and Jobs Act amended the income tax, but was not a full-blown reform of the tax system.

Several features of the new tax system (as with the old system) remain less than optimal. There is a tax base that is still overly complex and inconsistent with basic tax principles for efficiency and growth.

Several alternative tax regimes will be presented, including a rationalized income tax and systems based on consumed-income or cash flow.

Lecture Highlights

  1. How does our current tax system compare to a “pure” income- or consumption-based tax?
  2. Corporate and noncorporate business income are taxed differently; one approach to this difference is integrating the tax system. Because of the tax treatment of interest, businesses can also be taxed differently depending on whether they utilize debt or equity financing.
  3. Neutral or consumption-based taxes would treat all savings like an Individual Retirement Account or pension, either by deferring taxes or exempting returns. Examples of this include the cash-flow tax, a national sales tax, a value-added tax, and the Flat Tax.
  4. Expensing of investment should include equipment and structures.
  5. Most tax systems borrow from different approaches to tax foreign profits. Ideally, in some consistent manner, the tax system should stop at the border.
  6. The federal income tax code still contains more than 100 “tax expenditures,” provisions that offer preferential tax treatment to specific economic activities or groups of taxpayers, leading to reduced federal revenue. Which tax expenditures are appropriate depends on which type of tax you view as “normal.”

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