OECD Urges Tax Reform in U.S.

May 31, 2007

The Organisation for Economic Co-operation and Development (OECD) is a collection of 30 developed countries that embrace free markets and representative democracy. Every 1-1/2 to 2 years, the OECD publishes an Economic Survey on member countries and a few non-member countries. Each report, in the words of the OECD, “identifies the main economic challenges faced by the country and analyses policy options to meet them.”

Earlier this week, the OECD released the Economic Survey of the United States. Chapter 3 of that report addresses tax policy, and here are some excerpts from the OECD’s assessments and recommendations:

On entitlement program spending:

Under current law, public spending on retirement and health programmes is expected to rise toward 20% of GDP by the middle of the century; resulting soaring budget deficits would entail a government debt twice the size of GDP at that time. Raising tax rates to finance such spending would be an expensive and inefficient solution.

On tax rates:

On the revenue side, it may be difficult to sustain the recent reductions in marginal tax rates, while meeting the fiscal burden from entitlement programmes, although this would be clearly desirable. To the extent that revenues have to be raised, the tax base should be broadened, rather than reversing reductions in marginal tax rates.

On tax expenditures:

Since the comprehensive tax reform in 1986, which broadened tax bases and reduced marginal rates, most of the resulting gains in simplicity and efficiency have been lost through a renewed expansion in tax expenditures. To be sure, not all of them are undesirable. However, tax expenditures, which are distorting, ill targeted and ineffective, should be reduced or abolished.

On replacing income taxes with consumption taxes:

[C]onsideration should also be given to shifting the tax burden from direct taxes to consumption based indirect taxes – such as a national sales tax or a value added tax. This would produce efficiency gains, including reducing disincentives to saving.

On the home mortgage interest deduction:

In principle aimed at promoting home ownership to lower- and middle-income households, tax preferences have mostly benefited high-income households with easy access to home ownership. Furthermore, tax preferences have encouraged investment in residential property at the expense of other household assets, possibly affecting capital formation elsewhere in the economy and, thereby, productivity growth. The mortgage interest tax deduction should be replaced with a tax credit available to all home owners, with a maximum amount reflecting the average cost of housing, so as to promote home ownership, without unduly subsidising housing consumption. The interest deductibility on home equity loans and second homes should be eliminated to avoid encouraging overinvestment in housing.

These concerns raised by the OECD are being taken seriously by investors, and should also be taken seriously by policymakers. Information on how to obtain the full OECD publication is here.

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