Principles and Practices of Tax Reform Transition
Background Paper No. 23
Executive Summary The problems that have led Americans to turn thumbs down on the current income tax system are now well known. Taxpayers perceive it to be unfair. It is too complex for both tax payer and tax administrator. The complexities lead to unreasonable compliance costs and great uncertainties. The income tax hinders saving and investment and generally leads to an inefficient allocation of resources. Thus it stunts job and wage growth and ultimately weakens the ability of American companies to compete in world markets.
Likewise the principles that have guided the authors of most tax reform proposals are equally well established. The tax system should be simple. It should be fair according to some consistently applied standard of fairness. And it should be as economically neutral as possible so that the tax system does not diminish the economy’s ability to yield as many benefits as possible. While the principles underlying tax reform are well established, the principles underlying the transition from the existing tax system to a new system are not. The “transition issue” is often left as an afterthought to be handled later by technicians. Transition applies to the tax treatment of activities and arrangements entered into before a new tax system is adopted. It does not apply to activities undertaken after the adoption of the new tax system.
Whether politically appealing or not, tax reformers must eventually come to terms with a very long list of transition issues if tax reform is to evolve from campaign issue to reality. Rather than procrastinating, tax reformers ought to address these issues early and directly. Doing so could provide tax reform with extra momentum. Many concerns raised about fundamental tax reform have more to do with the tax treatment of existing economic arrangements than with how such arrangements would are under the new tax regime.