Tax Reform: Overview

Introduction

Tax reform is a major issue in United States politics. Revenues derived from income and property tax fund a variety of government programs, including welfare, defense, transportation, education, and environmental protection. The United States has a history of resisting increases in taxation and debating the equity and efficiency of the tax system.

Tax dollars are collected by both federal and state governments. Within the federal system, the largest share goes toward social services, followed by military spending and debts to foreign nations. At the state level, tax revenues are used primarily to fund education and health and human services; remaining funds are devoted to prisons, environmental concerns, and other programs.

The central questions in the debate regarding the US tax system include whether the existing graduated income and property tax should be converted to a flat tax or a consumption tax, whether government agencies are misusing tax revenues and thereby creating the need for additional taxation, whether the allotment of tax revenues should be changed to focus on programs that need increased funding, and whether the tax system should be simplified by discarding complicated deduction and benefit provisions. Most changes to the tax system generally affect those at the top of the income bracket; as such, the tax debate is often considered a class issue. Taxation is also a political minefield, causing many politicians to avoid working on solutions.

Understanding the Discussion

Consumption tax: A tax levied on individual commodities or services as part of the retail price paid by consumers.

Flat tax: An income tax levied at the same rate for all taxpayers regardless of income levels.

Income tax: A tax system that takes a certain percentage of a taxpayer’s income, the amount of which may vary depending on the income level of the taxpayer.

Inflation: An overall increase in the price of goods and services when compared to the average income level among the population.

Sin taxes: Taxes levied on products, activities, or services seen as harmful or undesirable, such as cigarettes, alcohol, and gambling.

History

In the United States, changes to taxation laws generally occur during times of internal or external crisis. New taxes are often levied during military conflicts or periods of national growth, and existing taxes are often reduced or repealed during economic recessions. Direct taxation on income and property was instituted and then repealed several times before becoming permanent in 1913.

During the early colonial period, the government relied on tariffs and custom duties imposed on the import and export industry to fund all government programs. Great Britain levied taxes against the American colonies in 1765, which led to protests of “no taxation without representation” and the earliest tax debates.

Under the Articles of Confederation, created in 1777 and ratified in 1781, the federal government had no power to tax citizens directly; only states could levy taxes. When the United States Constitution was adopted in 1788, Congress granted the federal government the power to levy consumption taxes. The government established taxes on alcohol, tobacco, and some food products. Debates and protests over the tax system were common, particularly regarding the alcohol tax.

The federal government initiated its first property tax in 1798, during a period sometimes called the Quasi-War, when escalating tensions between the United States and revolutionary France seemed likely to lead to armed conflict. The tax was levied on homes and businesses as well as slaves, who were considered taxable property. When Thomas Jefferson was elected president in 1810, he abolished direct taxation and focused on consumption taxes. During the War of 1812, Congress enacted temporary increases to excise taxes and customs taxes, which were repealed in 1817.

During the Civil War, consumption taxes were not sufficient to fund the military, and Congress passed the Revenue Act of 1861, which established the first income tax and raised the rates on most other forms of taxation. In 1862, Congress increased income-tax rates, especially for those in higher income brackets.

In 1872, as the federal deficit was decreasing, the income tax was abolished. The government obtained nearly 90 percent of its revenues from consumption and customs taxes. As the population grew, the tax system was unable to meet the requirements of government programs. Congress proposed a flat-tax system to increase revenues, but the Supreme Court rejected the proposal as unconstitutional.

In 1913, Congress passed the Sixteenth Amendment, making income tax legal under the Constitution and establishing a permanent income and property tax system. The tax debate soon became a class struggle between rural residents and more affluent urban residents.

Taxes were raised several times during World War I (1914–18) and again during the 1920s to fund government growth. During the Great Depression (1929–39), tax changes were required both to ease poverty and to recover from a growing federal deficit. In 1935, the Social Security Act was passed, adding a 2 percent income tax to fund new social services.

Taxes were raised again during World War II (1939–45) to pay for military spending. Protests against the change took place in many US cities. Following the war, taxes were reduced to ease economic strain, and Congress enacted several reforms to the tax system. New taxes were enacted during the Korean War (1950–53), which returned tax rates to pre–World War II levels.

During the 1960s and 1970s, inflation became a major political issue, and taxes had to be adjusted to match inflation rates. The Economic Recovery Act of 1981 adjusted tax rates for inflation but reduced funding for many social services, including federal aid for families and people with disabilities.

In 1993, the administration of President Bill Clinton enacted tax increases aimed at the top levels of the income hierarchy in order to combat a growing budget deficit. In 1997, as the deficit shrank, moderate tax breaks were initiated. The tax system of the 1990s left the nation with a budget surplus, which became a focus of George W. Bush’s 2000 presidential campaign.

Following Bush’s election, his administration enacted a $1.4 trillion tax-cut package in 2001, followed by additional tax-relief initiatives in 2002 and 2003. Bush’s tax-relief measures partially reduced the disparity in taxation between income levels by lowering taxes for those at the upper end of the income spectrum.

In 2005, Bush created the President’s Advisory Panel on Federal Tax Reform to analyze the tax system and propose measures for reform. In November 2005, the panel submitted a list of goals that included simplifying the taxation process by removing many tax credit and deduction programs. The Bush administration supported the idea of making then-current tax policies permanent through legislation. Critics argued that permanent tax levels would not allow the government sufficient flexibility to raise and lower taxes in times of need.

Tax Reform Today

Early 2009 saw the administration of incoming president Barack Obama committing to some form of tax relief but being cautious and somewhat resistant in the face of pressure from the Democratic Congress to repeal the Bush administration’s tax cuts. Nonetheless, in December 2010, President Obama signed into law a tax bill that extended the Bush tax cuts to 2012. The extension was a result of a compromise between the president and Republican legislators. In early 2013, Congress passed the American Taxpayer Relief Act of 2012, which extended most of the tax cuts for most income levels ($400,000 per year or less for individuals, $450,000 or less for married couples) but allowed rates to increase for higher income brackets, estate taxes, and payroll taxes, among others.

President Donald Trump's Tax Cuts and Jobs Act, passed in late December 2017, eliminated individual income tax deductions for state and local taxes, as well as all itemized deductions except charitable donations; reduced the amount of mortgage debt eligible for interest deductions to $750,000 from $1,000,000; increased the standard deduction; changed the income levels within each tax bracket; and more than doubled the exemptions for estate tax. Rates were lowered for each tax bracket, effective for a decade. At the same time, the law discontinued the corporate alternative minimum tax, cut the top corporate income tax rate permanently from 35 to 21 percent, and changed the system to a worldwide tax system. Businesses and other supporters believed the act would simplify tax filing for individuals and families, reduce taxes for most Americans, and encourage business growth, which would in turn result in wage increases and new jobs. Critics maintained that the tax cut benefited the wealthiest Americans and big business at the expense of the middle and lower classes and small business owners. Others objected to the increase in the federal budget deficit that the tax cut would likely bring.

In the first quarter of 2018, companies responded by making capital expenditures and giving workers one-time wage increases, fringe benefits, or bonuses. Numerous job losses and stock buybacks were also announced, however. In June 2018, the Congressional Budget Office predicted a deficit of over $2.3 trillion over the next decade as a result of the tax cut. The large-scale, long-term effects of the Trump tax reform remain to be seen.

Another major debate in tax policy, particularly at the local and state levels, surrounds “sin taxes” levied on socially proscribed products such as tobacco, alcohol, and sugar-filled beverages. Proponents of such taxes believe that taxes on harmful or undesirable products reduce their use and provide a valuable source of revenue for productive government programs. Opponents argue that the government should not use taxation as a way to impose moral guidelines. Another highly debated tax policy is a carbon tax, which is a tax on fossil fuels designed to reduce greenhouse gas emissions. While there is no carbon tax on a national level, several states have passed carbon taxes.

Political leaders have occasionally raised the possibility of transitioning to a flat tax or a consumption tax, but neither system has garnered support from legislators. Proponents of the flat tax and consumption tax say that adopting either system would greatly streamline the Internal Revenue Service (IRS), resulting in massive savings in terms of both government cost and the time and effort of taxpayers. Advocates of a flat tax claim that it would curb government spending while ultimately increasing tax revenue, while those in favor of a consumption tax claim it would lead to increased savings by individuals. Opponents argue that either system would benefit those at the upper end of the income spectrum but would not significantly benefit lower- or middle-class taxpayers and would in fact hurt those at the lowest end, who, under the existing system, earn too little income to have to pay income tax (approximately $20,000 per year or less).

These essays and any opinions, information or representations contained therein are the creation of the particular author and do not necessarily reflect the opinion of EBSCO Information Services.

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