Thursday, November 11, 2010

More on Radical Tax Reform

More on Obama's Deficit Commission...

The idea of simplifying the tax code by lowering tax rates and eliminating deductions is not a new one.

In the 1970s, an economics professor from Canada (Art Laffer) demonstrated that there are two rates that will produce the same revenue. A tax rate of 0% will produce the same revenue of a tax rate of 104% or higher, namely ZERO revenue. However, a 10% rate and a 90% are not inequivalent. Imagine a skewed bell curve. A 10% rate might produce the same revenue as 80% or 90% or 95% or some other high rate. It depends on a lot of things. Reducing rates can produce higher revenue by stimulating economic activity, but it depends on where the rate is in the context of the condition of the economy.

Second, there are a lot of serious people who believe that the current tax code severely distorts economic activity to the detriment of America. Should we give people a tax break for buying a big house? Probably not. Should we give them a break for taking a risk and investing in a new business? Yes, if we care about the long-term competitiveness of the U.S. economy. Unfortunately, the current tax does the opposite. We deduct big mortgages and tax capital gains. That's part of the problem.

The GOP was almost in complete agreement while Reagan and Clinton were Presidents that we needed radical tax reform in this direction -- either a flat rate income tax with limited deductions or completely replacing the income tax with a national sales tax. Jerry Brown agreed with this in 1992 too (Art Laffer was his economic advisor.)

We all had great hope when the GOP took control of the Presidency while keeping control of both Houses of Congress for the first time since before the Great Depression. Unfortunately, all discussion of radical tax reform died a quick death during the Bush administration. Bush was too busy creating new social programs like Medicare Part D and No Child Left Behind to be bothered with such trivia as the long term competitive nature of America.

The idea of radical tax reform is not dead. It has now made a surprising comeback in the Obama Deficit Commission.

Sure, there are partisan hacks like Sean Hannity who will piss and moan about the proposals just because Obama created the commission. However, it will be the left-wing of the Democrat Party who will have the biggest problems with this proposal. They are already out in force.

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