A Proposal for a Dual-Rate Income Tax

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A Proposal for a Dual-Rate Income Tax

• Testimony to the
• Presidents Advisory Panel on Tax Reform
• Chris Edwards
• Director of Tax Policy, Cato Institute
• May 11, 2005

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1. Proposed Dual-Rate Tax

• A simpler income tax that treats Americans more
  equally and promotes economic growth.
• Individual income tax rates of 15 and 27.
• Corporate income tax rate of 15.
• Cuts marginal tax rates on savings and
  investment, which moves toward a
  consumption-based system.
• Takes steps toward the Hall-Rabushka flat tax.

For dual-rate tax details, see Chris Edwards,
Options for Tax Reform, Cato Institute,
February 2005, www.cato.org/fiscal/tax-policy.html
.
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2. Dual-Rate Tax Individuals

• Individual income tax rates of 15 and 27. The
  top rate begins at 90,000 (singles) and 180,000
  (married). This rate structure integrates with
  the federal payroll tax to create a roughly
  consistent marginal tax rate on earnings at all
  income levels.
• Itemized deductions are eliminated, including the
  mortgage interest deduction and state/local tax
  deductions.
• Middle income families would have their marginal
  tax rate fall from 25 or 28 to 15.
• The top individual rate on dividends, interest,
  and capital gains would be 15. This structure
  builds around President Bushs dividend and
  capital gains cuts of 2003.
• Savings vehicles such as 401(k)s, IRAs, and HSAs
  would be retained. Indeed, Congress should
  consider liberalizing Roth IRAs and HSAs.
• Revenue neutral in 2004 based on Tax Foundation
  static microsimulation model.

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3. Marginal Income Tax Rates
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4. Combined Income and Payroll Tax Rates
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5. Dual-Rate Tax Corporations

• Corporate tax rate cut from 35 to 15.
• Equal treatment of interest and dividends. Both
  are taxed at 15 at individual level and 15 at
  corporate level.
• Corporate tax base broadeners include deductions
  for interest, employee health care, and state and
  local taxes.
• The corporate base should not be broadened with
  anti-investment provisions, as in 1986.
• Dynamic feedback effects from a corporate rate
  cut would be large. A March Joint Tax Committee
  report showed that a corporate rate cut would
  give a much bigger boost to GDP growth than an
  individual tax cut.
• The dual-rate tax structure could incorporate
  territorial treatment for international
  investments and capital expensing.

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6. Dual-Rate Tax Simplification

• Nearly all individual deductions and credits
  eliminated. All taxpayers would take the standard
  deduction.
• While that would be a huge simplification, the
  dual-rate tax retains an income tax structure and
  would not be as simple as a consumption-based tax
  such as Hall-Rabushka.
• For corporations, the sharply reduced tax rate
  would greatly cut incentives for both legal tax
  avoidance and illegal tax evasion. The compliance
  costs of current tax rules on multinationals are
  enormous because the rules are complex and
  because firms are so responsive to the taxes.
• Capital expensing and the territorial treatment
  of international investment would be simpler and
  more efficient.

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7. Dual-Rate Tax Fairness

• The dual-rate tax would greatly increase
  horizontal equity. Americans with similar
  earnings would pay similar amounts of tax.
• About 95 of households would pay tax at the 15
  rate.
• I support proportional taxation and the dual-rate
  tax takes a small step in that direction, but it
  is still very graduated or progressive.
• For higher earners, tax rates are cut but
  itemized deductions that favor this group are
  eliminated.
• For lower earners, the plan retains the earned
  income tax credit.
• For all earners, the plan retains the current
  standard deduction, while expanding the personal
  exemption from 3,200 to 4,500.

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8. Dual-Rate Tax Economic Growth

• The top marginal tax rates on dividends,
  interest, wages, and small business profits are
  cut.
• Reduced marginal tax rates would increase
  productive activities and reduce deadweight
  losses of the tax system.

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8. Economic Growth, continued
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9. Global Tax Competition

• The U.S. needs to respond to the global corporate
  tax revolution. KPMG data show that the average
  statutory corporate income tax rate in the
  30-nation OECD has fallen from 38 in 1996 to 30
  today (including national and subnational taxes).

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10. Conclusions

• Recent tax reforms (individual rate cuts, 15
  dividend and capital gains rates, partial
  expensing) should be extended permanently. The
  dual-rate plan would build on these reforms.
• The presidents call for a revenue-neutral reform
  necessitates trade-offs. The dual-rate plan
  eliminates most deductions and credits but cuts
  marginal tax rates on labor and capital. That
  would reduce tax complexity and increase fairness
  and growth.
• International competitiveness is a much more
  important today than during the last big tax
  reform in 1986. Multinationals are increasingly
  responsive to taxes with regard to real
  investment and the movement of paper profits. A
  corporate tax rate cut would attract inflows of
  profits and investment to the United States, and
  is the single best reform that policymakers could
  pursue.