Tax Reform
Martin Feldstein
Harvard University and
National Bureau of Economic Research
The Tax Structure Has Become
Much Better
• Reduced individual marginal tax rates
– Top rate down from: 91% in 1960, 70% in
1980
• Reduced corporate tax rate
– Rate down from 52% in 1960, 46% in 1980
• Fewer tax deductions and exclusions
– Major changes in Tax Reform Act of 1986
• Lower tax on dividends and capital gains
Favorable Effects of Previous
Personal Tax Reforms
• Lower tax rates improve:
– Work incentive
– Form of compensation
– Saving incentive
• Lower tax on corporate income, dividends and
capital gains improve:
– Saving incentive
– Form of investment (corporate vs other) and finance
(bias against dividends and in favor of debt finance)
Priorities for the Future
• Reduce marginal tax rates that distort
individual incentives
• Reduce corporate income tax distortions
that now
– Reduce saving by lowering net return
– Reduce dividend payout because of double
taxation
– Increase corporate use of debt finance
“Fundamental Reforms” Would
Achieve These Goals
• Value added tax (or national sales tax),
Flat tax, Consumed Income tax
• BUT
• Distributional problems eliminate pure VAT
and pure Flat Tax
• VAT and Consumed Income Tax involve
major transition problems
Two Possible Piecemeal Reforms
Could Also Achieve Those Goals
• Tax husbands and wives separately
• Integrate corporate and personal income
tax rates
Taxing Husbands and Wives
Separately
•
•
•
•
Lowers marginal rate on 2nd earners
Common practice in most other countries
Can be done in revenue neutral way
Can be applied to wage and salary income
only or to all income
Integrate Corporate and Personal
Income Taxes
– “Gross-up and credit” method has been widely used
in other countries
– Total earnings imputed to individual taxpayers
– Corporate tax regarded as withholding at source
– Individual receives tax refund if personal rate less
than “credit rate”
– Credit rate is 35% with complete integration but could
be less to achieve revenue neutrality
– Could be combined with other corporate tax reforms,
e.g., investment expensing
Favorable Effects of CIT Integration
• Lowers tax rate on equity investment and
saving
• Reduces anti-dividend bias in current law
• Reduces current bias in favor of debt
finance