Mitchell, Daniel J., “Tax Reform to Encourage Growth, Reduce the Deficit, Promote Fairness,” Senate Budget Committee Hearing, 03/01/12

Dr. Daniel J. Mitchell, Senior Fellow, Cato Institute

“The internal revenue code is needlessly punitive and complex. Some of its major flaws are:

1. High tax rates – Marginal tax rates on additional increments of productive activity are too high, discouraging people from productive behavior.

2. Biased treatment of income that is saved and invested – Because of the capital gains tax, the corporate income tax, the double tax on dividends, and the death tax, there is pervasive double taxation on capital, causing very high effective marginal tax rates.

3. Distorting loopholes – Many provisions of the internal revenue code are explicitly designed to encourage economically irrational choices.

4. Worldwide application – The United States have the world’s most onerous tax system for international activity.

5. Corruption – While in most cases technically legal, the common practice of swapping favorable tax policies for political support is corrosive.

6. Complexity – Nearly 100 years of tax changes have produced 72,000 pages of law and accompanying regulation.

Tax reform has the potential to reduce, or perhaps even eliminate, these problems. But it also could make them worse. To ensure the best possible outcome, lawmakers should be guided by these principles.

A. Tax rates should be as low as possible – Taxes are a price, and it doesn’t make sense to impose a high price of work and entrepreneurship. . The tax system should not discriminate against capital formation – Since every economic theory, even Marxism and socialism, holds that saving and investment is a key to long-run growth and higher living standards, it doesn’t make sense to impose extra-high tax rates on capital.

C. Government should not tilt the playing field with preferences or penalties – Luring people into making economically inefficient choices makes the economy less productive.

D. Territorial taxation – This is the good-fences-makes-good-neighbors approach to tax policy. Disputes with other nations become trivial if each nation is in charge of taxing economic activity inside its borders.

The ideal system, based on the above principles, is a low-rate, consumption-base, loophole-free tax.

The best-known tax meeting these criteria is the flat tax, as developed by Professors Hall and Rabushka at Stanford University’s Hoover Institution.

But the value-added tax is also satisfies these principles – assuming it is replacement rather than add-on tax. And a national sales tax also shares these theoretical qualities.

All of these tax regimes have different collection points, but the tax base is identical. All economic activity is taxed, but only one time and at a low rate.

If lawmakers want to improve growth, particularly in a competitive global economy, where labor and capital can cross borders in search of pro-growth fiscal policy, they should seek to reform the tax system so it fulfills these principles. Economists will not agree on how much additional growth such a system will generate, but they generally will agree that a low-rate, consumption-base, loophole-free tax is the way to minimize the damage caused by taxation.”

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