Treating tax reform as a decades-long effort to repeal the federal income tax entirely is the right attitude for conservatives to take.
Donald Trump has made waves by talking about eliminating the individual income tax in favor of a system of tariffs for federal revenue. This proposal — if one can even call it that, as there is no detailed plan of how it would actually happen — is, to use one of politicians’ favorite euphemisms, aspirational.
The federal government raised about $4.5 trillion in revenue last year. Total U.S. imports last year were worth about $3.5 trillion. Raising tariffs will lead to fewer imports (and exports), which would mean less to tax. And the federal budget is coming up almost $2 trillion short as it is. The numbers just aren’t there.
But phasing out the federal income tax over time should be something for conservatives to pursue. Crazy? Right now, yes, but that doesn’t mean policy can’t move in that direction, making it more possible in the future to repeal the federal income tax.
Conservatives at the state level have been phasing out their individual income taxes, following the models of income-tax free states such as Florida and Texas, which are attracting residents from higher-tax states. Even in states that aren’t phasing out their income taxes entirely, conservatives have moved toward a flat tax. These reforms have mostly been structured to gradually phase in over several fiscal years, subject to revenue triggers, so state budgets won’t see massive shocks. And they are not dependent on federal Covid money to make the math work.
Iowa went from a nine-bracket progressive income tax with a top rate of 8.53 percent to a flat tax of 3.9 percent. Arizona has a flat tax of 2.5 percent. West Virginia is on pace to eliminate its income tax entirely.
About half of taxpayers effectively pay no federal income tax. This is bemoaned by some, but it means we’re halfway to eliminating the federal income tax already.
Adam Michel of the Cato Institute has a new tax-policy plan out that would be one model for conservatives at the national level to consider. “Ideally, the federal government should shrink so much that the Sixteenth Amendment — which authorized the modern income tax — could be repealed outright,” he writes. “Short of repealing the Sixteenth Amendment, policymakers should continue pursuing reforms to the income tax system that alleviate double taxation and lower taxes on saving, investment, and work.”
Michel would cut the top income-tax rate to 25 percent, the capital-gains tax to 15 percent, and the corporate tax to 12 percent. He would also enact full expensing for investments and eliminate the estate tax, alternative minimum tax, and net investment income tax.
This would be possible by simplifying the tax code to eliminate deductions and tax credits. That would increase the tax base, so a lower tax rate can raise a similar amount of revenue. And it would raise that revenue in a less economically distortive way.
Just wiping out energy tax credits for businesses, which expanded greatly under the so-called Inflation Reduction Act, would save $119 billion per year, Michel estimates. Other special-interest-captured business tax subsidies cost $132.5 billion.
The much lower tax rates will make it possible to cut individual deductions as well without individuals facing a higher tax burden. Individual deductions, especially since the 2017 tax reforms, are disproportionately taken by high-income individuals, since most middle- and low-income individuals do not itemize their tax returns. “Eliminating itemized deductions and moving all taxpayers to the standard deduction could raise revenue by $336 billion a year,” Michel writes.
Exempting fringe benefits from taxation also disproportionately benefits high earners, who have more fringe benefits than lower earners. Michel would include fringe benefits in the tax base, treating them the same as wages, which would raise $447 billion per year.
He would also subject to taxation many nonprofits that aren’t really non-profit. “Nonprofit status should be eliminated for activities where there is a clear for‐profit private‐sector competitor,” Michel writes. So churches and charities would still be excluded, but organizations such as the NCAA, the PGA Tour, and credit unions would have to pay taxes.
The federal government does not have a revenue problem. “The erosion of fiscal space is driven almost exclusively by net interest costs and federal health spending,” Michel writes. We know from other countries that faced fiscal crises and successfully moved past them that spending cuts are much more important. Past conservative tax-reform efforts have not been as successful as they could have been because they did not include sufficient spending cuts to go with tax cuts.
Michel’s plan would have no chance of passing Congress as written. Way too many special-interest groups are harmed by having their special tax privileges removed, and they would send armies of lobbyists to make sure the plan dies. But this general approach — simplifying and flattening the tax code, by increasing the tax base and cutting tax rates — should guide conservative efforts at tax reform. The TCJA was a step in that direction, but there is still so much left to do.
Treating tax reform as a decades-long effort to repeal the federal income tax entirely is the right attitude for conservatives to take. It won’t be replaced by a tariff system in the next presidential term, and it shouldn’t be, but seeing the income tax as wrong in principle and bad for the economy is nonetheless correct.