Taxes are necessary to fund services provided by the government. Beyond raising revenue, the federal tax system has profound effects on economic performance, business decisions, and individual taxpayers.
Dissatisfaction with our current federal tax system has fueled a debate about fundamental tax reform due to concerns about the current federal tax systems economic inefficiency, unfairness, and complexity. In addition, tax policy, including tax expenditures, can be part of efforts to address the nations large long-term fiscal imbalance. The current tax system is widely viewed as complex, thereby reducing the ability of individuals to understand and comply with tax laws. To the extent that a tax system is not simple and efficient, it imposes costs on taxpayers beyond the payments they make to the U.S. Treasury. Further, the tax systems integrity and fairness is threatened if honest taxpayers believe that significant numbers of individuals and businesses are not paying their fair share of taxes.
Tax reform requires grappling with difficult issues. One is the amount of revenue the federal tax system should raise. The imbalance between revenue and spending will mean increasingly large and ultimately unsustainable federal deficits and debt. Tax policy needs to be part of a multipronged approach as policymakers assess how to alleviate the fiscal pressures.
Another issue is whether to change the tax base. The debate about fundamental tax reform is partly about switching from an income tax base to a national consumption tax. One type is a value-added tax, widely used around the world.
Another part of the tax reform debate is about reforming the current income tax by broadening its base and lowering rates.A broad tax base with lower rates can benefit economic efficiency but would require minimizing special tax preferences for specific types of investments and activities. The criteria typically used to evaluate tax policy provisions and to compare tax reform proposalsfairness, efficiency, simplicity, transparency, and administrabilityoften conflict with each other, requiring trade-offs.
Tax expenditures can help further federal goals through the tax system. They narrow the base and increase the tax rates needed to raise a given amount of revenue. The myriad of tax expendituresreductions in a federal taxpayers tax liability that result from special credits, deductions, exemptions and exclusions from taxation, deferral of tax liability, and preferential tax rateshave various economic and social policy purposes, but their success in achieving these goals is too often not assessed. These provisions are also an important reason why the effective tax rates on individuals and corporations, which attempt to measure taxes paid as a proportion of economic income, can differ significantly from the statutory tax rates. See also Tax Expenditures for more information.