U.S. and Swedish Trends in Tax ReformTax reform has become a major governmental policy issue in the UnitedStates as well as in the rest of the world.
Countries are attempting to balanceboth economic efficiency and provide equity in taxation. Governments arelooking to rewrite tax codes to minimize their impact on economic growth.Specifically, governments throughout the world are attempting to preserveincentives built into taxation to maximize economic efficiency. At the sametime, these governments are trying to cope with the growth in social welfareprograms throughout the past three decades. In this paper I shall discuss twonations which dramatically overhauled their tax systems, and whether or nottheir goals with tax reform were achieved.In the article “The tax reform act of 1986: Did Congress love it orleave it?”, Randall Weiss discusses the attitudes about taxes in the UnitedStates. He details the events and attitudes leading to the Tax Reform Act of1986, and shows how public perception about taxes has changed since then.
Healso discusses some of the tax reform proposals that are now currently beingthought about in Congress.In 1986 the United States Congress enacted the Tax Reform Act (TRA-86).The act passed with a great deal of bipartisan support. This support was madepossible by two features of the act. The first was that federal income taxrates were to be cut dramatically.
While this would lead one to believe thatfederal government receipts were cut substantially as well, it was the secondimportant feature of the bill that allowed it to be revenue neutral. Thisfeature was that the bill was to improve horizontal equity in the tax system.This would be accomplished by eliminating many of the deductions that manyindividuals, particularly the well to do, were allowed to make.Many of the complains about the tax system in the United States thatpreceded the Tax Reform Act were about the gross horizontal inequities that itallowed. A great deal of press preceding TRA-86 showed the public how many ofthe country’s wealthiest individuals were able to get away with paying little orno federal income tax. Eliminating many of these tax deductions and loopholeshad been the goal of several liberal Democrats for some time.
In addition,conservatives in Congress wanted to reduce the escalating federal budget deficitat the time. Also, a prevailing attitude of the time was that reducing marginaltax rates would benefit the economy. It was believed that specific tax breaksand deductions to support economic growth would not be needed with the greatlyreduced tax rates. The combination of Democrats wanting more vertical taxequity and Republicans wanting lower marginal rates allowed the Tax Reform Actto gain widespread support in Congress.Since TRA-86, tax policy in the United States has shifted away from basebroadening and lower marginal rates toward more progressive taxation andtargeted tax reductions. In 1990, and again in 1993, marginal tax rates wereraised on wealthy individuals in an effort to close the mounting federal budgetdeficit. Also, the perception in the federal government was the special taxcredits and deductions were needed to promote savings, education, and economicgrowth.
This is a direct reversal of the ideas that lead to TRA-86. People nolonger argued that tax rate reduction would in itself provide for economicefficiency.Currently, members of the United States Congress are introducing severaldifferent tax reform plans. Some of the plans, particularly the Republican planfor a flat income tax introduced by Rep. Dick Armey, would decrease theprogressivity of the current tax system.
In addition, a proposal for a nationalsales tax would result in a tax code that is less progressive than current law.On the other hand, a tax reform plan introduced by Rep. Dick Gephardt would makethe tax system more progressive. All of these reforms are intended to reducemany of the remaining tax shelters left in place by TRA-86. The Republicanplans in particular are not revenue neutral and are intended to increaseinvestment in the economy and contribute to efficiency.
However, these reformsare not in line with the policies enacted after TRA-86, and they are still yearsaway in the future at best.In the article “Tax reform of the century – the Swedish experiment.”,Agell, Englund, and Sodersten discuss the recent Swedish experiment in taxreform in 1991 (TR-91). As far back as 1978, the Nobel Laureate Gunmar Myrdalsaid that Sweden had become a “nation of waglers”. Himself being greatlyliberal, even Myrdal admitted that Sweden’s highly graduated income tax was anincentive to cheat on taxes. Also, the high corporate tax rate, whichoriginally was intended to encourage investment, created a capital lock in forcorporations.
This prevented companies from reinvesting their profits indifferent areas of their business to adapt to changing market conditions.Originally, it was believed that TR-91 would cost the Swedish governmenta 6% GDP loss in revenue. In actuality it cost about 1-2% of GDP in revenue.The top marginal tax rate on income dropped from 80% to 50%.
In addition, thecorporate tax was greatly reduced. To compensate for these losses, besidesreducing the number of tax loopholes, VAT was broadened to include more productsand housing was less subsidized by the tax code. In the short run this lead tosizable losses in read estates, and effective demand shifted from housing tocapital instruments and financial assets. Later, the top marginal rate wasincreased to 55%, and many modification to TR-91 have already been made.
The goals of TRA-86 and TR-91 were to increase economic efficiencythrough base broadening and reduce gross abuses of the tax system in bothcountries. To an extent, these goals were achieved. But both countries quicklyreversed their desire to reduce or eliminate tax shelters and lower marginalrates. In efforts to reduce governmental budget deficits, top income tax rateswere increased once again. It will be interesting to see whether the currenttax reform proposals now being discussed in the U.
S. Congress will take hold andshift policy back towards base broadening and more horizontal equity.