An AP article today explains that tax revenues this year are projected to be the lowest since 1950. Chalk this one up as a dog-bites-man story.
Our income tax system is highly progressive. Taxpayers pay higher rates as they earn more income. During recessions, incomes contract sharply, so there is less income to tax and the remaining income is taxed at lower rates. As a result, tax revenues dry up by design during recessions.
The recent “Great Recession” caused incomes to plummet at a historic rate. Hence tax revenues dropped to historic lows as a share of the economy as well. To anyone with a familiarity with our tax code, this is entirely unsurprising. It’s hard to have solid income tax collections with 9 percent unemployment.
When economic recovery finally takes hold, tax revenues will rise quicker than they fell. That is why the Congressional Budget Office in its most recent budget estimate showed that tax receipts will recover and even surpass their historical average of 18 percent of GDP by 2018.
In the AP article, Senator Kent Conrad (D–ND) is quoted saying that “the current state of the tax code is simply indefensible. It is hemorrhaging revenue.” Senator Conrad is no doubt intimating that tax reform is needed to fix the broken tax code.
He is right that tax reform is needed, but it’s not because the tax code doesn’t take enough of our money. The various deductions, credits, and exemptions in the tax code that cause it to “hemorrhage revenue” create a drag on the economy because they influence the economic decisions of individuals and businesses. Because there are so many of these provisions, the drag on the economy has become considerable.
Tax reform should not be used as an excuse to raise taxes above their historical levels.
Tax reform is needed to eliminate these economy-slowing policies and broaden the tax base. A broader tax base would also mean eliminating special-interest tax breaks that litter the tax code and act as a barrier to fundamental reform.
A broader base would allow lower tax rates, which are too high right now. These changes should be “revenue-neutral,” meaning they should be made without raising taxes and keeping tax revenues at no more than18 percent of GDP.
Tax reform could become a reality if all sides agree that the revised tax code should continue raising its historical amount of revenue. Of course, if Congress stopped trying to take more of our hard-earned income, then we’d really have a surprising story on our hands.