Pro-growth tax reform can be progressive

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Speaker of the House John Boehner (R-Ohio) receives the Speaker's gavel from outgoing Speaker of the House Nancy Pelosi (D-Calif.) on Jan. 5, 2011 in Washington, D.C.

Article Highlights

  • Bradford X tax has the potential to attract broad bipartisan interest because it incorporates features that both left and right hold dear

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  • Bradford X tax would spur economic growth by taxing consumption—not income

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For the first time in years, fundamental tax reform is at the center of public debate. Republican presidential candidate Herman Cain's popularity has surged, fueled by voter interest in his 9-9-9 tax reform plan. But Cain's plan has been widely criticized for being insufficiently progressive - for shifting too much of the tax burden onto low-income Americans. His plan would likely grow the economy, but its impact on tax progressivity understandably raises concerns for many voters.

It sounds like a painful tradeoff. For struggling Americans facing tax hikes in the here and now, the promise of greater prosperity in future decades offers little consolation.

It has all the benefits of consumption taxation—higher growth, no disincentive to save—without regressively redistributing the tax burden.

Luckily, we can escape this false choice. There is a tax plan that offers the best of both worlds: growth and progressivity. It's called the Bradford X tax.

Though it's not yet widely known, the X tax is a progressive consumption tax that has the potential to attract broad bipartisan interest because it incorporates features that both left and right hold dear.

Adopting the X tax would shift the federal tax system away from taxing income toward taxing consumption—a surefire way to accelerate economic growth. Although much of the benefit would not show up for several years, one economic study estimates that replacing the income tax system with an X tax could boost GDP by around 6 percent in the long run.

Consumption taxes promote economic growth because they avoid a central flaw of income taxes: their penalty on saving and investment. Income taxes put heavier burdens on those who save for tomorrow than on those who spend today, because savers, in addition to being taxed on the income they save, are taxed on the returns they earn on their saving.  Although both income and consumption taxes discourage work, consumption taxes are more efficient because they don't also discourage saving. This distinction makes consumption taxes more conducive to economic growth.

So what's the downside? Most consumption tax proposals are either regressive or revenue losers. 9-9-9 is an example of the former, while Rick Perry's plan is an example of the latter.

The X tax, though, allows for the best of both worlds. It has all the benefits of consumption taxation - higher growth, no disincentive to save - without regressively redistributing the tax burden.

Two features of the X tax (proposed by the late Princeton economist David Bradford) make it a consumption tax. First, individuals pay tax on their wages only, not on any income from saving. Second, firms are allowed to immediately write off their investments, rather than depreciating them over a period of years. As a result, the tax treatment is the same for those who consume today as it is for those who consume tomorrow.

Where does the progressivity come from? The X tax sets higher tax brackets for workers with higher wages, and lower brackets for low-wage workers. It also allows for exemptions and tax credits to ease the burden on low-income individuals. Firms pay a tax rate equal to the rate on the highest-paid workers. These features allow for almost any desired degree of progressivity.

In this era of economic malaise, it is little wonder that many Americans are excited by the prospect of pro-growth tax reform. Republican presidential candidates are right to call for consumption taxes, but voters listening to the current debate may think such an approach requires that we give up on tax progressivity. It doesn't.

What it does require is a willingness to think outside the box. If we turn to the X tax, we can maintain progressivity in the tax code while boosting economic growth.

Alan Viard is a resident scholar at AEI and is the co-author of an upcoming book on the Bradford X tax.  Chad Hill is a Jacobs Associate and the program manager for economic policy studies at AEI. 

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About the Author

 

Alan D.
Viard
  • Alan D. Viard is a resident scholar at the American Enterprise Institute (AEI), where he studies federal tax and budget policy.

    Prior to joining AEI, Viard was a senior economist at the Federal Reserve Bank of Dallas and an assistant professor of economics at Ohio State University. He has also been a visiting scholar at the US Department of the Treasury's Office of Tax Analysis, a senior economist at the White House's Council of Economic Advisers, and a staff economist at the Joint Committee on Taxation of the US Congress. While at AEI, Viard has also taught public finance at Georgetown University’s Public Policy Institute. Earlier in his career, Viard spent time in Japan as a visiting scholar at Osaka University’s Institute of Social and Economic Research.

    A prolific writer, Viard is a frequent contributor to AEI’s “On the Margin” column in Tax Notes and was nominated for Tax Notes’s 2009 Tax Person of the Year. He has also testified before Congress, and his work has been featured in a wide range of publications, including Room for Debate in The New York Times, TheAtlantic.com, Bloomberg, NPR’s Planet Money, and The Hill. Viard is the coauthor of “Progressive Consumption Taxation: The X Tax Revisited” (2012) and “The Real Tax Burden: Beyond Dollars and Cents” (2011), and the editor of “Tax Policy Lessons from the 2000s” (2009).

    Viard received his Ph.D. in economics from Harvard University and a B.A. in economics from Yale University. He also completed the first year of the J.D. program at the University of Chicago Law School, where he qualified for law review and was awarded the Joseph Henry Beale prize for legal research and writing.
  • Phone: 202-419-5202
    Email: aviard@aei.org
  • Assistant Info

    Name: Regan Kuchan
    Phone: 202-862-5903
    Email: regan.kuchan@aei.org

 

Chad H.
Hill

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