Fixing the Tax Code

Full of mismatched incentives, the American tax code is in dire need of reform, yet there has been relatively little pressure from families on Congress to make necessary changes. Why? Curtis Dubay of the Heritage Foundation says that tax reformers have done a poor job of explaining to American families how changes to the tax code would improve their economic situation.

Dubay hits on some of the main problems with the current tax code:

– High tax rates discourage families from sending a second worker into the labor force, because after accounting for the additional costs of a second worker — such as child care and transportation, among others — the high rates make the benefits of a second job not worth the costs.
– Because saving money is taxed — interest income, dividends and capital gains are all hit with high tax rates — American families are encouraged to spend money rather than save it. This only hurts families’ financial security and ability to cover costs in the future.
– Many businesses pay income taxes on the business owner’s individual tax return. When they face high tax rates, they are left with fewer dollars to reinvest in their businesses, raise wages and create additional jobs.
– Investment is highly taxed, so investors become more risk averse. This limits their willingness to invest in new businesses, and the drop in entrepreneurship limits the growth of new jobs.

How could these problems be fixed? Dubay offers a number of solutions, including:

– By transitioning the tax code into a system with a single, low rate, second earners could more easily enter the labor force, and incomes would rise.
– Taxing consumption (what Americans take out of the economy) rather than investment (what they put into the economy) would get rid of the incentives that discourage saving.
– By getting rid of investment taxes, Americans would put their money towards new business ventures, creating jobs as well as new products for consumers.

Dubay cites research from the Tax Foundation which indicates that American families could see their wages rise by 10 percent over 10 years due to tax reform.

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