Innovative options for raising revenue

Just two years after the largest overhaul of our nation’s tax code in decades, taxes continue to be the talk of the town. Ambitious proposals for sweeping reforms to existing taxes – and for introduction of new wealth taxes – dominate the discourse in presidential primary debates.

Fortunately, there are innovative, evidence-based tax reforms that would strengthen our tax code and make it more efficient and equitable. We present many such ideas in a newly released Hamilton Project book of tax policy proposals, “Tackling the Tax Code: Efficient and Equitable Ways to Raise Revenue.”

With the aging of the population has come rising revenue needs, potentially crowding out important investments in long-run economic prosperity. Early childhood investments, infrastructure, research and development and other priorities must be funded in order to sustain economic growth. But U.S. federal government tax revenues are low both in relation to U.S. history and to other advanced countries. Furthermore, high and rising inequality suggests a need to shift the revenue burden of U.S. taxation towards high earners.

There is certainly room to respond to our fiscal challenges by raising existing tax rates or via better enforcement of tax laws. But in some cases, existing taxes are simply not very progressive, placing excessive burdens on low- and middle-earners. Payroll taxes are a good example: They take a constant fraction of earnings up to a cap, meaning that they claim a vanishingly small fraction of the income of very high earners while placing a substantial burden on those with less. In other cases, the room to raise revenue is limited by the structural weaknesses of the taxes themselves.

For example, the current international corporate tax system is poorly designed to raise revenue without inducing multinationals to offshore their production or paper profits. That system insists on attempting to determine exactly where profits are generated. But in practice, firms have wide latitude to decide where to book their worldwide profits. They use this latitude to lower their tax bills, shifting both real production and paper profits to low-tax countries like Ireland and the Cayman Islands.

Fortunately, evidence-based tax reforms – and fundamentally new tax designs – can overcome these problems, particularly if the United States first tightens loopholes and limits the ability to hide profits from taxation. More broadly, the United States (and other countries) could adopt a reform known as formulary apportionment. This would give up on the quixotic attempt to allocate multinational profits accurately across countries.

Instead, multinationals would be taxed on the basis of their worldwide profits and the fraction of their sales occurring in the United States. Both of these quantities are much easier for tax authorities to observe than the division of profits across countries, and multinational companies have little ability to avoid their tax liabilities under this system. By protecting the international tax base, this reform would make it possible to efficiently raise revenue from firms that do business in the United States.

Beyond improving the current system, new progressive taxes that predominantly burden high earners would allow the U.S. to rely less on regressive policies like payroll taxes that place more burden on low earners. One interesting possibility is a financial transactions tax proposal, which the Urban–Brookings Tax Policy Center projects would raise about $500 billion over a decade (the large majority of which would ultimately be paid by high earners). This FTT proposal would represent a smaller burden for many market participants than the reduction in transaction costs they have experienced in recent decades, suggesting (along with research described by the authors) that a carefully designed FTT would not disrupt valuable financial market activity. An FTT might disrupt some high-frequency trading, but such activity is not highly socially beneficial. Long term investing and capital formation would not be meaningfully affected.

There are many ways the federal government could raise revenue in a progressive and efficient manner. In addition to the proposals noted above, reforming domestic corporate taxation, better enforcement of tax laws, broadening the tax base, more effective taxation of income from wealth and value-added taxes could all raise substantial sums – trillions of dollars over a decade, in some instances – and do so in ways that tilt the tax burden to high earners.

A well-designed overhaul of U.S. tax laws could raise more revenue for needed investment, provide a solid fiscal footing and make the tax system more supportive of broadly shared economic growth.

Kriston McIntosh is managing director of The Hamilton Project at the Brookings Institution. Ryan Nunn is policy director of The Hamilton Project and a fellow in economic studies at the Brookings Institution. Jay Shambaugh is director of The Hamilton Project and a senior fellow in economic studies at the Brookings Institution. The opinions expressed in this commentary are their own.