Income Tax Reform

How to improve the tax code is the subject of much debate. Proponents of reform often call for increasing fairness and simplicity. But people define those concepts in different ways. 

Policymakers focus on what types of income are taxed and at what rate. The broader the scope of the income taxed, the lower the tax rate needs to be to raise a given amount of money. 

The tax system can be used to promote different social policy goals and provide subsidies based on certain circumstances. For example, policymakers need to decide whether to tax some people more than others based on factors such as marital status, presence of children, and homeownership. They must also look at who pays how much in taxes, including as a share of their total income. 

Some options can inadvertently cause distortions in the decisions people make. For example, they may make choices primarily to minimize their tax burden. In addition, some tax provisions significantly increase the complexity of the system, making compliance more challenging. 

The tax code is fraught with tensions and tradeoffs. Efforts to satisfy one principle of tax policy can violate another. The so-called marriage penalty offers a case in point. A married couple is generally treated as one tax unit. They must pay tax on their total combined taxable income. The marriage tax penalty exists when the couple's tax liability is greater than the sum of what the two would pay were they not married and filed as individuals. It is impossible to eliminate the marriage tax penalties within the existing tax structure without violating other desirable features of the tax system, such as progressivity. 

Coordination among states is also an issue, particularly for people who work in one state but live in another. Uncoordinated tax systems can mean paying taxes twice on the same income. In addition, states and localities may compete with one another in offering tax incentives for businesses. Such incentives are often ineffective at driving local job development while diminishing revenue.