Tax Reform Proposal, or: The Closest Shave in Fiscal History

A break from the endless droning of monetary economics. Lately I've been enraptured by the subject of tax reform. For years we've been told by Democrats that we need to raise tax rates on the wealthy (over $250,000 by their estimates) and by Republicans that we need to lower rates on everyone (especially people who earn their living from investment income; less so for that vulgar income stream known as wages). I've never been entirely sure about how I feel about this, until now: I hate taxes, and think even a top marginal rate of 39% is a little absurd. And don't get me started on how high corporate rates are. On the other hand I hardly like the imagery of slashing tax rates on the opulent and benefits for the indigent. But lately I've concocted a reconciliation for the two.

It starts with an idea that no one likes and only a few brave politicians ever suggest, but I'll take it a step further: eliminate all Federal tax expenditures. To a man. Dead in the water. Take away all the goodies, and piss off everyone in America. I'd eliminate the tax deduction for employer-funded health insurance, charitable contributions, accelerated depreciation, tax deductions for dependents, mortgage interest deduction, and deductions on corporate bond interest and Treasury interest, to name a few. I'd also remove the lower rate paid on realized capital gains. Income is income, and it's all game, no exemptions.

And then I'd slash all the rates. By how much I'm not sure, because it depends on how much can be raised by eliminating these tax expenditures. I've heard that we "spend" about $1.2 trillion on these types of deductions, so that implies we could collect about 37.5% less in direct taxes. That's intense. Even if we reduced everyone's taxes by 37.5%, that's dramatic. Now imagine if we lower rates on everyone, but by 50% on the lowest income earners and only 24% on the highest earners. That's a budget neutral tax cut both parties could get behind.

The Return of American Savings...

This is something that I almost never see addressed in the media or practically anywhere else. And its a phenomena that bears mentioning, because it has tremendous implications for nearly every aspect of economic policy. I'm talking about the return of private savings in the United States. Take a look at the graph below; private saving as a share of gross domestic income is at a historic high since the late 1970s.

If this rate stays high, it will have tremendous benefits for the economy in the coming years.
1. Interest rates will remain low, regardless of international capital flows. This will keep interest costs on the Federal debt low as Medicare and SS costs continue to rise and alleviate pressure to raise taxes and run higher deficits.
2. Global imbalances will subside as domestic investment is funded out of domestic savings. This means a re-balancing of East Asian economies and even more net-factor payments to bolster American GNP.
3. Improved household net worth will take pressure off government social programs that make up 2/3 of Federal outlays. If individuals start accumulating savings at a faster clip, programs such as SS, Medicare, Pell Grants, ect. all become less critical for the median American, as retirement income, health spending, and college can be funded on an individual basis drawn on a private stock of savings.