Understanding the Tax Reform Debate: Background, Criteria, and Questions

Taxes are necessary because they fund the services provided by government. In 2005, Americans will pay about $2.1 trillion in combined federal taxes, including income, payroll, and excise taxes, or about 16.8 percent of gross domestic product. Beyond funding government, the federal tax system has profound effects on the economy as a whole and on individual taxpayers, both for today and tomorrow. Taxes change people's behavior and influence the economy by altering incentives to work, consume, save, and invest. This, in turn, affects economic growth and future income--and thus future government revenues. At the same time, the current tax system generates fierce controversy over fairness--who should pay and how much they should pay. In addition, the current tax system is widely viewed as overly complex, thereby reducing the ability of individuals to understand and comply with the tax laws. Furthermore, the tax system is costly to administer with most of the costs of administration, such as record keeping, understanding the laws, and preparing returns, borne by taxpayers. Concerns about the economic effectiveness, fairness, and growing complexity of the current tax system raise questions about its credibility. These concerns have led to a growing debate about the fundamental design of the federal tax system. The debate includes the type of base--income or consumption--and the rate structure--flatter or more progressive. Additionally, some question to what extent and how the tax system should be used to influence economic behavior and social policy.