Tax Reform

Tax Reform and the VAT

When President Reagan was elected into office
in 1980, he believed that high taxes were the main deterrent to
prosperity. Upon entering office the following January, the
Economic Recovery Tax Act of 1981 was instated, substantially
reduced personal business taxes. It lowered the marginal rates in
all brackets and capped the highest marginal tax wealthy individuals
pay at 50%. Businesses got relief as well through the accelerated
depreciation section of the act, which allows companies to expedite
the depreciation of their plants and equipment by taking larger
depreciation charges right away. Accelerated depreciation saved
corporations billions of dollars in taxes because these charges were
treated like a cost that is deducted from a firm’s income before
taxes are paid. Another section of the act introduced the
investment tax credit (ITC), which allowed a company to
purchase tools and equipment and subsequently receive a tax credit
based on the amount spent.

In 5 years time, people started feeling that
the tax code favored the rich and powerful. Many millionaires and
corporations avoided paying taxes. In 1986, Congress passed a tax
reform act that ended the traditionally progressive individual income
tax brackets. The law also added a 5% surcharge but it was later
changed. The law also made it difficult for the very rich to avoid
taxes altogether. The alternative income tax, which is the personal
income rate that applies whenever the amount of taxes paid falls
below a designated level, was strengthened. People had to pay a
minimum tax of 20% regardless of other circumstances or loopholes in
the tax code. Finally, the reform act called for the removal of the
ITC and a revision of the accelerated depreciation schedules.

By the 1990’s, government spending was growing
faster than revenues, and the government had to make up the
difference by borrowing. The Omnibus Budget Reconciliation Act of
was driven by the need for the government to balance its
budget. It combined future spending cuts with tax hikes and affected
government revenue in several ways. The law added the two top
marginal tax brackets, which affected the richest 1.2% of taxpayers.
It also removed the $135,000 cap on Medicare taxes. The alternative
minimum tax, which targets the wealthiest 250,000 taxpayers, was also
strengthened, making tax avoidance difficult for the extremely
wealthy. Another provision prevented single individuals with taxable
incomes in excess of $100,000 and couples with incomes in excess of
$160,000 from claiming some deductions that would lower their taxes.
Estate taxes were increased on properties valued at more than $2.5
million. Finally, the federal excise tax on gasoline was raised by
4.3 cents per gallon to 18.4 cents. This act, however, contained
some tax cuts. Credits worth $21 billion were given to lower-income
working families with children, and about $4.6 billion for low-income
housing were granted. Businesses even received some tax cuts to
offset the higher corporate tax rates, and approximately $5 billion
of credits for research and experimentation were approved.

The Value Added Tax

The value-added tax (VAT) is a tax imposed on
business at all levels of production, and based on the increase in
value, provided by each level. Because all stages of a value-added
tax are ultimately passed on to the consumer via higher prices, it
has been described as a hidden sales tax. The VAT has several
advantages. First of all, it is hard to avoid because the tax
collector imposes it on the total amount of sales excluding the cost
of inputs. Secondly, the incidence of the tax is widely spread,
which makes it difficult of a singe firm to shift the burden of the
tax to one group or another. Third, the tax is not readily apparent
to the consumer, because it has been included in the price before the
purchase is made. Fourth, the VAT is easy to collect because
businesses would make their VAT payments along side their tax
payments to the government. Finally, the smallest of VAT’s can raise
a tremendous amount of revenue. However, there are also
disadvantages to the VAT. The fact that the customer can’t tell what
the tax is, prevents them from being as vigilant about higher taxes,
and can make them feel like they’re being taken advantage of.
Another disadvantage is that the VAT would compete directly with the
state sales tax. The VAT is a federal sales tax to already-existing
state taxes. Therefore, in order to increase spending, a state may
have to forego their own tax in order to increase the selling of
their goods.