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Tax Reform and Budget Deficits in America

Republican leaders in the US House of Representatives have been at work for more than a year designing a major reform of personal and corporate taxes. Although the changes may widen the budget deficit in the short term, the incentive effects of lower rates will boost economic growth, implying lower long-term deficits.

CAMBRIDGE – The Republican Party’s leaders in the United States House of Representatives have been hard at work for more than a year designing a major reform of personal and corporate taxes. With an election looming in 2018, the House Republicans are determined to deliver a reform package and send it to the Senate for enactment.

This reform will be very different from the last major tax overhaul enacted back in 1986. The Tax Reform Act of 1986 focused on the personal income tax, lowering the top rate from 50% to 28% and cutting rates for lower-income taxpayers. The revenue loss was offset by changes in tax deductions and other accounting rules, producing a reform that was revenue neutral at each income level, even without taking into account the effects of lower tax rates on increasing economic growth and taxable incomes.

In the 30 years since 1986, the tax rates for high-income taxpayers rose significantly, from 28% to 39.6%, with an extra 3.8% tax on these taxpayers’ investment income. A detailed study by the Congressional Budget Office (CBO) of taxes between 1979 and 2013 concluded that while the effective tax rate fell in every quintile of the income distribution, it rose well above that 35-year average for taxpayers in the top 1% of the income distribution.

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