Evaluating Tax Policy: Eliminating Tax Loopholes vs. Increasing Marginal Rates

The Debate Heats Up: The debate surrounding whether to increase the marginal tax rate or eliminate tax loopholes is a hot topic in the current political climate. Both approaches aim to address fairness in the tax system, with proponents and opponents of each side presenting compelling arguments.

Current Tax Inequality

Contrary to the common myth that high-income earners pay little or no taxes, a closer look at the data reveals a different picture. According to recent studies, the top 1% of taxpayers contribute significantly more in taxes than the bottom 90% combined. In 2017, the top 1% of taxpayers paid 39% of federal individual income taxes, significantly higher than their 29.4% share of total reported income. This information challenges the notion that the wealthiest individuals are not paying their fair share.

Emerging Concerns: Tax Loopholes and Evasion

However, the conversation must not focus solely on the tax burden on the highest earners. The existence of tax shelters and loopholes is another critical issue. These deductions and credits, which are available to all taxpayers, allow individuals and corporations to reduce their tax liabilities. For instance, real estate depreciation, a common tax shelter, is also utilized by low and middle-income taxpayers to offset their personal and business expenses. This fairness argument forms a significant part of the debate.

The Case for Eliminating Tax Loopholes

First and foremost, eliminating tax loopholes is a straightforward method to increase overall tax revenue. In 2018, a staggering $3.7 trillion was collected in individual income taxes. Out of this, 2.4 trillion dollars came from federal, state, and local income taxes. It is logical to argue that if tax shelters and loopholes were removed, a larger portion of this revenue could be realized. This approach ensures that everyone, regardless of income level, pays their fair share, thereby promoting a more equitable system.

Arguments Against Increasing Marginal Tax Rates

Proponents of increasing the marginal tax rate often argue that the wealthy should contribute more to the common good. However, a higher marginal tax rate may not necessarily translate into more revenue. As incomes increase, tax avoidance strategies can become more sophisticated. Employers might choose to defer income distribution, thereby reducing the immediate need for tax payments. This could lead to a decrease in overall tax revenue, counterintuitively reducing the government's ability to finance public goods and services.

The Economic Impact of Tax Policy

Ultimately, tax policy must consider its economic impact. A marginal tax rate of 70 might appear ideal on paper, but its practical implications are complex. Higher tax rates could redirect investment into new business formations rather than stock markets, which can lead to job creation. However, this approach may also result in employers deferring income, undermining the effectiveness of the policy.

Towards a Balanced Approach

The ideal solution may lie in a balanced approach. While eliminating tax loopholes can increase revenue, a marginal tax rate must be set at a level that encourages economic activity and employment. The key is to strike a balance between fairness and economic incentives. Arbitrary income caps, which some policymakers suggest, may not be the best way to address the issue.

Conclusion: The debate over tax policy highlights the importance of a nuanced approach. Eliminating tax loopholes is a viable strategy, but increasing marginal tax rates must be implemented carefully to avoid unintended consequences. A balanced approach, focusing on both revenue generation and economic stimulation, is essential for a fair and effective tax system.