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Friday, October 28, 2005

OECD Calls for U.S. to Replace Corporate Tax with VAT

Oecd The Organisation for Economic Co-operation and Development has published Economic Survey of the United States, 2005, which recommends that the U.S. replace the corporate income tax with a broad-based value added tax and eliminate or cap several tax deductions:

The complexity of the personal and corporate income taxes has steadily increased since the last major tax reform in 1986, largely due to the continued proliferation of deductions, exemptions, credits and tax shelters that have substantially narrowed the tax base and created many distortions, several of which harm incentives to save. The Administration has charged an advisory panel with submitting options for federal tax reform with the aim of making the tax code simpler, fairer and more conducive to economic growth. A number of measures should be undertaken, even if the basic structure of the current income tax is retained:

  • The deductibility of interest on home equity loans (which are for consumption purposes) should be eliminated. The deductibility of interest on loans for the purchase, construction or improvement of houses should be limited to a much lower threshold and eventually phased out.
  • The exclusion of employer-provided health insurance premiums should be capped. The deductibility on federal tax returns of state and local tax payments and the exemption of interest on public-purpose state and local government debt should be dropped.
  • A more wide-ranging simplification of the personal and corporate income taxes with substantial base broadening and reduction in marginal rates as well as improved integration of corporate and personal income taxes would likely have substantial beneficial effects. The negative income tax for low-income workers (EITC) should be maintained, as should the current preferential treatment of major forms of retirement saving, even though its effect on household saving may be limited.

Beyond these reforms, further efficiency gains might be obtained through greater reliance on consumption taxation. The replacement of the grossly inefficient corporate income tax by a federal VAT should be considered. With a broad base, such a VAT would probably raise enough revenue to reduce reliance on income tax revenues and exempt an even larger share of the population from paying federal income tax; at the same time, retaining a personal income tax would allow the desired degree of progressivity of the overall tax system to be achieved. In addition, if states changed their own sales taxes to a VAT, jointly administered federal and state VATs could lead to substantial efficiency gains for economic decisions and tax compliance and administration.

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