U.S. and Swedish Trends in Tax Reform
Tax reform has become a major governmental policy issue in the United
States as well as in the rest of the world. Countries are attempting to balance
both economic efficiency and provide equity in taxation. Governments are
looking to rewrite tax codes to minimize their impact on economic growth.
Specifically, governments throughout the world are attempting to preserve
incentives built into taxation to maximize economic efficiency. At the same
time, these governments are trying to cope with the growth in social welfare
programs throughout the past three decades. In this paper I shall discuss two
nations which dramatically overhauled their tax systems, and whether or not
their goals with tax reform were achieved.
In the article “The tax reform act of 1986: Did Congress love it or
leave it?”, Randall Weiss discusses the attitudes about taxes in the United
States. He details the events and attitudes leading to the Tax Reform Act of
1986, and shows how public perception about taxes has changed since then. He
also discusses some of the tax reform proposals that are now currently being
thought about in Congress.
In 1986 the United States Congress enacted the Tax Reform Act (TRA-86).
The act passed with a great deal of bipartisan support. This support was made
possible by two features of the act. The first was that federal income tax
rates were to be cut dramatically. While this would lead one to believe that
federal government receipts were cut substantially as well, it was the second
important feature of the bill that allowed it to be revenue neutral. This
feature was that the bill was to improve horizontal equity in the tax system.
This would be accomplished by eliminating many of the deductions that many
individuals, particularly the well to do, were allowed to make.
Many of the complains about the tax system in the United States that
preceded the Tax Reform Act were about the gross horizontal inequities that it
allowed. A great deal of press preceding TRA-86 showed the public how many of
the country’s wealthiest individuals were able to get away with paying little or
no federal income tax. Eliminating many of these tax deductions and loopholes
had been the goal of several liberal Democrats for some time. In addition,
conservatives in Congress wanted to reduce the escalating federal budget deficit
at the time. Also, a prevailing attitude of the time was that reducing marginal
tax rates would benefit the economy. It was believed that specific tax breaks
and deductions to support economic growth would not be needed with the greatly
reduced tax rates. The combination of Democrats wanting more vertical tax
equity and Republicans wanting lower marginal rates allowed the Tax Reform Act
to gain widespread support in Congress.
Since TRA-86, tax policy in the United States has shifted away from base
broadening and lower marginal rates toward more progressive taxation and
targeted tax reductions. In 1990, and again in 1993, marginal tax rates were
raised on wealthy individuals in an effort to close the mounting federal budget
deficit. Also, the perception in the federal government was the special tax
credits and deductions were needed to promote savings, education, and economic
growth. This is a direct reversal of the ideas that lead to TRA-86. People no
longer argued that tax rate reduction would in itself provide for economic
Currently, members of the United States Congress are introducing several
different tax reform plans. Some of the plans, particularly the Republican plan
for a flat income tax introduced by Rep. Dick Armey, would decrease the
progressivity of the current tax system. In addition, a proposal for a national
sales tax would result in a tax code that is less progressive than current law.
On the other hand, a tax reform plan introduced by Rep. Dick Gephardt would make
the tax system more progressive. All of these reforms are intended to reduce
many of the remaining tax shelters left in place by TRA-86. The Republican
plans in particular are not revenue neutral and are intended to increase
investment in the economy and contribute to efficiency. However, these reforms
are not in line with the policies enacted after TRA-86, and they are still years
away in the future at best.
In the article “Tax reform of the century – the Swedish experiment.”,
Agell, Englund, and Sodersten discuss the recent Swedish experiment in tax
reform in 1991 (TR-91). As far back as 1978, the Nobel Laureate Gunmar Myrdal
said that Sweden had become a “nation of waglers”. Himself being greatly
liberal, even Myrdal admitted that Sweden’s highly graduated income tax was an
incentive to cheat on taxes. Also, the high corporate tax rate, which
originally was intended to encourage investment, created a capital lock in for
corporations. This prevented companies from reinvesting their profits in
different areas of their business to adapt to changing market conditions.
Originally, it was believed that TR-91 would cost the Swedish government
a 6% GDP loss in revenue. In actuality it cost about 1-2% of GDP in revenue.
The top marginal tax rate on income dropped from 80% to 50%. In addition, the
corporate tax was greatly reduced. To compensate for these losses, besides
reducing the number of tax loopholes, VAT was broadened to include more products
and housing was less subsidized by the tax code. In the short run this lead to
sizable losses in read estates, and effective demand shifted from housing to
capital instruments and financial assets. Later, the top marginal rate was
increased to 55%, and many modification to TR-91 have already been made.
The goals of TRA-86 and TR-91 were to increase economic efficiency
through base broadening and reduce gross abuses of the tax system in both
countries. To an extent, these goals were achieved. But both countries quickly
reversed their desire to reduce or eliminate tax shelters and lower marginal
rates. In efforts to reduce governmental budget deficits, top income tax rates
were increased once again. It will be interesting to see whether the current
tax reform proposals now being discussed in the U.S. Congress will take hold and
shift policy back towards base broadening and more horizontal equity.