loss”) to economic performance from the current tax code is directly related to marginal tax rates. As marginal rates rise, these efficiency losses rise more than proportionally, roughly as the square of marginal tax rates. Because of this distortion, tax reform efforts in the past, such as the bipartisan Tax Reform Act of 1986, focused on reducing marginal tax rates.
If marginal tax rates are cut, the tax base will expand as people reduce their tax avoidance and increase their productive activities (Feldstein, 1995). One series of studies has estimated that a permanent 5 percentage point reduction in marginal tax rates accounts for a 10 percent increase in capital expenditures.10
Given the adverse effects of high marginal tax rates from a growth or efficiency perspective, policy makers should want the lowest possible tax rates that raise the amount of government revenue desired. This consideration becomes particularly important for this study because the adverse effects of high rates would be magnified at the higher levels of revenue needed to achieve long-term fiscal sustainability under three of the committee’s four scenarios.11
Globalization is transforming separate but intensely competing national economies into a single world economy through rising cross-border trade and investment, migration of workers, and transfers of technology, with important implications for the tax system.
Most people are aware of globalization because of growing international trade. But the growth in trade has been dwarfed recently by the growth in international investment. Although the value of global trade has tripled since 1990, the value of global investment flows has increased 10-fold (as measured in nominal dollars between 1990 and 2006).12 These investment flows have put pressure on governments to restrain tax levels and reform tax systems with an eye to international competitiveness. The United States has a lower overall tax burden than many other advanced industrial countries. The total of federal, state, and local taxation in the United States equaled 28 percent of the economy in 2006, in comparison with an average for the countries in the Organisation of Economic Co-operation and Development (OECD) of 36 percent; see Figure 8-2. Although Japan and Korea have levels of taxation similar to the United States, most nations in Western Europe have higher tax burdens.
As OECD government budgets generally increased in size during the 1970s and 1980s, largely to finance increased services and social benefits, income and payroll taxes were the major sources of additional revenues. But in recent decades, many countries have greatly expanded their taxes on general consumption, such as VATs. In Europe, the average VAT rate rose