MARSHALL/DERHAM: Making our tax system more fair

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By Will Marshall and Mike Derham

Americans want a tax system that is fair, simple and capable of raising the revenue we need to pay the nation's bills. The one we have fails on all three counts.

That's why President Obama will probably have to add comprehensive tax reform to his already jammed agenda.

The first imperative of reform is to restore progressivity, the keystone of a fairer tax system. Since there is a lot of fatuous talk about "socialism" in the air these days, it's worth noting that progressive taxation, which dates back to 1913, is a deeply American tradition.

It recognizes that our free enterprise system couldn't function properly without public laws, rules and investments in common goods like schools, roads, police and defense. Those citizens who reap the greatest rewards from our modern, mixed economy therefore have an obligation to give back, as Thomas Jefferson put it, in proportion to the bounty they have received.

At the same time, a progressive tax code lightens the tax burden on families of modest means, while creating incentives for them to advance by getting a good education, starting small businesses and saving for retirement.

In 2007, income and wealth inequality in America reached an all-time high (as measured by the Gini coefficient). Since a progressive rate structure offsets income inequality after taxes, President Bush's lowering of the top rates had the perverse effect of compounding today's growing disparities of wealth and power.

That's why we like a creative proposal by economists Robert Shiller and Len Burman called the "Rising Tide Tax System." Under this approach, the federal tax code would change according to economic circumstances. It would grow more progressive when, as now, the income of the richest is growing fastest and inequality is rising. Conversely, when inequality is dropping — as we saw in the 1950s and '60s — the tax structure would flatten out. Supply-siders should like that. Any takers?

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In addition, here are four steps toward a fairer, simpler and more fiscally responsible federal tax system:

First, allow Bush's indefensible tax cut for the wealthiest families to expire in January 2011. That will return us to the same top marginal rate (39.5 percent) that was in place during the economic boom of the 1990s. It would also raise $53 billion in annual revenue, while keeping in place tax relief for low-income and middle-class families.

Second, eliminate tax giveaways to speculators. As the billionaire Warren Buffett famously pointed out two years ago, Wall Street titans pay less in taxes than their secretaries. The Bush administration's 2003 decision to lower the capital gains rate to 15 percent, along with the "carried interest" breaks for investment funds no doubt contributed to the frenzy that fueled the Wall Street bubble. Reverting to a 20 percent long-term capital-gains rate for the highest earners, and taxing carried interest as ordinary income, will generate $15 billion a year and curb speculation.

Third, root out corporate welfare. The U.S. tax code is honeycombed with unwarranted subsidies for businesses. While many of these began as efforts to protect nascent industries or provide incentives for sectors that benefit the country as a whole, special interests have in many cases kept these exemptions in the code long past their useful life. The Progressive Policy Institute has long called for charging an independent panel, modeled on the successful military-base-closing commission, with developing a subsidy hit list and submitting it to Congress for an up-or-down vote. Not only would this save money, but by broadening the base of business taxation it would also allow us to reduce the U.S. corporate tax rate to globally competitive levels.

Fourth, it's past time to introduce a new principle into the tax-reform debate: Tax waste, not work. The federal gas tax is kept artificially low; it doesn't come close to covering what economists say are the actual costs, including the environmental ones, of burning oil. Meanwhile, the payroll tax workers and employers pay to finance Social Security and Medicare has grown to the point that it takes a bigger bite out of the paychecks of working families than the federal income tax.

This makes absolutely no sense. Raising taxes on fossil fuels will reduce greenhouse-gas emissions and drive private investment toward clean fuels. And by using the revenue generated by taxing waste to reduce the tax on work, we could give U.S. businesses a stronger incentive to hire new workers.

These reforms don't exhaust the list of what needs to be done to haul America's antiquated tax code into the 21st century. But they go a long way toward making federal taxes fair to middle-class families again.

• Will Marshall is the president of the Progressive Policy Institute. Mike Derham is the chairman of the PPI's Innovation Economy Project.