'Dual-Rate Income Tax' System is a Good Tax Code Fix

As the President's Advisory Panel on Federal Tax Reform begins meeting this week to discuss revamping the current tax code, a new Cato Institute study proposes a simpler alternative that would have most Americans paying just 15 percent.

In "Options for Tax Reform," Cato Institute director of tax policy studies Chris Edwards addresses the unnecessary complexity and inefficiency of the present system and adds that the new tax code needs to reduce the size of government. "The corporate income tax and half of the 15.3 percent payroll tax create large hidden burdens on individuals," he writes. "The tax code is as intrusive as ever and treats Americans very unequally."

According to Edwards, some of the goals of reform should be to provide "greater tax visibility so that people can measure the cost of government," "fewer and slower-growing tax bases to better control the overall tax burden" and "maximization of privacy and civil liberties."

Edwards suggests a "dual-rate income tax," which he describes as a middle-of-the-road compromise between the well-known flat tax and sales tax plans. "This revenue-neutral option would convert the individual income tax to a two-rate system that eliminates most deductions and credits and allows nearly all families to pay tax at a low 15 percent rate," he writes. "A 27 percent rate would kick in for earnings above $90,000 (single) and $180,000 (married)."

Other parts of the "dual-rate income tax" for individuals include:

  • Dividends, interest and capital gains would be taxed from 35 percent to 15 percent maximum to promote growth and investment.
  • The standard deduction would remain the same, but personal exemption would be increased from $3,200 to $4,500.
  • Earned income tax credit and saving vehicles (such as IRAs) would be retained, but all other deductions and credits would be eliminated.

Edwards argues that the corporate tax rate should "be dropped to 15 percent and interest made nondeductible. These changes would equalize and cut the combined top income and payroll tax rates on wages, dividends, interest, and small business income to just under 30 percent, compared with between 35 and 45 percent under current law."

Related: Policy Analysis no. 536

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