Introduction
The US federal tax system is critical in funding government operations and promoting economic growth. However, the current backdrop of high interest rates and inflation underscores the need to acknowledge that the system is complex, inefficient, and possibly unfair (Trading Economics, 2024a, 2024b). Optimizing this structure is an equally complex process, but it requires constant adaptation in a dynamically evolving world. Drawing on historical perspective and current problems, this work proposes several changes to the tax system.
Current Problems
Before describing potential changes, it is necessary to provide a rationale. For several years, if not decades, one of the system’s critical problems, which impedes progressivity, has been observed and emphasized. It lies in the fact that, historically, since the 60s, the highest percentile of the wealthiest taxpayers contributed about 70%, but now this figure has settled at 37% (Tax Policy Center, 2023).
Moreover, some of the hottest political discussions concern issues in this subject area, such as inheritance and capital gains tax rates, which, again, primarily affect the most affluent population (Piketty & Saez, 2007). Since the volume of the tax budget, adjusted for population changes and inflation, has only increased, it is natural to assume that the treasury is also replenished by the middle class (Gruber, 2022). Statistics as of 2017 show that, separating the bottom 50% from the top 1%, the majority of taxes come from this group between 1 and 50% – more than half of the total fund (The Tax Foundation, 2020, p. 17). Consequently, the first fundamental problem is the long-term lack of progressivity in the system.
In addition, heated discussions within the authorities regarding inheritance tax and the assessment of capital gains and dividends also require appropriate solutions. Reform of capital gains and dividend taxation is necessary to address existing inequalities in the treatment of earned and investment income. From a fairness and equity perspective, such earnings should be taxed at the same rates as ordinary income (Saez & Zucman, 2020).
The estate tax is intended to prevent the concentration of intergenerational wealth at the top of the wealthy population. Still, in its current form, it burdens some small businesses and family farms. In its form, the second problem described is reminiscent of the first – the lack of fair progressiveness means the middle class is responsible for filling the treasury to a greater extent than the wealthiest population of the country.
Solving such problems requires an integrated approach. Unfortunately, a simple step in the form of tax cuts on certain items may not have a corresponding effect in the long term – the experience of the Tax Cuts and Jobs Act of 2017-2018 demonstrates this fact (Tax Policy Center, 2020). The short-term effect was driven by increased demand for investment but, at the same time, limited by tight monetary policy and low unemployment, which minimized the potential of such efforts, especially among less wealthy corporations (Tax Policy Center, 2020).
Statistical analysis showed spikes in consumption expenditures, dividends paid, and withdrawals, followed by a rollback to a linear trend (Gravelle & Marples, 2019). This practice cannot be called ineffective, since some short-term goals for maintaining the growth rates of GDP and wages were achieved. Still, later, many external factors intervened, complicating the assessment. Consequently, the measures proposed below take into account all the identified determinants and the experience of recent years.
Potential Reforms
Radical changes in progressive rates will be met with disapproval by the wealthiest population, in whose hands, among other things, lie the levers of pressure on the country’s economy. Adjusting income thresholds for each tax bracket to account for inflation will prevent tax bracket creep by ensuring people do not fall into higher tax brackets solely because of inflation. A smooth program to return current marginal rates to at least 39-41%, as was the case just a few years ago, will contribute to the gradual restoration of fairness and a reduction in the tax burden on the middle class (Tax Policy Center, 2023).
The increased costs for lower-income populations can also be addressed through tax breaks on consumption taxes and exemptions for specific items, such as Medicare or income used for housing or food (Peter G. Peterson Foundation, 2024). Achieving balance will require long-term reforms to reduce income inequality and equalize the relative value of after-tax income for corporations.
Adjusting the estate tax threshold through the exemption to a more reasonable level would balance fairness with the impact on small businesses and family farms. Increasing rates on investment income to stimulate not only stock markets but also production and the business itself can help reduce the risk of bubbles forming in the economy (Basse et al., 2021). In addition to addressing pressing monetary policy issues, the US Federal tax system should consider incorporating a carbon pricing mechanism to address climate change and promote environmental sustainability. Such changes may only increase companies’ profits in the long term. Still, incentives through deductions and other measures can speed up the process of weaning off dependence on non-renewable energy sources (Dumortier & Elobeid, 2021).
Conclusion
Finally, developing the legislative framework to eliminate loopholes that minimize tax liabilities, particularly in the corporate tax section, can promote equality and fairness by addressing the unequal share of payments between large and small businesses. This set of measures must be accompanied by mandatory control and monitoring of the financial situation, which is currently quite extreme due to the influence of many external and internal factors.
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