Tax Reform for a Fairer, More Vibrant Economy

Abstract

The paper reviews the recent literature on tax reform, and recommends abolishing the profits tax and treating personal incomes from all sources as taxable, including capital gains and dividends. Abolition of the profits tax will vastly improve the investment environment and eliminate wasteful distortions. We also offer an intermediate “gradualist” approach involving halving the profit tax rate and taxing half of dividends and capital gains. We augmented a model proposed by Chetty and Saez [1] to incorporate the effects of manager effort for investment and showed the strong adverse effect of the profit tax on investment. Given that successive increments in total personal incomes from all sources are typically characterized by increasing intensity in economic rent, a progressive tax structure with high marginal tax rates at the top and wide tax bands is not only more equitable, but can be justified on efficiency grounds.