Abstract
A prominent tax reform proposal made by Michael Graetz in 2008 (the Graetz Plan) would replace much of the federal income tax with a Value Added Tax (VAT), a new consumption tax. If enacted, low-income and middle-income Americans would file 120 million fewer federal income tax returns annually. The Plan would convert the mass income tax into a narrow “class” income tax on high-income Americans. Adoption of the Graetz Plan would promote economic growth and reduce the compliance and administrative costs of the federal tax system. Defenders of the mass income tax nonetheless oppose adoption of the Graetz Plan. This Article argues that the Graetz Plan, modified as suggested in this Article, could overcome two major impediments to adoption of the Plan: (1) the difficulty of reconciling the Graetz Plan and existing multipurpose refundable income tax credits; and (2) the potential loss of beneficial functions that the mass income tax may serve.
Part I summarizes the relevant portions of the Graetz Plan. Part II provides context for reform of existing refundable income tax credits and critiques the Graetz Plan’s suggestion to replace existing refundable credits primarily with payroll tax cuts. This Article identifies a new development that could facilitate adoption of the Graetz Plan while simultaneously improving the well-being of low-income Americans. Specifically, the 2021 temporary expansion of the federal Child Tax Credit (CTC) and the adoption of an advance payment system signal a bipartisan shift in policy and potentially a shift in public attitudes about making transfer benefit payments to families with children. Replacing most of the Earned Income Tax Credit (EITC) with an expanded CTC would facilitate administration of the CTC outside the federal income tax system. The remaining, smaller EITC could be replaced with a payroll tax reduction smaller than Graetz assumed. Replacing large, antipoverty and pro-family transfer programs that currently are embedded in the income tax would no longer be the Achilles Heel of the Graetz Plan.
Part III responds to arguments that the mass income tax serves various beneficial functions that a class income tax plus a VAT would not serve. This Part explores various functions, some of which are newly identified in this Article, currently served by the mass income tax. Ultimately, this Article concludes that learning to live without the mass income tax could enhance social welfare. Some functions currently served by the mass income tax still could be served—and even improved—in the context of adopting a modified Graetz Plan. Also, one function currently served by the mass income tax, enabling Internal Revenue Service administration of hundreds of tax expenditures (tax subsidies and other targeted tax cuts), has made the federal tax system dysfunctional and should be curtailed, not retained. Adoption of the Graetz Plan could provide a needed catalyst for fundamental tax expenditure reform, which could significantly increase federal revenue and improve the efficiency and fairness of the federal tax system. The net benefits of enacting the Graetz Plan and learning to live without Form 1040 are significant and underappreciated.