Reducing the Budget Deficit: Tax Policy Options

Molly F. Sherlock
Analyst in Economics

Tax reform and deficit reduction are two issues being considered by the 112th Congress. In recent months, a number of groups have published various plans for tackling the nation’s growing deficits. Other groups, such as the Senate “Gang of Six” and a group led by Vice President Biden comprised of Members of Congress, have engaged in deficit reduction negotiations.

This report analyzes various revenue options for deficit reduction, highlighting proposals made by the President’s Fiscal Commission and the Debt Reduction Task Force. Others, such as House Budget Committee Chairman Paul Ryan and the Obama Administration, have noted the importance of tax reform as part of deficit reduction plans. These plans, however, do not provide the same level of detail as the Fiscal Commission and Debt Reduction Task Force, and are therefore not reviewed in detail as part of this report.

Large budget deficits, rising national debt, and the growth of entitlement spending have raised questions regarding fiscal sustainability in the United States. The Congressional Budget Office (CBO) predicts a FY2011 budget deficit of nearly $1.5 trillion, or 9.8% of gross domestic product (GDP). Over the past three decades, budget deficits have averaged 3% of GDP. Large budget deficits have contributed to an increased level of federal debt, relative to the size of the economy. Increased debt levels are expected to lead to increased federal interest payments. If not addressed, the current fiscal situation could undermine economic growth.

Reducing federal deficits will likely require reductions in spending, increased federal revenues, or some combination of spending cuts and revenue increases. Federal revenues in 2009 and 2010, relative to the size of the economy, were low by historical standards. Reduced federal collections may be partially attributable to the weak economy and the fiscal policy response. Historically low individual income tax collections may also be partially explained by the 2001 and 2003 tax cuts. Spending through the tax code, via tax expenditures, also reduces federal revenues. The use of tax expenditures may undermine economic efficiency and equity in the tax code.

The primary sources of federal revenues are individual income taxes, payroll taxes, corporate income taxes, and excise taxes. Additional income tax revenues could be raised with a broader tax base, which could be achieved by eliminating various exemptions, credits, and deductions. A broader tax base could also allow for lower tax rates, without a loss in federal revenues. Broadening the tax base could enhance the economic efficiency of the tax system.

There are other options for generating additional revenues outside of the current tax system. The federal government could raise revenues through additional consumption taxes, excise taxes, or by imposing a tax on carbon.

The President’s Fiscal Commission and the Debt Reduction Task Force took different approaches in the tax reform components of their fiscal sustainability plans. The President’s Fiscal Commission raised additional tax revenues primarily through comprehensive income tax reform. The Fiscal Commission chose to broaden the tax base, allowing for both lower tax rates and increased federal revenues. The Debt Reduction Task Force’s proposal also recommended individual income tax reform. The individual income tax reforms recommended by the Debt Reduction Task Force were designed to enhance efficiency and increase progressivity in the income tax system. Additional revenues in the Debt Reduction Task Force’s plan originate from the proposed 6.5% debt-reduction sales tax.


Date of Report: August 8, 2011
Number of Pages: 37
Order Number: R41641
Price: $29.95

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