The Progressivity Ratchet

Abstract

This Article evaluates the consequences of the 2017 tax legislation for the future of progressive tax reform. The 2017 tax legislation introduced significant preferences for business income, including a cut in the corporate rate and the new Section 199A deduction for “pass-through” income. Many commentators criticized the design of the pass-through deduction and the legislation’s generally regressive effects but tacitly accepted or applauded the corporate rate cut as a desirable response to inter-national pressures. These changes also prompted renewed calls for progressive tax reforms, to increase the share of tax revenues raised from the wealthy. For one example, in early 2019, recently elected Representative Alexandria Ocasio-Cortez proposed a 70% top individual rate on taxpayers with the highest incomes.

This Article bridges these conversations on the 2017 legislation’s new preferences for business income and the future of progressive tax reform and introduces the “progressivity ratchet” as a theoretical framework for understanding their interaction. This framework first explains how poorly targeted tax preferences can increase the degree of tax avoidance in response to rate increases on other portions of the tax base. The framework then shows how this effect from poorly targeted preferences can interact with political economy constraints to limit the progressive potential of the income tax.

This Article then applies this framework to reassess the corporate rate cut and the pass-through deduction in the 2017 legislation. Both changes are examples of poorly targeted preferences which, if maintained, are likely to constrain progressive reforms in other parts of the income tax base, including reforms like that suggested by Representative Ocasio-Cortez. This “path dependency” threatens to be a lasting, regressive legacy of the 2017 legislation.

This Article concludes by evaluating different options to “re-verse” the ratchet and enable future progressive reforms. This discussion argues that a reversion to the rate dynamic under prior law—with a relative corporate penalty for most taxpayers and firms—is likely the most effective way to facilitate future progressive reforms, absent more fundamental changes to the tax base or the taxation of business entities.

Keywords: tax reform, progressivity, corporate income taxes, pass-through deduction

JEL Classification: K34, H20