Wall Street Journal op-ed, The Tax Reform Evidence From 1986, by Martin Feldstein (Harvard University, Department of Economics):

Experience implies that the combination of base broadening and rate reduction would raise revenue equal to about 4% of existing tax revenue.

Congress’s Joint Select Committee on Deficit Reduction is struggling to find $1.5 trillion in cuts over the next 10 years. This is a unique opportunity to use tax reform to reduce future budget deficits while lowering individual tax rates.

The Tax Reform Act of 1986, enacted 25 years ago last Friday, showed how a tax reform that includes lower rates can change incentives in a way that grows the tax base and produces extra revenue. … I studied a sample of individual tax returns (stripped of all identifying information) for more than 4,000 taxpayers provided by the U.S. Treasury Department. Because the sample contained the tax return of each individual for the years 1985 through 1988, I could compare the taxable income of individuals in 1985 with their taxable incomes in 1988, two years after their rates were lowered.

Taxpayers who faced a marginal tax rate of 50% in 1985 had a marginal tax rate of just 28% after 1986, implying that their marginal net-of-tax share rose to 72% from 50%, an increase of 44%. For this group, the average taxable income rose between 1985 and 1988 by 45%, suggesting that each 1% rise in the marginal net-of-tax rate led to about a 1% rise in taxable income.

This dramatic increase in taxable income reflected three favorable effects of the lower marginal tax rates. The greater net reward for extra effort and extra risk-taking led to increases in earnings, in entrepreneurial activity, in the expansion of small businesses, etc. Lower marginal tax rates also caused individuals to shift some of their compensation from untaxed fringe benefits and other perquisites to taxable earnings. Taxpayers also reduced spending on tax-deductible forms of consumption. …

These calculations have important implications for today’s deficit-reduction debate. Broadening the tax base by limiting the use of tax expenditures (the special tax rules that substitute for direct government spending as a way to subsidize health insurance, mortgage borrowing and other things) could raise substantial revenue. Doing so doesn’t require eliminating any of those tax expenditures. In a study of recent Treasury data, Daniel Feenberg, Maya MacGuineas and I found that limiting each individual’s tax reduction from the use of tax expenditures to 5% of that individual’s adjusted gross income would raise revenue equal to about 10% of current personal tax revenue.

Combining that base broadening with a 10% cut in all tax rates would be revenue neutral in a traditional static analysis. But the experience after the 1986 tax reform implies that the combination of base broadening and rate reduction would raise revenue equal to about 4% of existing tax revenue. With personal income-tax revenue in 2011 of about $1 trillion, that 4% increase in net revenue would be $40 billion at the current level of taxable income, or more than $500 billion over the next 10 years.

The Joint Select Committee should insist on counting that revenue as the starting point for a serious deficit reduction plan.