In the 1960s, and indeed well into the 1970s, the standard objective of tax policy design, well represented, for example, in the work of Pechman (1987), was the achievement of a broad-based income tax. Consumption taxes existed, of course, notably in Europe in the form of the value added tax, but these had arisen as improvements that eliminated the cascading effects of turnover taxes, and as indirect taxes were not viewed as effective vehicles for progressive taxation. Indeed, even as interest in broad-based consumption taxes grew during the 1980s, Pechman (1990) devoted his presidential address to the American Economic Association at the end of that decade to a spirited defense of the income tax.
As of the late 1960s, it was still accepted practice for countries to impose "classical" systems of corporate income taxation, treating corporations as entities independent of their shareholders and imposing tax on corporate incomes. The incidence and distortions of such tax systems had already been described in the influential work of Harberger (1962, 1966), who characterized the corporate income tax as a surcharge on corporate capital that drove capital inefficiently out of the corporate sector and through this adjustment process imposed an extra tax burden on capital as a whole, not just on corporate capital. The further distortion of financial policy had already been identified by Modigliani and Miller (1958), who observed that the corporate interest deduction led to a violation of their invariance result with respect to corporate financial policy. These distortions in the allocation of capital and the determination of financial structure prompted consideration of corporate tax reforms, notably through some form of "integration" of corporate and individual income taxes. Different schemes of dividend relief had already begun to arise, most notably through reduced corporate tax rates on distributed earnings adopted via a split-rate system or the basically equivalent imputation system of shareholder tax credits for corporate taxes paid. There was probably less intellectual support for reducing corporate tax rates. Indeed, at least one problem was seen in doing so, for if corporate tax rates were allowed to fall too far below top individual tax rates, then high-bracket individuals could lessen their tax burdens considerably by accumulating funds for extended periods within corporations.
The world of the 1960s was very different than now with respect to the magnitude of international capital flows. Even so, the appropriate taxation of foreign-source corporate income was an issue, with countries varying in their treatment by convention and by treaty. The most important perspective at the time was provided by Peggy Musgrave (1969), who discussed conditions under which different types of "neutrality" would be desirable. In particular, capital export neutrality—under which capital provided by a country would face the same overall rate of income tax regardless of the location of investment—would be desirable from the perspective of efficient world-wide capital allocation, and could be accomplished by having each country follow a system of world-wide taxation, taxing its outbound earnings at the same rate as its domestic earnings while providing a tax credit for the income taxes imposed by foreign governments on the same earnings.
Like many other countries, the US imposed a wealth transfer tax on the estates of the wealthy. In 1977, 7.65 percent of US descendants had taxable estates, facing a top marginal tax rate of 70 percent on estates over $5 million (US Joint Committee on Taxation 2007). Although the estate tax was understood to be especially susceptible to tax avoidance strategies using various accounting and financial structures (being labeled in that year by Cooper (1977) as a "voluntary tax"), it remained an accepted part of the US tax system. Even in the late 1970s, though, it accounted for less than 2 percent of federal revenues. Perhaps because of its limited importance as a source of revenue, it also had received relatively little attention from economic research.
In the past few decades, developments in economic theory and evidence, as well as changes in the structure of the economy and the political process, have had a marked impact on the state of thinking about capital income taxation—about how capital income taxes should be designed, and how important a role they should play in the tax system of an advanced economy like that of the United States. This paper reviews some of these developments, focusing primarily on economic research and concentrating on the three broad topics touched on above: the choice between income and consumption taxes, the form of the corporate income tax, and the role of the estate tax and related wealth transfer taxes.