As you know, I’m not enthusiastic about a fiscal stimulus plan. What we need is a stimulus plan that does not increasing the budget deficit or waste taxpayer funds but that does increase the incentive to produce output. So what would I do? Here’s a new idea.

The IRS knows how much income that each taxpayer reported last year. So let’s cut everyone’s marginal tax rate based on last year’s income. In other words, suppose that last year Joe earned $66,520 which puts him in a 25% tax bracket. Joe’s tax schedule this year will be exactly the same as last year except for every dollar earned above $66,520 the tax rate drops to 15%. We do this for all taxpayers so that each taxpayer has their own schedule and for each taxpayer there is a decreasing marginal tax rate.

Note that this plan increases the incentive to work and it doesn’t increase the deficit. In fact, the Tabarrok plan increases tax revenues! The key is a marginal tax cut with a different margin for every taxpayer based upon last year’s return.

That’s the basic idea but there are some obvious modifications that could solve various problems. For example, the new schedule could be based on an average of say the last three years of income or the average plus some roundup for growth etc. It’s also possible to cap the base on which the lower marginal tax rate applies, for example, we could create a lower tax rate on every dollar of income above last year’s income up to an increase of 20%.

It is true that a permanent system like this could be (partially) gamed but the system can work very well if used occasionally, say for the most serious recessions. We would also learn a lot by applying this system and looking at the taxpayer response.