President Trump has just unveiled the outline of his tax reform proposal. Tax reform done right can give our economy a needed shot in the arm. The big question is, of course, what is the right way to do it?
The Committee for a Responsible Federal Budget has proposed some sensible guidelines:
Promote Economic Growth and Dedicate the Gains to Deficit Reduction. The Joint Committee on Taxation and the Treasury Department have estimated that comprehensive tax reform can increase the growth rate of GDP over the next decade by .05 to .25% per year. For example, a .2% increase would reduce our debt by $550 billion over ten years (see chart). This does not fix our fiscal problems but it helps.
Maintain or Reduce Current Deficits. Make sure that any tax rate cuts are offset by revenue increases (i.e. shrinking tax deductions) so that the annual deficit is not increased. Ultimately, our fiscal challenges are unlikely to be solved without reducing spending, reforming entitlements and increasing revenue.
Set Permanent Tax Policy. The reconciliation process in the Senate, whereby a simple majority can approve legislation, disallows any increase in the debt beyond ten years. In other words, permanent tax reform will require a sixty vote majority to override a filibuster. This is the only way to achieve sound policy.
Avoid Unjustified Timing Shifts and Other Gimmicks. A timing shift is a gimmick if it doesn’t make economic sense. For example, gradually reducing tax rates, rather than cutting them immediately, would only delay revenue losses by shifting them to the future, and is therefore a gimmick.
Rely on Reasonable Economic Assumptions. A good example of a faulty economic assumption is to arbitrarily assume that a tax rate reduction will create 3% annual GDP growth and therefore pay for itself over a sufficiently long time period. Such a proposal was made by the economist Stephen Moore in yesterday’s Wall Street Journal.
Conclusion. Slow economic growth and massive debt are our country’s two biggest problems. Tax reform done right will speed up growth without worsening the debt. I will be paying close attention to the forthcoming debate on this issue.
My last several posts have expressed dissatisfaction with both presidential candidates and the hope that whoever wins in November (very likely Hillary Clinton) will work with the Republican House of Representatives to implement its “A Better Way” plan for national renewal.
In particular, faster economic growth would produce more jobs and better paying jobs and hence is highly desirable. As many people, including myself, have pointed out, it is low productivity growth caused by low business investment, which is largely responsible for slow economic growth.
The economist John Taylor has an excellent analysis of this problem. He points out that the rate of economic growth equals the growth of labor productivity plus the growth of employment.
He then shows that:
Productivity growth slowed from the mid-1960s until the early 1980s, then increased until the mid-2000s, and has slowed way down in the past ten years.
The labor force participation rate has dropped dramatically since the Great Recession but only a small part of this drop off was caused by demographic trends (i.e. more retirees).
Such relatively long cycles of productivity growth and decline (longer than normal business cycles) suggests that government policy is having a major effect on economic performance. According to Mr. Taylor, what is needed is:
Tax reform to lower tax rates to improve incentives for work and investment.
Regulatory reform to prevent regulations which fail cost-benefit tests.
Free trade agreements to open markets.
Entitlement reforms to prevent a debt explosion.
Monetary reform to restore predictability in financial markets.
Conclusion. Mr. Taylor makes a very strong case that faster economic growth is not only possible but even achievable in the short run if our national leaders would just make some common sense policy changes.
There is only one source of growth. Nothing other than productivity matters in the long run.
The vast expansion in regulation is the most obvious change in public policy accompanying America’s growth slowdown. Most recently under the Dodd-Frank Act and the Affordable Care Act, the financial and healthcare sectors of the economy have seen radical increases in regulatory intervention. But environmental, labor, product and energy regulation have all increased dramatically as well.
Regulation during the financial crisis did not fail for being absent. It failed for being ineffective.
The best way for the government to subsidize healthcare efficiently is to give straightforward vouchers which people can use to buy insurance or to fund health savings accounts. Such vouchers should replace Obamacare, Medicaid and Medicare.
The basic structure of growth-oriented tax reform is lower marginal rates, paid for by broadening the base by removing exemptions and loopholes. Several additional tax principles are:
The ideal corporate tax rate is zero. A high corporate tax rate hurts the workers more than anyone else.
A growth-oriented tax system taxes consumption, not income and savings.
Eliminating or moving away from taxing income, would lessen the value of personal deductions such as for mortgage interest or charitable donations.
The estate tax is a particularly distorting tax on saving and investment. The tax code should not give strong incentives to middle-age people to stop building their businesses or investing their money.
Solving our immigration problem would turn 11 million illegal immigrants into productive citizens. Guest worker and e-Verify enforcement are fixable problems.
How to speed up economic growth ought to be one of the basic issues in the presidential election campaign. Here are some good ways to do this.
Our economy has been stagnant since the end of the Great Recession five years ago. The median household income has not nearly returned to its pre-recession level. And now a new report has just appeared, “Room to Grow: conservative reforms for a limited government and a thriving middle class”, suggesting new approaches to address this major problem. The lead author, Peter Wehner, declares that “Americans do not have a sense that conservatives offer them a better shot at success and security than liberals. … Rather than speak about the economy in broad abstractions, conservatives need to explain how to put government on the side of people working to better their conditions.”
How can we raise median household income and put millions of unemployed people back to work, at the same time? Deficit spending is no longer a viable option because our national debt is way too high already. Quantitative easing by the Federal Reserve has been tried, hasn’t helped very much, and is now being unwound.
Consumer spending makes up 70% of GDP and so the most direct way to boost the economy is for people to spend more money. Can this be accomplished effectively and efficiently with government policy? The answer is yes!
Broad based tax reform is the way to do it. Lower tax rates across the board for everyone, paid for by closing the loopholes and deductions which primarily benefit the wealthy. Two thirds of the American people do not itemize deductions on their tax returns. This means that lower tax rates for all of these middle income people will put more money in their pockets, most of which they will spend, thereby massively boosting the economy.
Of course there will be pushback to this course of action from the millions of affluent Americans who benefit from all of the loopholes and deductions in our tax code. But our first priority by far is to help the many more millions of middle income Americans who are suffering from stagnant incomes at best or may still even be unemployed as a result of the recession.
The publication of two new books is causing a reevaluation of the financial rescue and its aftermath, e.g. “The Case Against the Bernanke-Obama Financial Rescue”. The two books are “Stress Test” by Timothy Geithner, former Treasury Secretary, and “House of Debt” by the economists Atif Mian and Amir Sufi. Mr. Mian and Mr. Sufi maintain that the government’s response to the financial crisis should have focused less on saving the banking system and more on the problem of excessive household debt. They discovered in their research that, during the housing bubble, less affluent people were spending as much as 25 – 30 cents for every dollar of increase in housing equity. When the bubble burst, and housing prices started to fall, these borrowers cut way back on spending which caused many businesses to lay off employees. The authors propose setting up a government program to help borrowers decrease what they owe in underwater mortgages.
Five years after the end of the Great Recession it would still be very helpful to speed up our lagging economy. Here are three different possible ways to do this:
The Keynesians say the best way to stimulate the economy is with more government (deficit) spending. For example, spending several hundred billion dollars a year on infra-structure would create hundreds of thousands, if not millions, of new construction jobs. I think this is a good idea, but only if it’s paid for with a new tax (e.g. a carbon tax or a wealth tax).
The Mian/Sufi plan, as described above, would alleviate mortgage debt problems for millions of middle class homeowners who are still under water, encouraging them to spend more money which would in turn boost the economy. The problem is that the M/S plan creates a moral hazard for mortgage holders unless it’s paid for by mortgage insurance which would raise costs for borrowers.
Broad-based tax reform, with lower tax rates for everyone, paid for by closing loopholes and limiting tax deductions for the wealthy, would automatically put more income in the hands of the two-thirds of tax payers who do not itemize deductions. These middle class wage earners would tend to spend this extra money thereby boosting the economy.
The point is that there very definitely are ways to boost the economy, some better than others, and it should be a top priority of Congress and the President to get this done.
The occasion of the publication of Timothy Geithner’s book “Stress Test,” giving his version of the financial crisis, has led to a number of newspaper articles looking back at the Great Recession and its aftermath. The New York Times’ economics reporter David Leonhardt has such an analysis “A Rescue That Worked, But Left a Troubled Economy” in today’s NYT. “The Great Depression created much of modern American government and reversed decades of rising inequality. Today, by contrast, incomes are rising at the top again, while still stagnant for most Americans. Wall Street is flourishing again.”
“The financial crisis offered an opportunity to change this dynamic. But the (Dodd-Frank) law seems unlikely to transform Wall Street, and the debate over finance’s huge role in today’s economy will now fall to others. Should the banks be broken up? Should the government tax wealth? Should the banks face higher taxes?”
In my opinion, the real problem is not our financial system but the strong headwinds which are slowing down the economy.
Globalization of markets which creates huge pressure for low operating costs.
Labor saving technology which also puts downward pressure on wages.
Women and immigrants having entered the labor market in huge numbers, and therefore greatly increasing the labor supply.
The loss of wealth in the Great Recession also means that even people with good jobs have less money to spend. What we sorely need is faster economic growth to create more jobs and higher paying jobs. How do we accomplish this?
The best way to boost the economy is with broad-based tax reform to achieve the lowest possible tax rates to put more money in the hands of the working people who are the most likely to spend it. Such lower rates can be offset by closing the myriad tax loopholes and at least shrinking, if not completely eliminating, tax deductions which primarily benefit the wealthy.
Lowering corporate tax rates, again offset by eliminating deductions, providing a huge incentive for American multinational companies to bring their profits back home for reinvestment or redistribution.
With millions of unemployed and underemployed workers, reviving our economy with a faster rate of growth should be one of the very top priorities of Congress and the President. Survey after survey show that this is what voters want. Why isn’t it happening?
I am a fiscal conservative, as well as a social moderate, which means that I don’t fit very easily into a standard mold. I am non-doctrinaire, non-ideological and mostly nonpartisan. I vote for candidates from both major parties as well as independents. I prefer a balanced government with neither party in complete control.
My most direct sources of information on fiscal and economic issues are the Wall Street Journal and the New York Times, both of which I read assiduously on a daily basis. When these two newspapers disagree on a particular issue, then I usually decide that the truth lies somewhere in between. Our biggest national problem right now, in my opinion, is the stagnant economy. In today’s WSJ, the lead editorial, “The Growth Deficit”, clearly describes how bad the situation is. Since the Great Recession ended in June 2009, our rate of GDP growth has averaged 2.2% per year. This compares with a 4.1% annual rate of growth for all post-1960 recovery periods.
Such a slow rate of growth causes all sorts of problems. First of all, it explains why our unemployment rate is still so high at 6.7% after five years of recovery. This means that between 15 and 20 million people are still unemployed or underemployed. Such a large human toll means a huge increase in government welfare expenses for food stamps, unemployment insurance, etc. Higher unemployment also means less tax revenue collected by the federal government. This translates into much larger deficit spending, adding to the already massive national debt.
There are lots of things which can be done to increase growth, for example:
Lowering tax rates on individuals to put more money in the hands of the 2/3 of Americans who do not itemize deductions on their tax returns. They’ll spend this extra income and create more demand! Pay for this by closing loopholes and deductions, which are used primarily by the wealthy. Besides stimulating the economy, this will simultaneously address increasing income inequality.
Lowering tax rates on corporations to encourage multinationals to bring their foreign profits back home for reinvestment or paying dividends. Again, balanced by eliminating deductions enjoyed by privileged corporations.
Relax regulatory burdens on small businesses where most new jobs are created.
Reform immigration procedures by boosting the number of H1-B visas to attract more highly skilled, and entrepreneurial, foreign workers.
Grant trade promotion authority to the President to speed up new trade agreements.
We should be clamoring for our national leaders to be acting on these fronts. A strong economy is the very backbone of our success as a nation!