America needs faster economic growth. Faster growth would mean more jobs, higher incomes, and less debt. Not only has the economy been slow to recover from the Great Recession and Financial Crisis, it was no great shakes even before the meltdown. As Fed Chairman Ben Bernanke said the other day, “The fact that unemployment has declined in recent years despite economic growth at about 2 percent suggests that the growth rate of potential output must have recently been lower than the roughly 2-1/2 percent rate that appeared to be in place before the crisis.”
Getting annual growth back to at least its post-war average of about 3.4% — plus a few years of hypergrowth to eliminate the jobs and output gap ASAP — should be a central goal of U.S. economic policy. This will require a full spectrum solution reforming education, regulation, immigration, and entitlements. But revamping the tax code has a big role to play, too. Any plan must result in a system that rewards innovation and work, not lobbying and cronyism. It would ideally generate enough revenue to pay for government without raising taxes on middle-income families. And it must be politically doable.
I love the idea of a flat-consumption tax, for instance. But while it meets the first objective, I’m not sure about the second. And I know it fails the third. But here are three approaches worth considering:
Unshackle business. Earlier this year, AEI’s Alex Brill offered a plan that would broaden the tax base and reduce the tax rate on business investment. It would kill or scale back some of the largest, most distortionary tax subsidies, while raising tax payments from higher-income earners without changing statutory tax rates.
The Brill Plan would a) phase down the corporate tax rate over the decade to 25%; b) make permanent the 50% bonus depreciation provision now in effect; c) gradually limit the tax benefit for home mortgage interest deductions; d) phase out the state and local tax deduction; d) repeal the alternative minimum tax to eliminate its compliance burden.
Focus on the family. Back in 2010, economist Robert Stein offered reform that, like Brill’s, would try to reduce the worst distortion in the tax code, while removing obstacles to capital investment. In addition, Stein would reduce the fiscal burden on parents, which he argues “actively discourages Americans from having children.” Among the core elements of the Stein Plan:
– Let companies distribute dividends tax free and permanently count a significant percentage of plant and equipment spending as business expenses in the year the purchases are made.
– Scrap the individual Alternative Minimum Tax and all itemized deductions except for mortgage interest and charitable donations. These two deductions would then be made available to all taxpayers, while decreasing the size so as to be revenue neutral.
– Set tax rates at 15% and 35%, with the width of the 15% bracket twice the size for married couples as for singles. Capital gains would be taxed at half those levels.
– Replace the standard deduction and personal exemption would be replaced by a tax credit of $2,000, adjusted for inflation annually, that could be used to reduce income taxes only.
– Replace the child credit, the child-care credit, and the adoption credit with one new $4,000 credit per child that can be used to offset both income and payroll taxes. It would grow at the same rate as the taxable wage base for Social Security, which is generally a rate faster than inflation.
Under this new tax system, most singles would get a tax cut of $175 while most married couples without children would get a tax cut of $350. But the biggest impact would be felt by parents. Take a married couple with two children, earning $70,000 a year: Under current law, this family generates income taxes of about $5,800 and payroll taxes of $10,710 (combining the employee and employer sides of Social Security and Medicare taxes). But under the tax structure outlined above, their income taxes would be completely eliminated and they would also receive a $1,500 credit against their payroll taxes. They would thus enjoy a tax cut of more than $7,000 per year compared to what they currently pay. …
So who pays more? Primarily high-income workers, but also upper-middle-class taxpayers who do not have children in the home (either because they have decided not to raise children at all, or because their children have already turned 18).
Invest, invest, invest. AEI’s Alan Viard has recommended a progressive consumption tax or “X tax.” Economic simulations suggest that replacing the income tax system with a consumption tax can boost economic growth. Here’s a summary from a proposal he contributed to:
The X tax consists of a flat‐rate firm level tax on business cash flow and a graduated‐rate household‐level tax on wages, fringe benefits, and defined‐benefit pension payments. Although the X tax is administratively similar to an income tax, the combination of two features makes it a consumption tax. First, households do not pay tax on interest, dividends, capital gains, or other income from saving. Second, firms immediately deduct business investments, rather than depreciating them over time.
A constant 35 percent tax rate will apply to firms’ cash flow and to wages in the highest bracket, with lower rates on other workers. Initially, a 15 percent tax rate will apply to the first $50,000 of taxable earnings and a 25 percent rate to taxable earnings between $50,000 and $100,000. The 15 and 25 percent tax rates may vary over time to keep revenue at 19.9 percent of GDP in future years. There would be no head‐of‐household filing status and no standard deduction.
Viard also likes the idea of a personal expenditures tax, which would work as follows:
Each household files an annual tax return on which it reports income, deducts all savings (deposits into savings accounts, asset purchases, amounts lent to others, and payments made on outstanding debt), and adds all dissaving (withdrawals from savings accounts, gross proceeds of asset sales, amount borrowed from others, and payments received on outstanding loans). The resulting measure equals the household’s consumption, which is taxed at graduated rates.
Viard explains the advantage of shifting to a consumption tax from an income tax:
Income taxation penalizes saving, a major source of long-run economic growth, while consumption taxation does not. Under an income tax, a worker who saves to consume in the future is taxed more heavily than a worker who consumes today. Both workers pay tax on their wages, but the worker who saves also pays tax on the returns to his or her saving. In contrast, under a consumption tax with a constant tax rate, both workers pay the same percentage tax on their spending, so there is no bias against saving. … Replacing the income tax system with an X tax would boost saving, which would increase the capital stock and promote long-run growth.
There’s a lot more to these plans than my summaries. But what they have in common is a focus on reducing economic inefficiencies and distortions — such as the current code’s anti-investment bias — that reduce economic growth. The plans also maintain the progressive nature of the current tax code or even expand upon it — while also keeping marginal rates low. They are the very opposite from President Obama’s approach which is to a) create a tax-hike straitjacket by trimming tax breaks while also raising marginal rates, and b) raise taxes on investment and innovation.
So who’s going to champion these ideas?