Sunday, August 7, 2011

Now is the time for tax reform

The United States is currently in an unenviable situation. The economic slump is approaching the end of its third year. At the same time, sky-high deficits and debt have resulted in a credit downgrade and a bitter partisan fight in Washington. Clearly, a return to economic growth would help solve both these problems.

Where will the growth come from, though? Stimulus spending has been tried--and has failed. Pro-growth tax cuts like those in 1961 and 1981 would not be politically feasible because of deficit concerns. One possible answer, suggested by WSJ columnist Stephen Moore, is revenue-neutral tax reform.

As Moore points out, a similar deal was struck in 1986, when the top income tax rate was lowered to 28%, which was balanced out by eliminating a host of deductions. The deal resulted in an estimated $1 trillion of economy-wide gains. This time, rather than lowering the marginal income tax rate (which was already done under Bush), a better idea would be to lower the corporate tax rate. Combining state and federal taxes, the US corporate tax rate is currently 39%, which is far higher than almost all other countries, and gives US companies a clear disadvantage in the global market. The employer portion of the payroll tax, which is basically a direct tax on hiring, also needs to disappear ASAP. If we want more hiring (which clearly we do), we shouldn't be taxing it.

How can we balance this out? For one thing, aggressively close off loopholes and tax subsidies. The real sad part of our corporate tax policy is that the largest corporations can hire armies of lawyers to figure out how to best exploit the loopholes--but mid-size businesses, without the ability to hire those lawyers, get hit with the full effect of the tax. That needs to end. Similarly, the favors to special industries (agriculture, hedge funds, green energy, etc) in the tax code need to be cut. Ethanol was a good start.

And if that doesn't balance the revenue effects of cutting the corporate and payroll taxes? Raise taxes on large high-yield capital gains, or put a tax on derivatives transactions. Unlike business, Wall Street does not create jobs or produce goods that add value to the economy. Large capital gains and derivatives are almost exclusively the province of the rich. And such a tax could discourage the kind of high-risk speculation that resulted in the 2008 crisis.

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