November 27, 2014

Pro-Growth Tax Reform: A Lot of Common Ground, But Still Some Stumbling Blocks

As part of the Strengthening of America -- Our Children's Future project that The Concord Coalition is co-sponsoring, a forum was held last week in New York on the topic of pro-growth tax reform.  The video of the full event is available here.  In the first part of the forum Martin Feldstein, a former chairman of the Council of Economic Advisors and a Romney adviser, joined Lawrence Summers, former Treasury secretary and an Obama adviser, to discuss what they considered pro-growth tax policy. 

At the event, Feldstein and Summers made it clear that when it comes to this subject, there is a lot of common ground between Republican economists and Democratic economists.  Here’s what I heard as some of the main points of agreement between Feldstein and Summers (what Summers referred to as the "structure that Marty and I have converged on"):

1.      Pro-growth tax reform means structuring the tax system to encourage longer-term expansion in the productive capacity (or "supply side") of the economy.

2.      This suggests that a broader, more even tax base, which supports relatively low marginal tax rates, is the best way to raise necessary revenue with the least distortion to those supply-side economic decisions (how much to work, how much to save, how much to invest in human or physical capital).

3.       A first priority to follow the "broadening the tax base" strategy is to reduce existing "tax expenditures" that are considered inefficient and/or unfair.  Tax expenditures are economically equivalent to government spending programs and make government bigger than indicated by the levels of direct spending. (Cutting revenues by increasing tax expenditures grows, rather than shrinks, the size of government.)

4.       Tax expenditures could be reduced in a variety of ways that don't have to target particular sectors of the economy (it could be done in across-the-board, broad-brush ways--e.g., Feldstein likes the idea of capping the total amount to a percentage of gross income) and can be done in a progressive manner, where tax burdens are increased relatively more on higher-income households (e.g., the Obama budget proposal to limit itemized deductions and even other tax expenditures to the 28 percent rate).

5.       To contribute to deficit reduction and therefore be pro-growth, tax reform does need to raise revenue (relative to the policy-extended, "business as usual" baseline, and even before any "dynamic scoring" type effects are accounted for).

6.       But pro-growth tax policy is a longer-term goal focused on mainly the supply side of the economy; we cannot immediately raise tax burdens in ways that would threaten to put our economy back in recession by reducing demand for goods and services too severely.

But I also heard some remaining sources of disagreement between Feldstein and Summers, which are probably indicative of where stumbling blocks to bipartisan tax reform remain.

1.      Beyond decreasing tax expenditures/broadening the income tax base, what are some other features essential to pro-growth tax policy? (i) Feldstein seems to favor continued low or even lower effective tax rates on capital income (more consistent with a consumption base), while Summers seems to favor reducing or eliminating the current preferential rates on capital gains and dividends (consistent with reducing tax expenditures under an income base); (ii) Feldstein would favor keeping marginal tax rates low across the income spectrum, including at the very top, while Summers would favor a return to higher rates at the top as necessary to restore fairness (greater progressivity) to the system; (iii) Summers explicitly said that effective (average) corporate income tax rates are too low, not too high, while Feldstein argues for corporate tax reform that is revenue-neutral at best with lower marginal tax rates on profits earned abroad; (iv) Feldstein would probably argue for a lower limit on overall revenues/GDP than Summers would, as consistent with the pro-growth goal.

2.       Beyond deficit reduction, what is needed to grow the economy's "supply side?" Feldstein would probably argue for working toward smaller government in scale and scope, while Summers clearly stated that pro-growth tax reform is (necessary but) "not sufficient" to address our nation's growth needs, because we have "under-invested" in many things.  Beyond raising national saving by reducing the deficit, Summers believes government should more directly help the economy invest more in education, infrastructure, the environment, health care, etc. -- the components of the productive capacity of the economy.  He stated that such public investments are a necessary complement to fiscal sustainability in a "pro-growth" fiscal agenda.  (And immediately, Summers emphasized that continued stimulus-type policies, to keep demand for goods and services up, are still necessary -- although Feldstein did not disagree with this.)

The conversation between Feldstein and Summers is a good indicator of the potential for achieving bipartisan tax reform consistent with not just "growth" goals but fairness and fiscal responsibility goals as well.  The broad contours of the common ground are indeed well "grounded," but some of the remaining points of disagreement might be significant enough stumbling blocks to make meeting halfway still challenging.

The second panel at the forum featured business leaders:  David Cote, chairman and CEO of Honeywell; Alfred West, CEO of SEI (and chair of the American Business Conference), and Navin Thukkaram, COO of Qwiki, Inc. 

Cote, who served as a member of the Simpson-Bowles fiscal commission, stressed the necessity of achieving a credible and bipartisan plan to address the unsustainable debt problem in order to reduce uncertainty in the business community so that businesses will be more willing to hire workers and expand production.   He said that the solution should include higher revenue, reduced entitlement spending and reduced discretionary spending. 

Cote also said that how policymakers choose to handle the "fiscal cliff" can be either a potential disaster that could cause a global recession, or an opportunity that could spark a robust economic recovery.  He suggested that policymakers should avoid a repeat of last year's extended debate over raising the debt ceiling. 

West said that we need a business environment and a tax code that promote growth, stating that any program to reduce debt must start with economic growth.  He suggested that nothing would have a more positive effect on growth than embracing a debt reduction plan and sticking to it. West urged policymakers to seriously consider comprehensive plans such as the Simpson-Bowles and Domenici-Rivlin deficit-reduction proposals.  West also argued that the corporate tax rate should be reduced and that the tax base should be broadened by weeding out tax preferences and expenditures.

Thukkaram said that Americans have been very good at creating fiscally sustainable enterprises, but that our government has unfortunately fallen short.  He added that the lack of confidence in Washington's ability to address our fiscal problems is discouraging business from investing.  He urged policymakers to take a number of specific steps that will make the tax code more predictable and conducive to encouraging investment in small businesses.