What tax changes are needed most?
Tax the wealthy to promote more innovation, not for redistribution
President Obama’s proposed budget put forward a number of changes to individual tax rates, largely focused on raising taxes on the wealthy and lowering taxes on everyone else. But if the Republican agenda of supply side economicsbased tax cuts for the rich is misguided, so, too, is the Democratic agenda of using the tax code to boost middle-class, aftertax incomes.
Unfortunately, the president’s proposals would do little to address the fundamental problem of competitiveness that is behind the stagnation in middle-class incomes. Instead of simply redistributing wealth — which will have limited impact on economic growth — higher taxes on the rich should be used to pay for lower corporate tax rates, enhanced funding for research, development and infrastructure and other programs that have a direct impact on growth.
The president’s proposal to raise the individual tax on capital gains and dividends from 20 percent to a new combined rate of 31.8 percent is not, as many conservatives complain, the wrong policy simply because it is a tax increase. This change in itself would cause little economic harm because modestly higher taxes on personal income have a very limited negative effect on investment and growth. Specifically, changes in capital-gains taxes appear to affect mainly the timing of asset sales, not the gross level of investments.
The problem is where the president wants to spend the increased revenues: tax reductions for the middle class. While this sounds good on the stump — who doesn’t want to pay a few hundred dollars per year less in taxes — these reductions would have no effect on either investment or growth.
Any additional tax revenue should be committed to America’s future investment by companies — not current consumption by American taxpayers.
A number of studies have shown that corporate taxes are the most harmful to investment and economic growth. Like it or not, capital is increasingly mobile, allowing companies and investors to invest worldwide to find the highest rates of return. This pressure will only increase. Unfortunately, the United States imposes some of the highest statutory and effective corporate tax rates in the developed world. And compared with many of our competitors, which reward companies that invest in research and development and new machinery and equipment with lower tax rates, U.S. incentives are minimal. This is despite the fact that every dollar of forgone revenue from the R&D tax credit generates as much as $2 in additional research spending from the private sector.
We should be asking the rich to bear a greater portion of the tax burden to transition the country to a tax system capable of growing, retaining and attracting dynamic companies, thus creating the investment and jobs needed to provide opportunity for all. Instead, the president has reverted to the discredited argument that, by redistributing money, we can somehow make the country better off both now and in the future.
This approach does nothing to change the competitive landscape facing the U.S. economy.
Most Americans are not very concerned about income inequality. They are concerned about stagnant wages and economic uncertainty. These concerns cannot be solved merely by giving them a few hundred, or even a few thousand, dollars more through lower taxes.
To solve the underlying problems of slower productivity growth, lagging technological innovation and declining competitiveness, we need to deal with more fundamental challenges. A modern tax code with a lower corporate rate and stronger incentives for research and development would be a great first step.