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Republican tax policy, as least when politically successful, has been a combo of (a) supply-side, top tax rate cuts to spur growth by changing incentives to work, save, and invest and (b) direct tax relief to immediately increase take-home pay.
Ronald Reagan didn’t cut just top marginal tax rates. Nor did George W. Bush.
So it is profoundly odd that Marco Rubio’s tax plan co-authored with Mike Lee is viewed by some as abandoning party orthodoxy or even Democrat-lite because it would expand the child tax credit (also strengthening families and helping parents invest in their kids), a point Ramesh Ponnuru makes in his new National Review piece. Lee-Rubio is, however, not a flat tax. Nor does it prioritize deeply cutting top personal income tax rates. In those two significant ways, what Rubio is offering is different than the plans being offered by some other GOP presidential candidates.
Still, the plan’s proposed top rate of 35% is six percentage points lower than the average top rate of 41% that existed during the 1983-2007 Long Boom. Oh, and it also completely eliminates investments taxes and radically transforms the corporate tax code. So pretty growthy. In the piece, Ponnuru offers a tax-policy reality check and some myth busting to those pushing really deep cuts to top personal rates:
Some supply-siders argue that Lee-Rubio should have proposed bringing the top tax rate still lower, which would do more to improve incentives to work, save, and invest, and thus encourage growth. The Wall Street Journal prefers Christie’s top rate of 28. But this lower rate would not be likely to have a large economic effect. First, we should expect diminishing returns. When Reagan cut the top rate from 70 to 50, the after-tax return on a dollar earned rose 67 percent. Cutting the top rate from 35 to 28 would raise it only 11 percent.Second, Republicans have repeatedly overestimated the growth effects of income-tax rates – predicting a bust when Clinton raised taxes and a boom when George W. Bush lowered them. Neither occurred, and in fact growth rates were better under the higher Clinton income-tax rates than under the lower Bush ones. Any positive effect of lower tax rates on growth are small enough that other factors can overwhelm them.Third, it’s not clear that getting the rate on high earners so far down is politically realistic. A tax package that combined some reduction in the top rate with tax cuts that directly benefited the middle class would almost certainly stand a better chance of enactment. That is, after all, how such tax-rate reductions have been achieved before.
Not that Lee-Rubio is perfect by any means. But it is trying to address the right issues: How to boost growth, and how to make sure the fruits of that growth are broadly experienced in the modern American economy. I would be fine with just dropping the top personal rate a point or two (if only to signal opposition to letting rates drift ever higher), reducing rather than eliminating capital gains taxes, doing deep corporate reform, expansions to the child tax and earned income tax credit to boost working class and lower-income paychecks … and then all the other things — education, regulation, entitlements, public investment, immigration — necessary for a diversified, total-return, economic growth portfolio. I guess I would like more boldness on that other stuff, and a bit less on taxes. And no red ink.
The U.S. is still regarded as the top economic power, even more so than last year, but most people around the world continue to believe that China either will eventually replace or already has replaced the U.S. as the world’s leading superpower. A median of half across the countries surveyed say that the U.S. is the world’s leading economic power, while only 27% say that of China. While a median of only 14% say China has already replaced the U.S. as the top superpower, majorities or pluralities in 27 of 40 countries say China will eventually become or has already replaced the U.S. as the top superpower.
The economic dynamism generated by democratic capitalism is a key element of the American Project’s persuasive power. But there are other models, such as China’s state-directed capitalism conjoined with an authoritarian state. Years of very fast Chinese growth and relative US stagnation have made China look like the strong horse to many — especially those not-so-interested in democracy. “I have seen the future, and it’s capitalism with Chinese characteristics!” The Beijing Consensus. As the Economist put it back in 2011:
Too many people—not just third-world dictators but Western business tycoons—have fallen for the Beijing consensus, the idea that state-directed capitalism and tight political control are the elixir of growth. In fact China has surged forward mainly where the state has stood back. “Capitalism with Chinese characteristics” works because of the capitalism, not the characteristics.
But now China is slowing, perhaps sharply. And while the US path to dynamism means rediscovering and returning to its strengths, China must do what it has never done before. AEI’s Derek Scissors on the challenge:
In 1978, China began to grant limited private property rights and to permit limited competition. These steps helped create an economic miracle, among other things lifting 850 million people out of poverty over a generation. But for more than a decade now, the Communist Party has chosen not to move forward on private property rights and competition, instead emphasizing an unprecedented amount of state-directed spending. The result is a severely damaged environment, an unbalanced economy, and a painful debt burden.
This is not hindsight. The stagnation path was visible six years ago, when China choose to massively expand credit in response to the financial crisis. Weaknesses in the economy can be traced back to policies initiated six years before that, in 2003. Because the fault lines have been developing for some time, they will require years of difficult reform to address. The current government has pledged such reform but largely lacked the nerve to initiate it, much less sustain it. The single most likely result is that China will share the fate of many other economies and fall far short of being wealthy.
So the good news about “bamboo capitalism” is that if it does transform China into a dynamic, innovative economy with a high degree of competitive intensity, it means China itself has probably adopted a lot more of the economic freedoms that American prosperity is built upon. We’ll see what those surveys say five or 10 years from now.
Glenn Hubbard and Kevin Warsh outline how the US economy might reach that 4% GDP growth goal Jeb Bush has been talking about (via the WSJ):
The average growth rate was 4% or higher 17 times in the rolling four-year periods since 1950. It can reach that goal again. But it won’t be easy, and it will require a fundamental change in the conduct of economic policy. …
Short-term policies such as temporary tax and spending changes that have characterized the recent years should be set aside in favor of longer-term tax reform and removal of other barriers to economic growth. This means policies that bring more people into the workforce. It means encouraging real capital investment to drive higher levels of productivity growth. It means resetting long-run expectations of potential for every individual, household and business. It means making the United States the best place in the world in which to invest and work.
Examples? Fundamental tax reform that is directed at increasing the incentives for work and driving investment in productive assets. Real regulatory reform that firmly and consistently recognizes, measures and balances economic benefits and costs—and no longer protects incumbent firms from disruptive new competitors. Tax and regulatory reform can make the United States the preferred destination for work and investment.
Trade policies must continue to break down non-tariff barriers to open global markets. Education policy must be geared toward empowering schools to put students and the skills they need above entrenched interests. And support for training can foster investment in skills over time. When the right policy choices are made, monetary policy could get out of the business of trying to bail out the economy from the failings of other macroeconomic policies.
As Hubbard and Warsh say, it won’t be easy. ( I discussed this in my recent The Week column.) And, again, this McKinsey chart suggests the scope of the challenge:
By the way, Jon Hartley has an interesting take on the 4% growth goal over at Forbes.
View related content: Pethokoukis
For your edification:
It’s Not About Uber: Beyond the W-2 vs. 1099 Debate – Marina Gorbis and Devin Fidler | “The danger is that we will use old classifications, like W-2 and 1099, to solve problems that are unique to this new work landscape, laying groundwork for polarization and years-long legal battles.”
A fearless culture fuels U.S. tech giants – James Stewart |
European countries have tried to replicate the critical mass of a Silicon Valley with technology centers like Oxford Science Park in Britain, “Silicon Allee” in Berlin and Isar Valley in Munich, and “Silicon Docks” in Dublin. “They all want a Silicon Valley,” Jacob Kirkegaard, a Danish economist and senior fellow at the Peterson Institute for International Economics, told me this week. “But none of them can match the scale and focus on the new and truly innovative technologies you have in the United States. Europe and the rest of the world are playing catch-up, to the great frustration of policy makers there.” Petra Moser, assistant professor of economics at Stanford and its Europe Center, who was born in Germany, agreed that “Europeans are worried.” “They’re trying to recreate Silicon Valley in places like Munich, so far with little success,” she said. “The institutional and cultural differences are still too great.”
Why some student debt may be a good thing – Josh Mitchell | “The paper, released Thursday by the centrist Democratic think tank Third Way, uses previous research to show that college students with some amount of education debt are more likely to graduate than those with less or no debt–up to a point.For those who began college in the early 2000s, the subjects of this study, $10,000 was the magic number. Graduation rates improved along with debt up to that level, then decreased as debt increased beyond $10,000. The pattern occurred for students from both poor and wealthy households.”
Seen That Job Listing for a While? It’s No Coincidence – Josh Zumbrun | “Across the economy, the time it takes to fill jobs is lengthening, according to two new pieces of research. Blame it on the raft of interviews, tests and screenings that job candidates must go through.”
Robot impact on productivity – Randall Parker |
Check out this table of employment by sector in the US economy. 5 different sectors each employ more people than manufacturing does. Consider the prospects for automation in each of these sectors. For example, the retail trade has about 15 million worker, wholesale has about 5 million, and transportation and warehousing has about 5 million. Well, picture self-driving trucks, self-driving local delivery vehicles, totally automated warehouses, and easy online ordering. The need for store employees, vehicle operators, and warehouse and wholesale employees will drop dramatically from robots and IT systems. Goods will move from factories to end purchasers with little human involvement. I expect IT systems will continue to automate a lot of financial work including investment management. Index funds beat active managers. Robo-advisors for money management will probably make it easier to manage your money. Betterment, WealthFront, Charles Schwab, and Vanguard are among those offering automated investment advising.
View related content: Pethokoukis
The Wall Street Journal editorial page offers a lengthy criticism of Senator Marco Rubio’s tax plan — “Rubio’s Tax Mistake” — first coauthored with Senator Mike Lee. To be more precise, it’s a lengthy criticism of Rubio’s proposed expansion of the child tax credit. Why does the WSJ hate that credit so much? It argues a bigger child credit (a) does nothing for economic growth and is thus (b) a waste of money that could be better spent on lowering the top personal income tax rate below the 35% rate in the Rubio plan.
A few thoughts: First, to the extent that higher take-home pay would allow families to invest more in their own kids and reduce family instability and stress, the tax credit does have a pro-growth aspect. Human capital counts, too, and this would be a human capital gains tax cut for the folks creating and raising the next generation of workers. Now the WSJ might counter that a better solution for a struggling middle class would be to supercharge GDP growth by deeply cutting the top rate. Yet note that Rand Paul’s new flat-tax plan with its low, low, low 14.5% top rate would only increase growth by about 1 percentage point a year for the next decade, according to the Tax Foundation. We are talking about a Three Percent (ish) Economy not a Five Percent Economy, if you buy the group’s optimistic modeling assumptions. (Indeed, the same Tax Foundation modeling shows a significantly bigger growth impact from the Rubio plan thanks to its sweeping, supply-side investment and corporate tax reform.)
Second, the WSJ fails to consider the possibility that right now a “rising tide” might not not so easily lift all boats in a US economy where globalization and automation are buffeting the middle class. Faster growth is necessary, of course, but may not currently be sufficient for broadly experienced prosperity. What’s more, smart supply-side reforms may take some time to raise US growth potential. (That sure seemed to be the case with the Reagan tax cuts.) For instance: The WSJ points out how the economy flagged after the slow-motion tax cuts of George W. Bush, which also included a larger child tax credit. It was “only when Mr. Bush pushed in 2003 to accelerate the rate reductions and slashed the capital gains rate to 15% from 20% did the economy take off and save his re-election.”
Interestingly, then, that productivity growth was markedly slower in the four years after the capital gains tax cut than in the four years previous, 3.5% annually vs. 1.9%, with so-so average GDP growth of 2.9%. Anyway, allowing families to keep more of what they make — via the child tax credit — or supplementing their wages through the earned income tax credit are good income-support ideas as we hopefully engage in deep structural supply-side reform from taxes to regulation to education. (Although the “average is over” scenario should be kept in mind.)
Third, the WSJ says Rubio “let himself be swayed by a coterie of non-economist conservatives who view the tax code as an engine of social policy” and “denigrate marginal-rate cuts as politically déclassé … .” This is a strange criticism when some of the key folks driving the traditional supply-side movement have not been PhD economists, including former WSJers Steve Moore and the late Jude Wanniski (whose supply-side classic, “The Way the World Works,” is currently sitting on my bookshelf). And I think supporting American families is pretty darn good economic policy. (And a political point from Ryan Ellis: ” All successful Republican tax bills are a mixture of pro-growth and pro-family.”) Lee put it well during a 2013 speech at AEI:
For family is not just one of the major institutions through which people pursue happiness. It is the one upon which all the others depend. More than that, in recent years, the family has emerged as perhaps the most important institution in our economy. The family is an incubator of economic opportunity, and an indicator of economic success. It is every individual’s primary source of human and social capital: habits and skills like empathy, self-discipline, trust, and cooperation that grow more economically important every day. The family is where we learn the skills to access and succeed in America’s market economy and civil society… and thereby create new opportunities for others to do the same. The primacy of family should inform conservative policies about everything from welfare to education to transportation to criminal justice. If there is any single group of people in the entire country whose equal opportunity to pursue happiness we should make sure to protect, it is our ultimate entrepreneurial and investor class: America’s moms and dads.
Now all that said, the Rubio plan is not perfect. But by acknowledging — through policy choices — some fundamental problems with the US economy, it gets some big, important things right. And a child tax credit expansion is one of those things.
A recent Economist issue highlighted the role of assortative marrying in the US inequality story. From its review of “Inequality: What Can Be Done” by Anthony Atkinson:
In America, for instance, incomes at the top of the scale began pulling away from the rest quite soon after 1945. Yet household inequality—taking account of taxes and transfers—did not rise until what Mr Atkinson calls the “Inequality Turn” around 1980. Several factors contributed to this, including changes for women and work. After the second world war, when female labour-force participation grew rapidly, high-earning men tended to marry low-earning women; the rising numbers of working women reduced household inequality. From the 1980s on, by contrast, men and women tended to marry those who earned like themselves—rich paired with rich; rising female participation in the workforce exacerbated inequality.
Bosses are now more likely to marry other executives rather than secretaries. The 2014 study “Marry Your Like: Assortative Mating and Income Inequality” found that if marriage matching today were the same as in 1960, income inequality would be less. A 2006 New York Times article explored reasons behind the trend:
For one thing, more couples are meeting in college and other educational settings, where prospective mates come prescreened by admissions committees as discerning as any yenta. … Secondly, men and women have become more alike in what they want from a marriage partner. This convergence is both cultural — co-ed gyms and bars have replaced single-sex sewing circles and Elks clubs — and economic. Just as women have long sought to marry a good breadwinner, men, too, now find earning potential sexy. “There are fewer Cinderella marriages these days,” says Stephanie Coontz, author of “Marriage, a History.” “Men are less interested in rescuing a woman from poverty. They want to find someone who will pull her weight.” … And finally, there’s what Schwartz calls the growing “social and economic distance” between the well educated and the less so, a gulf even ardent romantics may find difficult to bridge.
Additionally, the late Gary Becker looked at how assortative mating affects the correlation between incomes and SAT scores:
The combination of assortative mating with higher returns to IQ could have dramatic effects on relative mobility if the effect was to insulate to a significant degree a prosperous family’s children from economic risk. And it may be. The adults in high-IQ families are disproportionately represented in the jobs (professional, managerial, financial, and so forth) that pay well, and their income can and often is used to give their children a boost—for example in the form of payment of tuition to high-quality (and very expensive) private schools, payment to tutors, a variety of other educational enrichments, and entry into high-quality colleges without need for their children to borrow to finance college (or graduate or professional school) and thus assume debt.
Colleges like to admit kids from high-income families, seeing such kids as future donors. And high-IQ parents are likely to produce high-IQ children, further enhancing the children’s attractiveness to first-rate colleges. These factors, which loom larger the greater the inequality in the income distribution, because that inequality creates a highly affluent tier of families (a proximed by the income shares of the top 10 percent and within that group the top 1 percent) are likely to reduce relative mobility, by securing a disproportionate number of the top college and university admissions and top jobs for children of the intellectual-economic elite.
Can slow-growth Europe become a turnaround story? And by “turnaround story” I mean grow at GDP rates that Americans would see as signs of national decline. Say, 2 to 3% a year. McKinsey thinks so if the region gets much-better supply-side policy:
If Europe pushes forward on reform, it could sustain GDP growth that is well above current forecasts. The European Commission forecast 1.5 percent annual GDP growth to 2025 at the time of writing. By way of contrast, in a scenario in which all countries were to close the gap with the region’s top-quartile performers on productivity and mobilising the labour force, the growth rate could be 2.1 percent a year—or more if Europe adopts the kind of growth-enhancing reforms we discuss in this report.
The below chart show 11 keys areas which are ripe for reform:
Many of the McKinsey ideas require “more Europe” not less, meaning greater economic integration. Here are the suggestions for creating more entrepreneurship:
Europe is home to some of the most innovative countries and companies in the world but spends only 2 percent of GDP on research and development (R&D), just ahead of China, at 1.9 percent. In particular, Europe’s private-sector R&D spending—at just 1.3 percent of GDP—lags behind that of South Korea (2.7 percent), Japan (2.6 percent), the United States (1.8 percent), and other countries. Analysing company-level R&D spending, we find that Europe’s gap is concentrated solely in electronics, software, and Internet services.
One of the more tangible ways Europe can encourage innovation is by using government procurement. This approach has a successful track record. One example is the way procurement by the US Department of Defense spurred the development of semiconductors. European governments spend more than 5 percent of GDP on procurement, compared with only 0.7 percent on public R&D and 0.1 percent on subsidies for private-sector R&D.
Governments could also deepen the Single Market, set Europe-wide standards and regulations for transformational technologies such as autonomous vehicles and open data, unblock barriers to entrepreneurship, and accept “creative disruption”. Additionally, governments could support large-scale step-up of public co-financing of risk capital for new ventures, as France is attempting to do. This could help close the innovation gap with the United States, whose tech companies have dominated many of the coming disruptive technologies and explain the entire R&D spending gap between Europe and the United States.
Will those ideas really create a more dynamic startup culture? How do you get both society and government to “accept creative destruction”? Sounds like a tall order, especially if you are depending on top-down initiatives to counter deep cultural attitudes and norms. Tough to reproduce America’s deep magic. Just consider where Europe is starting from in terms of creating unicorns, or billion-dollar technology startups (via the FT):
According to the data compiled by GP Bullhound, the British investment bank, the region has produced about a three tech companies every year since 2000 that have either been sold, floated on the stock exchange or been valued by investors at $1bn or more. … The study shows the cumulative value of all European unicorns created since 2000 is around $120bn. By comparison, Facebook currently has a market capitalisation of $275bn, while Uber has achieved a valuation of $40bn from investors while remaining a private company.
View related content: Pethokoukis
It’s difficult to have a “hot take” on Rand Paul’s cleverly named “Fair and Flat Tax” plan based on a Wall Street Journal op-ed. There are a lot of moving pieces here, as this excerpt shows:
In consultation with some of the top tax experts in the country, including the Heritage Foundation’s Stephen Moore, former presidential candidate Steve Forbes and Reagan economist Arthur Laffer, I devised a 21st-century tax code that would establish a 14.5% flat-rate tax applied equally to all personal income, including wages, salaries, dividends, capital gains, rents and interest. All deductions except for a mortgage and charities would be eliminated. The first $50,000 of income for a family of four would not be taxed. For low-income working families, the plan would retain the earned-income tax credit. I would also apply this uniform 14.5% business-activity tax on all companies—down from as high as nearly 40% for small businesses and 35% for corporations. This tax would be levied on revenues minus allowable expenses, such as the purchase of parts, computers and office equipment. All capital purchases would be immediately expensed, ending complicated depreciation schedules. … The plan also eliminates the payroll tax on workers and several federal taxes outright, including gift and estate taxes, telephone taxes, and all duties and tariffs. I call this “The Fair and Flat Tax.”
A few very preliminary thoughts (subject to change as more info arrives):
— This deviates from a classic Hall-Rabushka flat tax in that it is not a consumption tax on the personal side. It still double taxes investment income. Certainly merely returning to Bush II-levels of investment taxation is less politically risky than the zero option in this age of “middle class economics.” Indeed, his earlier 17% flat tax did eliminate investment taxes. Same thought about his taking families of four off the tax rolls.
— Paul says the plan loses $2 trillion, but I wonder if that doesn’t include dynamic scoring.
— I am dying to see the distributional tables on this, especially given the apparent elimination of the child tax credit and health exclusion. Indeed, this plan really needs to be viewed in the context of his entire economic agenda, including healthcare reform, entitlement reform, and blockgranting welfare programs. I am certainly dubious of any plan that sees steady declines in entitlement spending as a share of GDP, not just projected spending increases.
— To accept this plan, you also need to accept the Paul vision of severe government shrinkage as realistic. As I wrote a few months back:
Think about this: The number of Medicare beneficiaries will increase by 50%, or 25 million, over the next 15 years. The number of people age 65 or older will increase by about one-third over the next decade, according to CBO, and by 80% between now and 2039. What’s more, “aging is the key driver of spending over the long-term” for Social Security and Medicare. That’s just the mandatory spending. At the same time, nondefense discretionary spending is already at a historic low. Just keeping total federal spending at the levels seen over the past generation would seem a tough task. And at the same time you want to balanced the budget while also slashing tax revenue? Impressive.
I recently posted the policy agenda of a group of tech-oriented economists, execs, and venture capitalists who are worried that the economics benefits of the digital revolution are being too narrowly shared. But as the current Goldman Sachs-JPMorgan productivity debate shows, we need a better handle on what’s really happening to the US economy today to help prepare for tomorrow. So from the same tech group, here is a research agenda for the digital economy:
— Creating better measures for the digital economy and welfare, including supplements or replacements for metrics like GDP, productivity, unemployment, and inflation. We can’t manage what we don’t measure. Yet our current metrics miss much of the value of the digital economy.
— Identifying business models in which technology is a complement to – not a substitute for – labor and creating a taxonomy of their common characteristics.
— Analyzing changes in labor and capital demand by using new data sources like online job boards.
— Identifying what skills have the most job openings and which have the greatest excess supply of labor.
— Summarizing the key improvements in AI and related technologies and mapping their implications onto job and skill demand as they diffuse throughout the economy.
— Identifying the policies that could encourage diffusion of technology and best practices across companies and countries
— Understanding the effects and implications of a basic income or a guaranteed annual income. There have been a few experiments in the US and around the world with variants on this concept, but no systematic analyses of its effects.
— Understanding the incentives and costs associated with expanding the earned income tax credit and other types of wage subsidies.
— Forecasting when and in what order we should expect various jobs to become automated, and what new kinds of work may be needed. Based on those conclusions, we can shape education policy and workforce training efforts to enable people to excel at jobs that can best be done by humans.
— Using techniques from big data to develop new indexes for innovation and welfare.
— Creating better methods for accurately measuring the health of an economy – by developing large scale surveys and experiments (e.g. conjoint analysis) to measure what people really want and value.
— Understanding the relative importance and roles of technology, globalization, tax policy, the minimum wage, labor organizing and other factors in the recent growth of inequality in the United States and other countries.
— Developing new principles for personal data that protect privacy while encouraging effective data use for developing new products, reducing costs, matching needs to resources, and increasing overall welfare.
— Understanding the macroeconomic implications of digital currencies and crypto-currencies, include those that are highly decentralized. Assess how increasingly intelligent agents will affect the efficiency and dynamics of financial markets.