The federal spending component of this quagmire of course must be addressed, particularly when one considers that the "debt held by the public," at the end of fiscal 2012 came to $11.27 trillion, or 72.5 percent of GDP — higher than at any time since the end of debt-financed World War II. Just 10 years ago, it was 33.6 percent of GDP.
When it comes to the tax component during this lame duck session, however, lawmakers should punt and extend the Bush era tax cuts – the current marginal income tax rates, current taxes on capital gains and dividends and the estate tax as it is today -- for at least one more year to provide breathing room and an on ramp for a real debate on tax reform in 2013. This is the right thing to do to bring reassurance to the employers, investors and markets that will help revive our economy.
Beyond restoring our fiscal balance, we need economic growth and we need favorable tax policy to stimulate that growth. In many ways, tax policy is the tail wagging the economic dog. It is time to have a serious discussion about broad tax reform as we did in 1978 and 1986. It’s time to look not only at tax rates but what we are taxing in the first place. A reduction in marginal rates can help stimulate economic growth but those lower rates should not be paid for with higher taxes on savings and investment in exchange.
Lawmakers must understand that not all tax cuts are alike. Take capital gains, which have long been demonized as a break for the “wealthy one-percenters.” In reality, low or zero capital gains taxes have positive micro and macro economic impact. They are the seed corn for new start-ups, high tech and mom-and-pop small businesses and they have an impact on the macro-economy by reducing the cost of capital for investment. Reducing or eliminating the capital gains tax is a foot in the door for more fundamental tax reform, which most economists, recent presidential commissions and the experience of the rest of the world suggest that the U.S. needs. We need to shift from harshly taxing saving and investment to taxing consumption. Under such a system, there would be no need for lower capital gains taxes; like all saving and investment, they would be exempt from taxation. We would have a larger economy and more wealth.
An econometric study by the highly respected economist Dr. Allen Sinai concludes that raising the U.S. top individual capital gains rate from the current 15 percent rate to 20 percent, as suggested in several deficit reduction plans, would cut annual economic growth by an average of .05 percent per year and job growth would decline throughout the economy by an average of 231,000 from 2011-2016. Conversely, Sinai notes that eliminating the capital gains tax increases GDP by a little over 0.23 percentage points per year. Jobs increase by an average of 1,322,000 per annum while the unemployment rate drops 0.7 percent at its lowest point. This is real food for thought for President Obama and lawmakers.
If we are to restore long-term prosperity, we need to end the war on savings and investment — namely, the draconian taxes on capital gains, dividends and the generational wealth built from estates.
Lawmakers will be looking for ways to pay for any extensions on marginal tax rates. Instead of trading those reductions with higher taxes on the hard earned income, retirement security and the risk taking that fuel innovation and growth, they should consider a consumption tax.
Such an idea may seem politically ambitious, but any provision that restores confidence and risk taking, creates jobs and promotes long-term economic growth should be “on the playing field” in the next congress.
Bloomfield is president and CEO of the American Council for Capital Formation.