Tax Reform for Both Capital and Labor

Growth is the problem. Or more precisely, slow growth is the problem. It’s the reason so many public policy questions in the United States now seem impossible to resolve. And it is the reason about 65 percent of voters believe the country is on the wrong track, according to an averaging of recent public polls by RealClearPolitics.

The public is right to be concerned. The government announced today that GDP growth was 4.6 percent in the second quarter of this year. Normally, that would be a good number. But it comes on the heels of a 2.1 percent decline in GDP in the first quarter. The combined growth for the first half of the year was therefore just 1.25 percent.

Marco Rubio, Mike Lee

Sens. Rubio (left) and Lee put forward a tax proposal this week that would significantly benefit working families.

The extremely slow pace of economic growth in the first part of this year fits with the trend since the nation emerged from the deep recession associated with the financial crash. Average GDP growth from 2010 through 2013 was just 2.2 percent.

So restoring a faster pace of economic growth must be the nation’s top priority. Without more growth, every other problem is likely to get worse, not better, no matter how much effort is put into solving them. Among other things, it will be very difficult for the U.S. to assert itself in world affairs over the long-run with an anemic domestic economy. And it is lower income households, not the rich, who will suffer the most if the country remains stuck in slow growth indefinitely.

Many analysts are making the case that a fundamental impediment to faster growth is the dysfunctional U.S. tax code as it applies to both individuals and corporations. Some policymakers agree. Recently, Senators Mike Lee and Marco Rubio laid out a blueprint for fundamental restructuring of both the individual and corporate income tax systems.

The Lee-Rubio plan is focused correctly on creating a simpler, less distortionary tax law. The tax base would be broadened by closing loopholes and limiting deductions. This would allow for a substantial lowering of rates. For individuals, they propose folding today’s multiple tax brackets into just two: 35 percent for higher income households, and 15 percent for everyone else. The corporate income tax rate would be lowered from today’s 35 percent to very likely a level in the range of 20 to 30 percent.

“Investment capital is critical to improving productivity…but the U.S. needs a growing, educated, and dynamic workforce too.”

Importantly, the Lee-Rubio plan also provides a large tax cut for families raising children. They would provide an additional $2,500 per child on top of today’s child credit of $1,000. Consequently, their plan would provide substantial tax relief to working families with children – far more than traditional tax reform plans that focus entirely on lowering income tax rates.

Some critics, such as Dan Mitchell of the Cato Institute, believe the focus on supporting middle class families with children is mistaken. He urges lowering the top rate below 35 percent instead, arguing that such a plan would produce faster economic growth, and thus help middle class families even more than an expanded child tax credit.

But it is important to realize that strong economic growth is not just about unlocking more investment capital to grow businesses. It is also a function of an expanding and more productive labor force. Indeed, economic growth is really just the sum of change in the size of the workforce plus the change in the workforce’s productive capacity.

Investment capital is critical to improving productivity, and reducing the top marginal tax rate would spur more investment because investors would keep more of the returns.

But the U.S. needs a growing, educated, and dynamic workforce too. The Lee-Rubio tax credit expansion would give families more resources to invest in what will become the future workforce of the American economy.

An expansion of the child credit isn’t the only option for a pro-family tax cut. Another approach would be to lower directly the payroll tax rate paid by workers on their wages. After all, the payroll takes a bite out of every worker’s paycheck. Reducing it would encourage some businesses to hire more workers, and some workers to devote more hours per week to their jobs.

The particulars of a sound tax reform plan should continue to be debated over the coming months. What should not be in dispute, however, is the need for a pro-growth reform plan that is attentive both to those making investments in American businesses and to those who work for them.