Whatever the outcome in November, our new president will be saddled with a tremendous economic mess.
The United States is drowning in debt, some $19.3 trillion right now. Entitlement spending is about to explode, including the costs of Obamacare that were conveniently delayed until its chief author left office. The cost of servicing what will soon be a $20 trillion federal deficit is heading higher and consuming a larger percentage of government spending. The United States' fiscal situation is on an unsustainable trajectory.
The situation, however, is not hopeless. There are steps a new president can take to improve the situation.
But there's one thing he – or she – absolutely must deal with right away.
Right now, only a massive reprogramming will place the U.S. economy on a sufficiently productive path to pay its current and future obligations. Some may view the following proposals as extreme, but they are absolutely necessary. Whether they are feasible depends on whether we can summon the political and moral courage to enact them.
Taxes Are Killing Us, We Need to Cut Them
The tax code is the DNA of the economy. It establishes incentives for different types of economic behavior. Unfortunately, the U.S. tax code has been hijacked by Wall Street, Big Business, Big Oil, and other "Big" special interests.
The result is a system that favors debt over equity and speculative over productive investment.
In some cases, such as the totally unjustified tax breaks given to hedge fund and private-equity managers, the wealthiest Americans are allowed to pay significantly lower tax rates on their income than lower-earning Americans.
Until these flaws in the economy's DNA are fixed, the United States will keep growing more indebted, less productive, and less competitive.
The first step is to broaden the tax base and promote tax fairness. A common misconception is that the way to promote "fairness" is to raise taxes: That type of thinking is the product of minds that understand little of economics and less about human nature.
Lower tax rates benefit everyone but particularly those who aspire to the top of the economic pyramid. Higher tax rates discourage economic activity and encourage people to avoid taxes.
The government is an inefficient allocator of capital. Higher tax rates reduce the return on capital, create disincentives for investment, and reduce the amount of capital available for investment in productive activities such as technology, education, building new factories and capital goods, and research and development.
They also reduce the capital available to invest in raising labor productivity to enhance economic growth and income gains. In short, they trap the nation in an economic death spiral.
Leaving more income in the hands of the private sector, on the other hand, is the surest pathway toward economic revival (which we certainly need right now).
My solution is simple:
- Drastically lower all income tax rates. Individual tax rates (including payroll taxes) should be lowered to 10% on all incomes below $100,000 per year, 20% on all income below $1,000,000 per year, and 25% per year for all income above $1,000,000.
- Get rid of tax deductions. Ordinary income tax rates should be lowered and all individual deductions (with two exceptions) reduced or eliminated. The only tax deductions that should be kept in place are the charitable deduction, which should be capped at 20% of income annually, and retirement plan contribution deductions for taxpayers with income below $500,000 per year. Taxpayers with higher incomes should be permitted to contribute to these plans, but their deductions should be capped. Businesses should continue to be able to deduct their ordinary and necessary business expenses from their income to determine taxable income.
- Stop "rewarding" people for borrowing money. One of the biggest flaws in the tax code is that it creates enormous incentives to borrow money. This makes the U.S. government – which means the U.S. taxpayer – a partner in every single debt transaction in the economy. Every time someone borrows money, he or she is subsidized by his fellow citizens. Is it any wonder that debt never stops growing? An essential step that must be taken to fix the tax code and strengthen the economy is ending the interest deduction for all debt – and that includes the hallowed home mortgage deduction. Once we start treating equity and debt equally, the foundation of the American economy will strengthen as equity replaces debt in individual and corporate capital structures. An appropriate period to phase-in this change (i.e., five years) should be provided, but we must bite the bullet and recapitalize our economy with equity.
- Stop killing businesses with obscene corporate tax rates. The U.S. corporate tax rate of 35% is among the highest in the world; it should be cut in half to 17.5% and applied to net income after all reasonable and necessary business expenses. Special tax breaks should be eliminated except where they relate to scientific or medical research. High U.S. corporate tax rates are placing American corporations at a serious competitive disadvantage because they make the United States an undesirable location for corporate headquarters and investment. Rather than criticize U.S. companies for taking advantage of perfectly legal strategies to reduce their tax burdens, Congress should lower these tax burdens and make it more attractive for U.S. companies to remain domiciled and invested in their own country. Corporations respond to incentives, and the U.S. tax code currently incentivizes them to get out of town.
Like monetary policy, tax policy suffers from the flawed belief that economic actors do not respond to incentives. Tax policy loses the forest for the trees; it focuses on tax rates rather than overall tax revenue. Each time tax rates were lowered, tax revenue increased because economic growth increased.
It is common sense that taxpayers will spend less time avoiding taxes if they are required to pay lower rates and if they believe the system is taxing them fairly. If overall corporate tax rates were lower, more revenue would remain in the United States, and more taxes would be paid here which, after all, is the point of the tax code in the first place.
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About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.