Secretary Geithner wages class warfare at the expense of collective well-being

Douglas Holtz-Eakin Former Director, CBO
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Secretary Geithner is evidently reflecting the left’s desire to wage class warfare at the expense of everyone’s well-being.  It is time for him to recognize that the U.S. has a growth problem.  The U.S. economy is growing, albeit slowly, not declining. GDP has been rising since the third quarter of 2009, and employment is up from its trough in December 2009, NFIB’s small business confidence index is up, consumer confidence is up, and the ISM manufacturing and non-manufacturing indices are above 50, signaling growth. There is substantial and widespread evidence of an ongoing economic expansion.  It is time to put aside the mistake intellectual framework of Keynesian counter-cyclical fiscal fine-tuning known as “stimulus.”

A pro-growth strategy is not complicated: low, efficient regulation; adherence to opening markets to competition at home and abroad; protection of the rewards to innovation and risk-taking and a streamlined, competitive tax code.  In choosing pieces of the agenda, it is especially important to recognize that at this juncture the balance sheets of both households and governments are severely impaired.  Instead, the real payoff to growth strategies will be supporting the ability of the business community to spend in the U.S. and sell abroad.

From this perspective Secretary Geithner’s blind worship of the sunset of the 2001 and 2003 tax laws is especially perplexing.  Those tax laws are a central aspect of business taxation. The Joint Committee on Taxation projects that $1 trillion in business income will be reported on individual income tax returns in 2011.  Notably, of that $1 trillion, nearly one-half, $470 billion, will be reported on returns that will be subject to the top two rates of 36 percent and 39.6 percent if EGTRRA and JGTRRA are allowed to sunset.

According to Gallup survey data conducted for the National Federation of Independent Business (NFIB), half of the small business owners in this group fall into the potential 36 percent and 39.6 percent tax brackets.  This means there is a pool of more than 20 million workers in those firms directly targeted by the higher marginal tax rates. This is likely a conservative estimate as it ignores flow-through entities with one to 19 workers.

Eliminating the tax uncertainty regarding their future would be an important step in the right direction. It has been widely noted that uncertainty over the policy environment itself may contribute to a desire by businesses to hoard cash instead of spending.  A temporary extension of the tax laws will merely defer resolving the uncertainty over the tax policy outlook.  In the other direction, a permanent extension would set expectations, permit long-range business planning, and support long-term economic growth.  Notice that at the same time, there would be immediate economic benefits as businesses step up their spending to match the improved long-run outlook.

In thinking about permanent extensions it is useful to recognize that not all the components are equal from a growth perspective.   Innovation, investment, and saving decisions are directly affected by structure of marginal tax rates, the taxation of returns to equity investment in the form of dividends and capital gains, and provisions for capital cost recovery (e.g., Section 179 expensing).  In contrast, provisions for refundable tax credits, marriage penalty relief, and other targeted incentives make no contribution to growth incentives.

Lastly, many believe that a deep structural reform of the tax code is essential to generate maximum feasible growth.  Any such reform would be built on low marginal rates, investment and innovation incentives, and a broad base.  A temporary extension that simultaneously raises marginal rates, diminishes investment incentives, preserves a narrow base, and perpetuates uncertainty is a step in the wrong direction from every perspective.

The reality is that the U.S. economy is growing, but too slowly for meet the needs of the unemployed, build the capacity to shoulder the burdens the debt explosion places on it, and meet our obligations to the next generation.  Every policy should be focused on growth, not sugar-high “stimulus” fixes.  For tax policy, this is simple.  Near-term tax policy should be relentlessly pro-growth, enhancing the strength of the business community, assisting households repair damaged balance sheets, and consistent with a path to tax reform.   Secretary Geithner is pushing an agenda at odds with both objectives.

Douglas Holtz-Eakin is president of the American Action Forum.