In the run-up to the coming battle for the right to run against Barack Obama — which begins, effectively, the day after Election Day 2010 — it’s worthwhile to examine the economic policy proposals of the potential candidates. First up is Newt Gingrich, simply because (unlike many of the other potential candidates) he’s laid out his own policy prescriptions several times. Gingrich’s plans currently consist of:
- A 50% reduction in SS and Medicare tax for both worker and company for two years
- 100% expensing for small business investment
- Matching China’s capital gains tax (0%)
- Matching the Irish on corporate tax rates (12.5%)
- Abolishing the estate tax permanently
First things first: the payroll tax abatement is no good because it’s not permanent. If you’re going to do it, then you can’t sunset it after two years, otherwise you don’t change people’s behavior.
I’ll consider the payroll tax reduction in terms of the Obama view of it, which is that it should apply to every dollar of income, not the first $106K or whatever it is. (That change by itself means that SS can’t refer to it as “insurance” anymore, rather than the transfer program it is, but that seems to have slipped by everyone.) Gingrich is talking about a 7.5% or so reduction in the base-rate tax on income. By the back of my envelope, I compute an effect of a little more than $100 bn/year. Not very much.
What I’d prefer is a 100% abatement of ALL income and payroll taxes. This produces a stimulus of nearly 10% of GDP. You obviously can’t do that permanently. It would serve as a way to allow people to rebuild their personal balance sheets. Tax cuts are exactly like fiscal stimulus in that they put government money directly into the economy. I say that notwithstanding the standard objections because the Keynesian multiplier is phony in a balance-sheet recession like this; and also because fiscal stimulus programs have proven so hard for governments to do effectively.
That said, the problem with getting tax cuts enacted is that they remove a lot of the political control from the process. With stimulus spending, you can make a lot of well-connected people happy by funding their priorities. But tax cuts fund the priorities of ordinary people, so you can’t buy the benefits of corruption with it. Democrats won’t stand for this willingly.
And the problem with a broad tax cut like mine is that it gives proportionally more benefit to higher earners. The old “rich people don’t need a tax cut” problem. But as I showed above, the numbers don’t really work with any other approach. A small abatement in the payroll tax, especially a non-permanent one, just won’t do enough for aggregate demand to make a big dent in the employment picture.
Full expensing is okay as emergency measure. It distorts accounting reality a little too much for me to like it on a permanent basis. The cap gains tax rate should probably be about 5%, although I can accept zero. A corporate tax rate of 12.5% would be heaven-sent, but only if combined with continued preferential treatment for personal dividends.
The estate tax is an instrument of social rather than economic policy, and it’s exceedingly detrimental to the sustainment of a wealth-building society. I’m in favor of abolishing it, but not because this would fix the employment problem. It won’t.
Where’s my most important tax reform? I want a zero tax rate on all retained earnings for companies up to a certain size, say $100mn/year in revenue, although that would have to be adjusted by industry sector and company type. I also want a zero capgains rate on realized value for start-up companies up to a certain size, but you’d get that with the zero capgains rate you already have.
As I’ve been saying for several days now, the biggest problem we may be facing in terms of aggregate demand is the sudden lack of normal investment returns due to the ZIRP. If we try to address this with a sudden jump to a 2 or 2.5% policy interest rate, we could couple it with your radical tax-reform proposals in order to prevent a sudden deep recession. But you’d need a full income/payroll tax abatement for a couple of years to make it fly. Half of the payroll tax isn’t nearly enough.
And it has to be recognized that a lot of the economic disorder now isn’t mechanical but psychological. Obama keeps saying that our problem is being protracted because it took eight years of Bush to create the problem in the first place. Does he mean it’ll take him eight years to fix it? This is obviously silly because other countries have already returned to strong growth while we continue to stagnate.
The people are adjusting to a radically different set of expectations, including the prospect of permanently lower investment returns. We’re doing what economies do naturally in such circumstances: come very slowly back to some kind of normal. By creating huge uncertainty, Obama himself is protracting the weakness, so his analysis that Bush is to blame couldn’t be more wrong. People will need stable conditions for a long time (possibly years) before they start investing again. Expectations matter in macro policy.
And of course, we’ve overlooked the huge pile of gorilla poop in the center of the room: the structural deficits due to healthcare spending over the next 20-30 years. A proper growth strategy would address this problem. With extensions as I’ve described, you have the beginnings of a growth strategy, so that’s hopeful.
