The post-election wrangle over extending the Bush tax cuts will take place in the worst possible environment for making good policy: A lame-duck Congress facing an artificial deadline to deal with a highly contentious issue after a nasty election. Even from a substantive policy perspective alone, the debate is a bad one, because there’s no consensus among reputable economists about the impact of lower marginal tax rates—the empirical literature is murky, at best.
The fundamental problem underlying this debate is that the U.S. tax code is an outdated and overgrown morass of bad policy. Our current tax system was designed for a primarily domestic economy. But now we live in a world where the unit of economic value creation is now the supply chain, which crosses multiple national borders and cannot be easily divided into domestic and foreign components. And the whole tax system is increasingly perceived as unfair and complicated, with more and more preferences and loopholes added in. What we really need is a sweeping tax reform aimed at promoting growth and innovation, designed for today’s supply-chain economy and simplified for the benefit of all taxpayers. But we’re not going to get this in the 2010 lame-duck session.
So how can we think about the upcoming tax debate in constructive terms that focus on fostering the kind of meaningful growth and innovation that lead to good jobs and long-term prosperity? We can start by identifying broad principles of what our tax system should look like in order to encourage growth, innovation and jobs, and attempt to apply those principles to the choices Congress must make about extending the Bush tax cuts. In doing so, we can hopefully encourage Congress to take steps that will move us closer to the kind of tax system we need, rather than farther away.
One such principle is the idea that the rates on income from capital investment should be kept low, because it is an important element of the kind of broader tax system we need: one that attracts and encourages capital investment, rather than reducing investment options by raising the cost of capital.