With a Weak Economy, We Need Smarter Policies

The old tricks aren’t working any more. The government’s tools for a weak economy have been to lower interest rates, borrow and spend, or have a war. Now, interest rates are so low that you can’t earn enough on your savings to keep up with inflation, the government owes $31,666 for every man, woman and child in America, and we have two of the longest running wars in U.S. history. We need something new, something smarter.

Here’s a radical suggestion. Let’s stop collecting taxes in foolish ways. All we need are two simple changes to our existing system.

Start with capital gains and dividends. Right now, people who earn more money in a year than you could dream of making in your lifetime pay only a 15% tax on most of that income, which is less than the Social Security and Medicare taxes that any middle class wage earner pays on their income. With patience and good planning, they pay no tax at all on their gains. Why do we have such a strange system? Economists will cite two reasons.

First, if we tax these earnings from wealth as heavily as we tax earnings from work, then the wealthy will tend to spend more of their money instead of investing it. But the government just went deeper into debt sending out billions of dollars in checks to try (not very successfully) to get people to spend money. So why are we bribing the wealthy to NOT spend money?

Second, because people can avoid having taxable gains by simply not selling their stock, having a normal tax rate on gains will tend to keep investment dollars from flowing to the best investments, which is bad for the economy. But what if instead we got corporations to pay out all of their earnings as dividends and then have to ask people to reinvest the cash? That would be a much more effective way to make money flow where it should.

Now consider corporate tax. Under our system, if a U.S. corporation earns $1.00 in Switzerland and keeps the cash out of the U.S., it keeps $1.00. If it earns the same $1.00 in the U.S., it must give $0.35 to the tax man. So where do you suppose companies will put their most valuable activities? Worse, this is an addiction. Again, if the company brings the cash home it pays tax, so it reinvests anyplace but here. Reinvesting that cash at a 4% return abroad is as good as getting a 9.5% return after bringing it home. That kind of incentive is what has been killing U.S. jobs and keeping down U.S. wages. There is less demand for U.S. workers because this is a bad place to invest, so employees can’t demand as much pay.

What is the simple solution? Give corporations a deduction for paying dividends, and make up the lost tax revenue by getting rid of the capital gain benefits on the individual side and raising taxes a bit on people earning over $500,000 a year. On average, the over $500,000 group would still pay total federal and state income tax of only 37.6%. Cash would flow and jobs would grow. Wouldn’t that be smarter?

Matt Lykken is an international tax attorney and the Director of SharedEconomicGrowth.org.
Biographical information at http://www.sharedeconomicgrowth.org/home/aboutus.html [1]