What Kinds of Tax Cuts are Best?
With just two months until the November elections, the White House is seriously weighing a package of business tax breaks – potentially worth hundreds of billions of dollars – to spur hiring and combat Republican charges that Democratic tax policies hurt small businesses, according to people with knowledge of the deliberations.
Among the options under consideration are a temporary payroll-tax holiday and a permanent extension of the now-expired research-and-development tax credit, which rewards companies that conduct research into new technologies within the United States.
Milton Friedman expressed the view that all tax cuts are good tax cuts, and overall I agree: any tax reduction means more purchasing power in the hands of people and businesses, not government.
But some tax cuts are better than others.
If policy is focussed on short-run stimulus, tax cuts should create a strong incentive to shift spending from the future to the present. A standard example is a temporary investment tax credit. I am not a fan of setting tax policy based on short-run considerations, but among the stimulus options being discussed, this one is relatively sensible.
If policy is focussed on improving economic efficiency, tax cuts should:
1. be permanent rather than temporary (to reduce uncertainty)
2. be cuts in the highest marginal rates (since these are the most distorting)
3. be cuts in capital income taxes (since capital is more responsive to tax rates than labor).
From these perspectives, the temporary payroll-tax holiday is not especially appealing. It might shift new hires to the present, but at a cost of reduced hiring when the holiday expires. This future offset can also occur with a temporary investment tax credit, but the new capital is durable.
A permanent extension of the research and development tax credit is defensible: R&D is a kind of investment, and reduced taxation of investment makes sense. But I would prefer lower tax rates on investment across the board, so government is not encouraging some kinds of investments over others.
So, these proposals are better than nothing, but we can do much better.
Categories: My Blog
ElGreco
Tax cuts without spending cuts are simply tax cuts today, financed by tax increases sometime in the (now near) future.
happyjuggler0
ElGreco,
Don’t forget the possibility of less government spending in the future than there otherwise would have been….
Zariel
Didnt know the forum rules allowed such brlilanit posts.