Why Tax Reform Is Better than Tax Cuts - Context

I think everyone across the political spectrum can agree that there are inefficiencies in our tax code—and that in some ways it creates warped incentives and leads to imbalances or potential imbalances in the economy. So a thoroughgoing tax reform would be positive, but it’s extremely difficult to do politically.

When we look at the forward outlook for tax policy, I want to differentiate very clearly between tax reform and tax cuts. Tax reform, to me, means something that is revenue neutral from a government perspective. You reduce taxes in one place, but you close loopholes in another, and the net effect is that the government receives the same amount of revenue.

That would be unabashedly good for growth and for the economy because it would increase the efficiency of the tax code. Every loophole creates an incentive somewhere in the system that may or may not be economically ideal, and reducing those and leaving the government financial balance in the same place would be a very good thing.

It’s very hard to do politically, of course. We haven’t had a thorough revamp of the tax code since the 1980s because every loophole has behind it a constituency and it’s difficult to negotiate among those different groups to come up with something comprehensive. It really does have to be comprehensive.

Tax cuts are easier because they don’t have to be comprehensive. You can just simply cut taxes, and, of course, that’s almost uniformly popular. Unfortunately, the history of it is that they don’t spark a whole lot of growth in economic terms, and especially not if those tax cuts tend to go to groups that already have significant cash or significant abilities to spend. Wealthier households are a good example. If you cut taxes on wealthier households, they’re more likely to save it than to spend it.

And to an extent the same is true of the corporate sector. There’s a lot of talk about cutting the corporate tax rate, but corporations are already cash rich in many cases. They have the ability to invest and have chosen not to. So I’m skeptical that giving them a tax break, by itself, would encourage them to invest in a way that they haven’t before.

The net effect, then, of a tax cut, I think, is that you don’t get a lot of growth, but you do get a larger government budget deficit and higher debt load. And those things can lead to tighter financial conditions through higher interest rates, both from the Fed and further out the curve, that might offset the growth impact.

So from an economic perspective, I would say that a tax reform package would be a very good idea; a tax cut idea doesn’t strike me as a particularly favorable outcome.