Congress Would Hate to Lose Its Tax-Code Toys

It isn’t working. Or it didn’t work. At least it hasn’t worked yet. Why not try something different?

“It” refers to traditional countercyclical monetary and fiscal policies that are used, as the name suggests, to counteract the effects of recession and subpar growth. For the Federal Reserve, this means stimulating aggregate demand, which generally entails lowering the benchmark overnight rate and increasing the money supply through outright securities purchases; or, in the current environment, using unconventional tools -- carrot, stick and sledgehammer -- to drive down longer- term interest rates.

On the fiscal front, the federal government stimulates aggregate demand, according to Keynesian theory, by borrowing and spending the money on things like infrastructure projects and transfer payments to the states and the unemployed. The government also influences aggregate supply by lowering marginal and capital-gains tax rates. If you tax something less, you get more of it.

So here we are, three years and trillions of dollars later, with an economy growing at 2 percent and an unemployment rate exceeding 8 percent for 40 consecutive months. The interest rates on Treasury securities are at or near historic lows. Ditto mortgage rates. The $831 billion fiscal stimulus in 2009 was either too small, poorly designed or ineffective: Take your pick. The Federal Reserve’s quantitative easings and curve- twisting operations? Bank credit is growing, albeit slowly -- 5.7 percent in the past year -- but lenders are still sitting on about $1.5 trillion of excess reserves.

Photographer: Rick Friedman/Bloomberg

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Photographer: Rick Friedman/Bloomberg

Something Different

Maybe it’s time for something completely different. How about using structural solutions to address what is touted to be cyclical weakness in the economy? And if the elevated unemployment rate turns out to be structural, a result of a skills mismatch between employers and job applicants, so much the better.

We hear all the time that businesses suffer from uncertainty: uncertainty over future tax rates (see: fiscal cliff), and uncertainty over the added costs of Obamacare.

If that diagnosis is correct, then why not give them the kinds of long-run policy initiatives that will soothe their tortured psyches, arouse their animal spirits and instill the confidence needed to invest for the future? And what better way to do all that, and more, than comprehensive tax reform?

“Knowing the worst is better than knowing nothing,” says Bill Dunkelberg, chief economist of the National Federation of Independent Business. “If we’re going to have higher taxes, at least we know what they are.”

While the NFIB’s Small Business Optimism Index hit a 4 1/2- year high in April, it remains in recessionary territory, he says.

I am somewhat sympathetic to the argument that uncertainty about future tax rates and health-care costs is an impediment to investment, especially if that “uncertainty” is tinged with “pessimism,” as it is today.

The future is always uncertain. It was uncertain in 1999, yet investors were buying stocks of Internet companies that had no revenue, no profits and no real business plan. It was uncertain during the condo-flipping frenzy in 2005, as well. And no one mistook irrational exuberance for uncertainty.

The reverse is true today. Potential homeowners don’t expect house prices to rise anytime soon. Concern about further declines may be keeping them sidelined, even in the face of record low mortgage rates.

Three F’s

Normal policy tools have been blunted this time around as the need to pay down debt trumps the lure of rock-bottom interest rates. So if President Barack Obama and Congress are intent on doing something to accelerate the healing process, the best thing they could do is put the economy on a sound long-run footing with low, stable tax rates; no loopholes or exemptions; realistic entitlement reform, including a gradual increase in the retirement age for Social Security; containing health-care costs by allowing consumers to evaluate cost versus quality (and quantity) of care; and a budget that recognizes the government’s spend-now-pay-later strategy is unsustainable.

Why, small businesses would be so ecstatic to see government do the right thing -- and all the special-interest groups so upset -- their spirits would soar.

The way things now stand, any given tax policy has a maximum guaranteed life of two years, which is one term in the House of Representatives. That’s why fiscal policy has to be fixed (in stone) once it’s fixed (improved). Forget tax cuts that are temporary, targeted and timely. They don’t work. And they never end up being timely. Stop tweaking tax rates to get a little more spending here, a little more investment there, and try something big, broad and bold instead.

I doubt Congress would approve of my “Three F’s” plan for the tax system: Flatten it, fix it and forget it. It would take all the fun, and much of the money, out of their job. Still, lawmakers should put fiscal policy on automatic pilot and leave short-term cyclical management to the Fed. Yes, the Fed makes mistakes. But it doesn’t take months of deliberations and horse trading to arrive at something that is almost unrecognizable because of all the unrelated add-ons.

Before the 2007-2009 recession, small businesses accounted for most of the job creation in the U.S. For a firm with, say, 15 employees, hiring someone is more than creating a job; it’s “an investment,” Dunkelberg says. Investing is a long-term proposition, so the more firms know upfront, the easier it is to plan for the future.

If the business of America is business, firms need an environment that allows them to do what they do best. The last thing they need is another jobs plan drafted in Washington.

(Caroline Baum, author of “Just What I Said,” is a Bloomberg View columnist. The opinions expressed are her own.)

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Today’s highlights: the editors on Europe’s banking union and restoring U.S. fisheries; Ezra Klein on the tectonic shift in the Republican approach to health care; Amity Shlaes on women who can have it all; Brian Barry on why Romney shouldn’t avoid the inequality debate; Richard J. Carroll on why some tax cuts work and others don’t; Jane S. Shaw on how Mitch Daniels can shake up higher education.

To contact the writer of this article: Caroline Baum in New York at cabaum@bloomberg.net

To contact the editor responsible for this article: James Greiff at jgreiff@bloomberg.net

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