Want Fiscal Stimulus? Simplify Taxes

Beyond the Fed's exemplary monetary policy, a true economic rebound will require Congress to drastically streamline the code

By Christopher Farrell

You have to hand it to Federal Reserve Board Chairman Alan Greenspan: Once again, he's showing he knows how to exercise leadership during an economic crisis. The Fed has acted decisively since September 11 by reducing its benchmark interest rate by a percentage point in two swift moves, to 2.5% -- the lowest rate since 1962.

And despite criticisms that the nation's central bank is simply pushing on a string, a steady stream of rate cuts all year did keep the economy out of recession before the terrorist attacks. Low interest rates propped up the housing market, a gain that more than offset the losses many investors suffered in the stock market. Consumers also shored up their balance sheets by taking advantage of cheap rates to refinance their mortgages.


  However, monetary policy is no longer enough to revive an economy plunged into negative growth by terrorism. The key question now is fiscal policy. A consensus appears to be growing among policymakers that any fiscal-policy stimulus package should be more than $100 billion. Congress and the Bush Administration have already hiked government spending by some $45 billion, much of it targeted toward defense and national security. And on Oct. 4, President Bush said he would push for a stimulus plan as large as $75 billion to "invigorate this economy."

Now comes the difficult part. Plenty of proposals are floating around Washington, many of them favored schemes of industry and other special interests that are being dusted off in the current environment. Among the most popular proposals: A lower capital-gains tax rate, reduced corporate income taxes, a tax rebate, a temporary cut in payroll taxes, or more likely, some combination of these ideas.

Each proposal may have individual merit. But taken singly or together, these maneuvers will only make a far too complicated tax code even more Byzantine. Already, it's full of credits, deductions, exemptions, and income phase-outs, especially after the passage of President's Bush's gargantuan, gimmick-laden tax bill earlier this year. For instance, new education tax breaks that take effect in 2002 expire in 2006; the estate tax is phased out until 2010 but is restored in 2011; and it takes years for families to escape the widely reviled marriage penalty.


  Why not take the opportunity offered by the nation's need for fiscal stimulus to ditch the mess of the 2001 tax-cut law and create a far simpler tax code instead. Get rid of as many deductions, credits, and phase-outs as possible, including eliminating the distinction between taxing ordinary income and capital gains. Broadening the tax base would allow Congress to sharply reduce income tax rates and get rid of the many inequities that have crept into the code over the years. Congress could act quickly since the supporting data are available -- tax specialists such as Joel Slemrod of the University of Michigan have long studied the trade-offs inherent in populist tax simplification.

A concerted push to steer Washington away from the hard-to-track tax-subsidy game would maintain fiscal discipline. Tax simplification would mark a genuine improvement in fiscal policy, and best of all, it would accomplish these goals while stimulating the economy.

Farrell is contributing economics editor for BusinessWeek. His Sound Money radio commentaries are broadcast over National Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BW Online

Edited by Douglas Harbrecht

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