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Brooks Wilson's Economics Blog: Barro on the Fiscal Crisis and How We Got Here

Friday, July 29, 2011

Barro on the Fiscal Crisis and How We Got Here

Robert Barro is one of those economists whose ideas deserve careful consideration.  In “Robin Hood Can't Lead Us Out of the Debt Hole,” he provides a summary of how the United States got into the current economic mess, the relative effectiveness of government actions, and provides thoughts on policy that would help clean up the mess.  I particularly like his ideas on tax reform, which I quote in part.
One possible package of reforms would include setting the U.S. corporate and estate tax rates permanently to zero. These taxes are inefficient and generate little revenue. Also, to restore a more efficient allocation of capital across the economy, we should phase out—gradually—tax preferences for home-mortgage interest, state and local income taxes, and employee fringe benefits. Marginal income tax rates should also be lowered across the board. Finally, to raise additional revenue to meet entitlement obligations, we could adopt some kind of broad-based, flat-rate consumption tax such as a value-added tax of the kind used in Europe. In this country, a rate of 10% with few exemptions should raise around 5% of GDP annually.
The political danger of a value-added tax is that it is so efficient at raising money it will encourage governments to grow even larger. That's why it only makes sense as one component of a fiscal reform, including reductions in the long-term path of entitlement outlays.

Lowering the corporate to zero makes sense for at least two reasons.  First, there is a difference between the incidence of a tax, who writes the check and the burden of that tax, who ultimately pays it.  In the long run, that burden falls mostly on consumers.  Lowering the corporate tax rate to zero would acknowledge that economic fact.  Second, it would take an arrow out of the political quiver of corporations that benefit the most politically entrepreneurial business leaders.  A similar arrow would be removed from politician’s quiver.  Politicians would lose some ability to bribe or extort businesses to further a politician’s or group of politician’s policies.  Investment decisions would more closely be linked to the fundamental profitability of projects. 

Lowering estate taxes to zero would free estates to allocate funds to the best possible investments not the best investment given tax treatment.  Again the economic efficiency would increase.  

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