Focus on Economic Growth, Not Tax Credits

August 21, 2014

Dan Mitchell from the Cato Institute recently wrote about the debate over increasing the child tax credit or lowering marginal tax rates. He says lower marginal tax rates would have a bigger impact on the incentive to work and could lead to a better economy in the long run. From the Wall Street Journal:

"Now let's look at the economics. The most commonly cited reason for family-based tax relief is to raise take-home pay. That's a noble goal, but it overlooks the fact that there are two ways to raise after-tax incomes.

"Child-based tax cuts are an effective way of giving targeted relief to families with children, particularly when compared to a reduction in tax rates, which would have only a modest impact on take-home pay for a family in the 10% or 15% tax bracket.

"The more effective policy—at least in the long run—is to boost economic growth so that families have more income in the first place. Even very modest changes in annual growth, if sustained over time, can yield big increases in household income."

The focus of any tax reform should be economic growth. Growth has the best chance in the long term to improve quality of life and raise living standards for middle and lower income groups.

Instead of debating an increased child tax credit or lower rates, Mitchell suggests a couple potential compromises that would put growth at the forefront:

"While the camps disagree on lower individual income tax rates vs. child-oriented tax relief, both agree that the tax code's bias against capital formation is very misguided. The logical compromise might be to focus on reforms that boost saving and investment, such as lowering the corporate tax rate, reducing the double taxation of dividends and capital gains, and allowing immediate expensing of business investment."

Our work finds that these provisions could have a significant impact on economic growth. According to the Taxes and Growth Model, a corporate rate cut to 25 percent would boost GDP by about 2 percent in the long term and lift wages by just slightly less. We also find that moving to full expensing of business investment would boost GDP by about 5 percent in the long term and lift wages about over 4 percent.

These types of changes can provide serious long term benefits for the economy and should be the focus of any potential tax reform.

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