Three New Year’s Resolutions for Tax Policymakers

December 29, 2020

The world is ready to close the book on 2020 and start fresh in 2021, awaiting widespread vaccination, an end to the pandemic, and the beginning of a new chapter of economic recovery. With a fresh start in mind, and a healthy dose of optimism, here are three New Year’s resolutions for crafting better tax policy in the coming year.

1. Understand how taxes affect decision-making

Understanding and then specifying how a tax change will affect people’s decisions to work and invest can help better evaluate expected economic effects. A great place to start is this 2017 blog post by my former colleague Scott Greenberg.

When thinking how tax policy affects the economy and growth, people often assume the only thing that matters is putting more money in somebody’s pocket. Debates then center on the question of whose pocket. This is the idea of an income effect: if people have more money, they will engage in more productive activities. Income effects are important for economic output in many cases, especially when the economy is operating below its potential.

But the amount of money in someone’s pocket is not the only thing that matters. Relative prices matter too. This is the idea of a substitution effect: if work is made cheaper relative to leisure, people will work more; and if investment is made cheaper relative to consumption, businesses will invest more.

2. Make the tax code stable.

Taxpayers deserve stability. They should not have to gamble on what their tax situation will be over the coming years. Stable, permanent policies allow taxpayers to make better decisions and lead to more pronounced effects than temporary policies characterized with uncertainty. Making the tax code stable would include deciding once and for all on the status of remaining tax extenders, tariffs, and upcoming expirations scheduled under the 2017 tax law, as well as designing better ways to implement and phase out economic relief measures.

3. Make the tax code neutral and less distortive to decision-making

When different industries or investments are treated differently by the tax code, it can distort relative prices and affect decision-making by firms and individuals. Even in instances where externalities might be present and economic theory would indicate a tax solution to better price something, taxes should be carefully designed. A piecemeal approach to taxes—for instance, the current mix of energy-related tax provisions—can result in suboptimal outcomes. Making the tax code neutral would include implementing permanent full expensing for physical and human capital investments, eliminating the double taxation of saving, and reevaluating industry- and technology-specific provisions.

As we await the end of a global pandemic that has caused untold hardship through loss of life and livelihood, policymakers at all levels of government can work together to clear the path toward economic recovery.

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