President Obama's economic proposals in Tuesday’s State of the Union address were a disappointment. His ideas — free community college, an enhanced tax credit for child care and higher taxes on high-income earners and large financial institutions — failed to go beyond mere talking points. With no chance of engaging the Republicans, they will surely die without a hearing.
But the president’s proposals do invite a case for a comprehensive tax and entitlement reform, one based not on redistribution but on growth, work and opportunity.
Our unwillingness to confront mounting inefficiencies in the nation’s tax code and growing obligations in entitlement programs has led to increasingly limited options. Corporate tax reform is held hostage to the misguided idea that tax cuts and tax increases must be balanced within the corporate sector alone, and to the faulty assumption that beneficial tax reform will not raise economic activity.
Piling up child tax credits and subsidies for health care over narrow household income ranges, as the president proposes, leads to high rates of taxation on earnings from work as assistance is phased out. Likewise, raising marginal tax rates on investment by the well-to-do reduces asset prices and is a threat to continued economic expansion.
So how can we enhance growth, work and opportunity? Four steps can help get us there.
The first is to move to a simple business tax system, with a lower marginal tax rate and no special industry preferences. There would be no separate corporate tax, only a single business income tax for all businesses. Ideally, investment would be expensed, and its cost deducted in the year it was made, rather than deducted gradually. Businesses would be able to bring back overseas profits free of additional United States taxes. A one-time modest tax on current overseas earning could be used to help finance reform. Such a business income tax would encourage both growth and investment opportunities in the United States, while offering more jobs and higher wages to American workers.
The second step is to use the individual income tax to better reward work. The top tax rate for most Americans would be the same as the business income tax rate. To maintain progressivity, a surtax on wages would be collected on very high earners. To make work more attractive, low-income workers, including single workers, would receive an expanded earned-income tax credit and a tax credit to buy health insurance (as opposed to the more complex subsidies that exist under the Affordable Care Act). The earned-income tax credit would be phased out gradually.
Workers would have the choice of switching to options available under current law for employer-provided health insurance and a health savings account, or a tax deduction for their own health insurance and health savings account as incomes rise. Reductions in marginal tax rates to support work would be paid for by limits on tax deductions for more affluent households.
The third step focuses on education and training. Like investment in technology and machines, investment in human capital should be deductible from income. Out-of-pocket educational expenses for bona fide schooling and vocational training could be tax deductible for all but affluent households. Personal re-employment accounts could be made available to all individuals facing more than temporary unemployment, with individual financial support for training and a bonus for re-employment.
The fourth step is to strengthen retirement security, while acknowledging the need for fiscal consolidation in entitlement spending. Minimum benefits for Social Security and Medicare could be strengthened to ensure that people with low lifetime incomes avoid poverty in old age. To reduce future deficits in these programs and to free up funds to support work and opportunity for younger workers in the future, Social Security benefit growth would be slowed for more affluent individuals.
In the same spirit, changing Medicare so that individuals would purchase insurance from one of a number of competing plans, with the federal government paying part of the cost, could focus the largest subsidies for health insurance on those with low lifetime incomes. Converting Medicaid to a block grant — in which federal support would be turned over to states — would give governors the flexibility to support health insurance tax credits for low-income residents, community health centers or other experiments in health insurance and delivery at the state level.
These four steps offer a road map for growth, work and opportunity without sacrificing income security. Other policies, including free trade, open competition and immigration reform, are also important. But these four steps can take place in a budget discussion, and congressional leaders and the White House have both emphasized the need for a more timely budget resolution.
While the reforms I sketched are comprehensive, they can be implemented in discrete steps — no “grand bargain” is required. And realistic proposals to advance growth, work and opportunity, not ideological talking points, are what we need right now.