Middle-Income Wage Earners Need a W: Cut Business Taxes First

By Larry Kudlow

Friday, March 31, 2017

After the breakdown of health-care reform, both President Trump and the Republican Congress need a W — a win.

And not just any win, but one that will play into the public demand for faster economic growth, better jobs, and higher wages. Recent polls show the nexus of growth, jobs, and tax cuts vastly outranks health care.

So, most important, middle-class wage earners need a W.

We’ve had job creation, but it hasn’t reached all sectors of the population. Consequently, the employment-to-population ratio remains historically low. So does real-GDP growth.

From 1950 to 2000, growth averaged 3.5 percent a year. During the Obama recovery — and frankly going back to the year 2000 — growth has hovered at only 2 percent per year. Real wages have barely improved. New business startups have actually declined. And productivity has flattened.

The hole in the center of this tepid growth story is a lack of business investment. It’s the missing ingredient. From 1950 to 2000, total business fixed investment averaged a strong 5.3 percent annual growth. But since 2000, that figure has dropped to only 1.7 percent.

For 50 years, the capital-labor (K/L) ratio increased by an average 3 percent a year. The capital stock rose 4.3 percent per year. But since 2009, the K/L ratio has fallen by 0.2 percent per year, and the capital stock has grown by only 1.5 percent yearly. This is why productivity and wage gains have been minimal. And the root cause is the lack of business investment.

But the GOP can remedy this by providing new tax incentives (including a rollback of costly regulations) right now. Specifically, the new Republican priority should be business tax cuts first.

While health-care reform simmers on the back burner, the president should go right to business tax reform. It can be nice and simple and easy to understand. There’s virtually a bipartisan consensus for it. Separate it out from the broader and far more complex and controversial issues related to individual tax reform.

Yes, we desperately need personal-tax simplification. We also need lower tax rates across-the-board. We need to clamp down on loopholes and unnecessary crony-capitalist deductions to broaden the tax base. But that’s a much more difficult and longer battle. Save it for next year.

There are hundreds of tax lawyers in Washington who can separate out business income from personal income. That will allow legislation to reduce tax rates for the small S-Corp companies as well as limited-liability partnerships and proprietorships.

So let’s end the war on business. Let’s reward, rather than punish, success. Congress need only go for a 10 percent repatriation rate, a 15 to 20 percent tax rate for large and small businesses, and immediate expensing for new investments.

And perhaps to draw in some Democrats, legislators can use part of the roughly $200 billion in repatriation revenues to provide an equity base for a privately owned and run infrastructure fund. No new Fannie or Freddie. No government directors. Keep it all in the private sector.

And forget the crazy border-adjustment tax (BAT). It would badly damage consumers and the economy when what we need is faster growth.

Meanwhile, don’t obsess over various reconciliation rules. Reconciliation can be whatever you want it to be. The so-called Byrd rule, which stipulates deficit neutrality over the long run, has been broken many times over the past 30 years.

And maybe this time the GOP will talk to the Senate parliamentarian. Or perhaps the president of the Senate, Vice President Pence, can overrule the parliamentarian.

With lower business tax rates and more net business investment to grow the capital stock, the economy is capable of growing over 3 percent yearly. And that 1 percentage point increase from the 2 percent baseline would yield, according to the CBO, more than $3 trillion in deficit reduction over the next ten years.

The misbegotten BAT, and its phony $1 trillion pay-for, can be buried in a deep gravesite inside a large crypt.

Perhaps the major selling point for business tax cuts is the fact that the biggest beneficiaries are middle-income wage earners — not so-called rich people and rich corporations.

Importantly, the best research on this has been done by Kevin Hassett of AEI, and in recent years supported by a number of papers. Ironically, Hassett is slated to be chairman of the president’s Council of Economic Advisors, as soon as his vetting process is complete. No one makes the case better than Hassett that business tax cuts are a middle-class tax cut.

So, with the postponement of health-care reform, we now have more than four months before the August recess to give the country the fuel injection it needs: a boost for wage earners and businesses and consumers and productivity and better jobs.

Put business tax cuts first. Right now.