PREMIUM SEARCH Search by job title, geography and build a list of executive contacts
The Federal Reserve Board took action this week that should sustain the economy's long-term vitality. The fed hiked short-term rates a quarter point to 5.75%.
What's to like about a hike in interest rates? Consumer, business, and investor confidence in the Fed's monetary stewardship is a major reason why February marks a record 107 months of uninterrupted growth (BW, 2/14/00, Cover Story, "The Boom"). And the market's approving reaction to the rate hike suggests a widespread expectation that inflation will stay tame over the long-haul (see BW Online, 2/3/00, "Finally, Fedspeak the Market Understands"). Stable prices encourage long-term planning and improve the allocation of scarce resources in a market economy. Thanks to a federal budget surplus that could total as much as $2 trillion to 3 trillion over the next decade, fiscal policy has a unique opportunity to further enhance the economy's long-run stability.
Nearly 40 years ago, economist Milton Friedman noted that constant lurches in tax policy significantly add to economic uncertainty and discourage long-term planning by households and businesses. So perhaps policymakers should take advantage of these flush times to streamline our Byzantine tax system.
TAX CUTS? WHO CARES?
So far, the pols are doing what comes naturally to them: They're using taxes to try to curry favor with the electorate. President Clinton, acting as Al Gore's surrogate, is proposing $350 billion in tax cuts targeted toward the middle class. Republican candidate George W. Bush has his $483 billion tax-cut plan that offers something for everyone, while rival John McCain is pushing a more modest $240 billion tax reduction over five years. Yet voters don't seem to be interested in the tax-cut mantra.
One reason may be that most families will pay a smaller share of their income in federal taxes in 1999 than at any time in the last 25 years. Another reason may be growing repugnance at the tax system's complexity. For instance, from 1981 to 1997 the percentage of taxpayers who use a paid preparer increased from 42% to 52%.
The tax code is riddled with too many deductions, credits, exemptions, and exclusions. The system is expensive, too. The annual cost of filing for individuals and businesses, taking into account time and money spent on expert advice, ranges between $75 billion and $130 billion, according to a recent study by William Gale, economist at the Brookings Institution, and Janet Holtzblatt of the Treasury Dept. Others calculate a far bigger tab. Much of the complexity is wasteful and inefficient.
NEEDLESSLY COMPLICATED.
For example, policymakers, corporate executives, opinion-leaders, and almost every baby boomer agree that Americans need to save more for their retirement. Yet look at our bizarre retirement-savings system. There are 401(k)s for the private sector; 403(b)s for nonprofits; 457s for state and local government employees; Keoghs, SEP-IRAs, and Simple-IRAs for small businesses and the self-employed; individual retirement accounts and Roth-IRAs for those individuals that qualify. These retirement plans all have different rules. Take an employee of a state social-welfare agency. She can't roll over a 457 into an IRA when she leaves her job. But she can roll over a 401(k) plan into an IRA if she works at a private company. Alas, if she decides to leave the private sector to take a job at a nonprofit, she can't roll her 401(k) into her new 403(b). Sound needlessly complicated? It is.
The radical tax-reform proposals threaten too much turmoil. Instead, let's streamline the existing system
Married couples with an adjusted gross income of up to $150,000 can contribute $4,000 to a Roth IRA. The income limit for the same couple that wants to set up a traditional IRA is $50,000. Go figure. Instead of coming up with new wrinkles, why not harmonize the rules, and make it easier for wage earners to save for their retirements no matter where they work? The more radical tax reform proposals, such as a flat tax or a national sales tax, threaten too much economic disruption and turmoil. Instead, keep the existing progressive income-based system but streamline it, flatten out the rate structure, and broaden the tax base.
Using the revenue raised to increase standard deductions removes people from the tax system, and using the revenue to reduce tax rates reduces the value of sheltering and cheating, say Gale and Holtzblatt in their superb paper, "The Role Of Administrative Factors In Tax Reform: Simplicity, Compliance, and Enforcement." In short, broadening the base and reducing the rates, which in general may be considered efficiency-enhancing, can also be simplifying.
PREPARING FOR A DOWNTURN.
In addition, policymakers could further enhance long-term economic stability by tapping any surplus for paying down government debt. It's an approach endorsed by most economists, including the nation's chief economist, Federal Reserve Board Chairman Alan Greenspan. The Treasury is starting to pay down the $3.3 trillion in debt held by the public, and the agency's money mandarins are even contemplating retiring the bellwether 30-year bond issue.
Paying down the debt when times are good -- as they are now -- gives the government greater financial flexibility when the downturn eventually comes. What's more, the budget surplus numbers are a projection. Remember the $300 billion deficit projections during the Bush Presidency? Paying down the debt with money from yearly surplus prevents fiscal irresponsibility. The larger point is that a cleaned-up tax system and less government debt would bolster consumer confidence and advance long-term planning. Best of all, fiscal policy could become a force for economic stability rather than financial uncertainty.
Farrell is contributing economics editor for Business Week. His Sound Money radio commentaries are broadcast on Saturdays in 151 markets nationwide EDITED BY DOUGLAS HARBRECHT
Get BusinessWeek directly on your desktop with our RSS feeds.
Add BusinessWeek news to your Web site with our headline feed.
Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video.
To subscribe online to BusinessWeek magazine, please click here.
Copyright 2000 , by The McGraw-Hill Companies Inc. All rights reserved.
Printer-Friendly Version
