Economist John Cochrane

Economist John Cochrane

From John Cochrane at The Grumpy Economist, Economic Growth

This is part of a 10,000 word essay that is worth every second of the time it takes to read.

The central goal of a growth-oriented tax system is to raise the revenue needed to fund necessary government spending at minimal distortion to the economy, and in particular minimizing the sorts of distortions that impede the growth process.

A first objection comes from those who want to pair reform of the code with substantial rises in overall revenue. This has been the main stumbling block to tax reform under the Obama Administration.

Second, our tax code mixes raising revenue with a host of special provisions designed to encourage specific activities and transfer income to specific groups or businesses. Objections come from those who what to preserve one or another subsidy, deduction, or exemption.

Third, our tax code mixes raising revenue with efforts to redistribute resources across income and various demographic classes.

The result is paralysis. The answer lies in separating the arguments. One could go so far as to separate the actual legislation.

First, we should discuss the structure of the tax code separately from the proper level of revenues. Let us agree that we will eliminate deductions and exemptions and have three brackets. Start with a revenue-neutral code. But agree that we can separately and much more frequently adjust the rates, which adjust the overall level of revenues.

Second, we should separate the tax code from the subsidy and redistribution code. Let us agree, the tax code serves to raise revenue at minimal distortion. All other economic policy goes into the subsidy code. And subsidies should be on-budget and explicit. So, you want a subsidy for home mortgage interest payments? Sure, let’s talk about it. But it will be an on-budget expense — we will send checks to home buyers if we do it. You want to give $7,500 to each purchaser of electric cars? Sure, let’s talk about it. But it will be an on-budget expense. We will send $7,500 checks to electric car purchasers if we do it.