How Much Economic Growth Can Tax Reform Deliver? Part III

Alex Brill | AEIdeas

I believe that the current US tax code imposes drag on US economic growth and alternatives to the current system could result in an increase in the capital stock, a boost in worker productivity, and thus an increase in wages. This positive economic result would occur slowly over time as new investment is deployed and workers adopt to new opportunities.

Key to realizing this opportunity is a reduction in the tax burden on new investment. Conversely, affording taxpayers a windfall gain on old investments should, to the extent possible, be avoided. As I’ve noted previously, certain transition costs associated with tax reform can be deficit financed; the long-run deficit impact — including consideration of the potential macro-dynamic effects — should be budget neutral. In other words, to promote growth, tax reform should be constructed in a manner that does not lead to excessive crowding out of private investment with new public borrowing.

Done right, effective tax reform will add multiple tenths of a percentage point to the real GDP growth rate for a decade or more until the transition to a new, higher level of output is reached. Once the transition is complete, US economic output could be more than $1 trillion higher every year thereafter.

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