Faculty News & Research

A Biden Business Agenda: Improving Tax Policy, Investing in Future Growth

By Bob Needham

This is the fourth in a series of articles asking Michigan Ross professors what they hope to see from the incoming Biden administration on specific business topics. In this post, Assistant Professor of Business Economics and Public Policy Nirupama Rao addresses taxes and spending.
 

First, in the short term, should the federal government approve further pandemic “stimulus” action? If so, what form(s) should it take — direct aid to small businesses, and/or direct payments to individuals?

Rao: The trend in the monthly jobs reports — five straight months of slowing growth — indicates that this recovery is faltering. With the pandemic intensifying in the U.S., the need for virus relief is acute. Congress will likely pass a half-measure in the near term, alongside a bill that will fund the government and avoid a shutdown.

Effective relief will offer three key forms of economic support: 

  • An extension of unemployment insurance benefits
  • Nutritional support for families not reached by unemployment insurance
  • Aid to states and cities to avoid budget cuts that would hold back the recovery 

Longer term, the U.S. needs countercyclical policy that is responsive to economic conditions. Waiting on Congress to pass stimulus bills following a slowdown has often led to delays that hamper economic recovery and leave families without the support they need. Instead, the U.S. should legislate long-term automatic stabilizers that will kick in, for example, when state unemployment rates exceed a threshold or rise quickly.

President-Elect Biden has proposed increasing the federal income tax for those earning more than $400,000. Does this make sense? 

Rao: One broad priority will be to bring federal tax revenue back in line with average historic revenue and how much our government typically spends. The federal government typically spends about 20% of GDP. Last year, with Republicans controlling both houses and the presidency, federal spending amounted to 21% of GDP. The Biden plan brings us closer to actually paying for our normal level of spending by raising revenues to about 19% of GDP. 

The plan is to raise these added revenues progressively in part by returning the top individual income tax rate to 39.6%. There will be thorny issues to be resolved, such as whether to allow individuals to once again deduct their state and local taxes, and to allow more homeowners to deduct mortgage interest. All in all, though the Biden tax plan will raise revenues, most economic analyses suggest it will have only a modest direct impact on economic growth.

What else would you like to see the Biden economic plan tackle?

Rao: The Biden tax plan has some excellent ideas on the corporate tax front, including reversing half of the 2017 corporate tax rate reduction and closing loopholes in the 2017 act that encourage profit shifting. In addition, I would like to see the new administration revisit the tax rules surrounding investment, simplifying the tax code by allowing for greater expensing, but also reducing financing distortions by limiting the deductibility of interest. 

The pandemic has also laid bare the critical role that affordable, high-quality childcare plays in our modern economy. I hope Congress is ready to work with President-Elect Biden’s team to finally offer American families robust childcare support that would boost labor supply at a time that participation rates are falling.

Which aspects of the Biden economic plan are cause for concern?

Rao: While I support raising taxes on high-income groups, I do worry about the marginal tax rates that could result from a combination of raising the top tax rate to 39.6%; eliminating the income cap for Social Security taxes, effectively raising taxes on incomes above about $140,000 by 12.4%; and continuing the Trump-era elimination of of state and local tax deductions. Top marginal tax rates could well exceed 50% in higher-tax states like New York or California. We need to think hard about the impact we might be having on the tax capacity of state and local governments and behavioral responses.  

Should the federal government be actively concerned with reducing the budget deficit in the near term, or can that wait for a stronger overall economy?

Rao: Some of the thinking on deficits has changed in economics and policy circles in recent years. This is in part due to the experience of the last 10 years. Since 2010, annual deficits have grown from $1.3 trillion to $3.1 trillion while the national debt has more than doubled to $21 trillion and outpaced annual GDP. 

Nonetheless, real interest rates have fallen from 4.3% in 2000 to less than zero today — in 2020 bond markets are paying the U.S. government to borrow. This has upended worries that government borrowing will drive up interest rates and crowd out private investment.  

Instead, some economists are rethinking how we should view the debt, with some, like Larry Summers, former secretary of the treasury, and Jason Furman, former chairman of the Council of Economic Advisers, suggesting that rather than comparing the debt to annual GDP, we should think about how much of GDP is absorbed by payments to service the debt. Falling interest rates make much heavier debt levels affordable. 

We should also be thinking about what we are spending the money on. Are the deficits we are running going toward investments that will buy us stronger economic growth in the future? That may be true for subsidies for corporate R&D but less true for write-offs for business lunches and other tax breaks for top income groups. It is likely true for investments in young children; making community college more accessible; and rehabilitation of the physical capital of our economy, such as our crumbling bridges, subpar broadband, and strained public transportation systems. 

The U.S. economy has structural headwinds, including low productivity growth and aging demographics, that widen the scope for government investment to bolster growth in the near and longer term. We are lucky that debt markets are willing to pay us to make these necessary investments. We should take them up on their offer. 
 

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Nirupama Rao
  • Sanford R. Robertson Assistant Professor of Business Administration, Assistant Professor of Business Economics and Public Policy