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The tax reform debate is stuck in the 1970s

The economy has changed radically; Republican priorities have not.

Donald Trump with New York Mayor Ed Koch and Gov. Herb Lehman in 1978.

The biggest policy fight left in 2017 is stuck in the 1970s.

Tax reform is lining up like this: Republicans want big, business-friendly tax cuts to spur savings and investments while Democrats complain it’ll blow a hole in the deficit. These terms of debate made sense 30 to 40 years ago. Back then, the economy was stuck in a particular kind of rut. With inflation high and profits low, companies weren’t investing and creating new jobs even as a torrent of new workers was flooding the labor force. Very high interest rates lurked in the background.

Both Republicans and Democrats agreed this nexus of issues was a problem, so they had a debate over what to do. There were ideological disagreements about the prescription but consensus on the diagnosis. In his first term, Ronald Reagan implemented the conservative prescription. In his second term, the much-lauded bipartisan 1986 tax reform bill represented a reasonable high-minded compromise of the two poles of the debate.

But today is different. Corporate profits are high, not low. Inflation is low, not high. The workforce is growing slowly, not quickly. Borrowing is cheap, not expensive.

Everything about the situation has changed— except the tax policy debate. And the result is that Congress’ No. 1 priority has almost nothing to do with the biggest problems facing the country.

We’re having a very familiar argument about taxes

“By immediately lowering the corporate tax rate to 20 percent,” House Speaker Paul Ryan said last week, “this bill will stimulate investment, job creation, and economic growth in the United States.”

Nancy Pelosi, the day before at a Rhode Island fundraiser, slammed the plan in equally familiar terms. “It blows up the deficit while saying it is going to pay for itself,” she said. “It never has.”

These basic lines could have been copied from an argument about George W. Bush’s 2001 or 2003 tax bills, from a debate over Bob Dole’s 1996 campaign proposals, or from Ronald Reagan’s first year in office.

Will a big tax cut spark investment by shifting incentives, or stifle it with too much borrowing, or can we find a magic solution in revenue-neutral tax reform?

Reagan’s argument with Jimmy Carter about tax cuts versus deficit reduction made sense because it related to what everyone agreed was the main problem of day. But that was a long time ago. America’s big contemporary problems — poor public health, weak labor force participation, ecological sustainability — won’t be addressed by policy ideas cooked up in the high-inflation, low-profit pressure cooker of the 1970s.

The whole tax reform debate is, in crucial ways, a time-wasting distraction.

The ’70s were a crazy time

In the late 1970s, the American economy was mired in a state known as “stagflation” — meaning high unemployment and fast-rising prices.

Unlike today, the actual pace of raw job creation was pretty fast. Baby boomers were leaving school, women were entering the workforce in droves, and the economy was adding jobs — just not enough jobs to accommodate all the people who wanted them. Inflation was high too, with consumer prices rising a staggering 13 percent in 1980.

Corporate profits as a share of national income had sunk to an unusually low level, and stock market returns were dismal once you took inflation into account.

Reagan’s response was to come up with a plan around increasing the financial rewards for investors and rich people. The idea was that by making it more profitable to be in the job creation business, you would spur job creation. Whether you agreed or disagreed with his approach, it at least made some kind of clear sense — profits and investment really were low.

The Democratic objections that Reagan’s program would excessively balloon the budget deficit also made sense. Big deficits force the Federal Reserve to choose between inflation and higher interest rates that stifle investment — and at the time, both inflation and interest rates were high. The argument was, miraculously, a basically sensible disagreement about the best way to tackle a legitimate problem.

“Tax reform” is the higher synthesis of ’70s politics

In 1986, we reached the apogee of Reagan-era policymaking with a tax reform bill that pulled the amazing trick of sharply reducing marginal tax rates (hooray for the supply side) while actually raising revenue (hooray for deficit reduction) by closing loopholes.

Post-’86, we’ve seen various swings of the pendulum back and forth between budget-busting Republican tax cuts and penny-pinching Democrats. Republicans are currently trying to implement a somewhat weird mashup of early-Reagan supply-side tax cuts with late-Reagan high-minded tax reform. And for much of this year, the savvy journalistic thing to do has been to scold Republicans for trying to enact deficit-busting tax cuts under the guise of high-minded tax reform.

But the better question might be why we are still talking about this.

The politics of the 1970s, after all, would have been totally different if inflation, unemployment, interest rates, and labor force growth were all low while corporate profits were high. And yet here we are in 2017. Inflation is low. Unemployment is low. Interest rates are low. But the labor force is barely growing, and corporate profits are high. So why are we still having an argument about whether big marginal tax cuts to incentivize investment are a good idea with the main Democratic counter being that big deficits will create their own investment roadblocks?

The Republican proposal solves a non-problem

The centerpiece of the current Republican tax initiative is a giant cut in the corporate income tax. And one can certainly imagine a situation in which excessively low after-tax corporate profits would be considered a serious policy problem. Businesses won’t invest, after all, unless it’s profitable to invest.

But at 6.4 percent of GDP in 2016, the share of national income going to after-tax corporate profits isn’t low — it’s high.

Indeed, throughout the entire 1970s, ’80s, and ’90s, corporate profits never got this high. And when profits did rise to 6.5 percent of GDP in 2006, that didn’t touch off an investment boom — it was the calm before the storm of the Great Recession.

Republicans on some level must recognize that their core idea doesn’t make sense, since you never hear them say that the big problem with the American economy is that corporate profits are too low. If you said that, people would think you were stupid. Not only are profits high, but stock market returns have been extremely good in recent years. The American economy, whatever else you might think of it, is being very kind to business owners right now. Making it even kinder isn’t going to accomplish anything useful.

The Democratic countercharge — that the GOP plan adds too much debt — has the virtue of at least being correct, mathematically. On the other hand: Who cares?

When Democrats started raising the debt objection to Republican tax plans during the Carter administration, nominal interest rates were very high and the specter of inflation loomed large. Democrats weren’t just arguing about accounting ledgers; they were arguing that the GOP plan to boost investment would fail and backfire by raising interest rates. But these days both inflation and interest rates are low. Blowing trillions of dollars on making big companies and rich people richer doesn’t seem like a great idea to me, but a bigger deficit per se won’t make the sky fall.

Congress should try to solve some real problems

Once upon a time, we had stagflation and low corporate profits. But today we don’t.

Instead, we have a set of new, different problems. For example:

  • There is an acute scarcity of housing units in most of America’s most prosperous metropolitan areas.
  • The process of regional convergence by which poor parts of the country have historically grown faster than rich ones has halted and may even be reversing — with communities built around now-shuttered factories especially lacking in opportunity.
  • Opioid overdoses have reached an unprecedented level and show no sign of slowing down.
  • Greenhouse gases emitted as a byproduct of fossil fuel consumption are putting the planet on a trajectory for unsustainable levels of warming.
  • Despite a fairly high college enrollment rate by international standards, the large share of Americans who don’t finish their degrees has left us with a mediocre ranking in terms of college completion and a lot of people saddled with useless debt loads.
  • Exorbitant child care costs are limiting women’s ability to fully participate in the workforce as well as limiting families’ ability to have as many children as they say they’d like.

Those are not the only problems in America today, but they all seem like well-known and important issues that were genuinely not big problems when Reagan and Carter faced off in 1980. Things change. Alongside new problems, we have a couple of hardy perennial issues in the American economy, including rates of child poverty and lacking health insurance that are very unusual for such a rich country. America has long had an unusually high murder rate, and after 20 years of decline it’s been on the rise recently.

Reasonable people can disagree about the relative priority of these issues and, of course, about how best to solve them. But having disputes about priorities and solutions is what the give and take of making policy is about. The point is that unlike a paucity of available capital or adequate financial rewards for successful business investment, these are all real problems. And they’re problems whose solutions probably do involve some form of large financial commitment, potentially on the scale Republicans are contemplating for their tax bill. But instead of considering any of these issues, the political class is frozen in a back and forth that’s now decades out of date.