The Republican tax reform effort under the leadership of President Donald Trump has the expressed goal of stimulating business and economic growth. By putting more money into the hands of American taxpayers, Republicans hope to fuel increased consumer spending. Increased consumption should, in turn, lead to job creation By lowering the corporate tax rate and revamping the corporate tax code, they hope to encourage renewed investment in the US economy and workforce. In many respects, the Republican approach is the traditional approach government has continually relied upon to help stimulate the economy. It is the same approach that has continually failed to meet expectations, because it is an approach that does not recognize the reality of the situation in the United States.
The stimulus package of the Obama Administration and the two stimulus packages of the George W. Bush Administration demonstrate the limited capacity of the government to build the economy. With tax reform and other policy shifts in sight, there is an opportunity to restructure the economy to help the areas of the economy most important to job creation and business development. Reducing regulation, slashing taxes, and ending tariff-free trade will not, however, be enough to accelerate and sustain economic growth. Ultimately, an economy must provide for the needs of the population it serves or it cannot be sustained. Today, it does not. Thanks to a widening income gap and a growing number of poor, an increasing amount of wealth is being concentrated into the hands of a shrinking minority.
The US is geographically divided into an growing number of extremely wealthy communities and extremely poor communities with a diminishing number of middle income communities. As such, the US economy is failing to properly distribute wealth to the businesses, individuals, and communities that make up the vast landmass that is the US. The tax cut approach assumes the US economy is like a massive factory awaiting a reason to produce massive amounts of goods and jobs. Economically prosperous areas have the opportunities to ramp up production and the earnings to utilize tax breaks. Without sufficient earnings, however, tax breaks are meaningless. The problem is that far too many businesses in far too many communities do not have enough consumers nor enough revenue to justify the risk of growth or sustain growth.
Policymakers may want to consider an alternative approach. For average American investors, a lower rate for capital gains tax serves as a long-term incentive to invest their money in order to ensure their financial future. It helps them build wealth for retirement while fueling the continued economic growth of the country. Because stock markets afford individuals a convenient vehicle for investment, versus directly risking their savings in a local business venture, most people invest in the national and global economies through various financial instruments, including IRAs. Money is funneled into investments that have more stringent reporting requirements, with the greatest benefits and risks going to those who invest in segments expected to grow the fastest. The benefit to the economy is a readily available, broad base source of capital that can be used to expand economic activities on Wall Street and on Main Street.
It is important to recognize businesses, industries, and economies depend on three kinds of capital: financial, intellectual, and labor. The investment of financial capital provides businesses with the money they need to open their doors, maintain their operations, and expand as their customer bases grow. This is why investors and banks are so important. It is also why the investment of financial capital is rewarded with either a share of a business or interest payments. The need for the investment of intellectual and labor capital is not, however, always appreciated or properly rewarded. To restructure the economy to benefit average Americans, intellectual and labor capital need to be cultivated. Over the past few decades, the financial sector of the economy has been a persistent bright spot, in part, because policymakers crafted policies to cultivate financial capital. One such policy has been a reduced capital gains tax, which offers a window into ways labor and intellectual capital can also be cultivated.
Unfortunately, a vibrant financial sector does not directly create too many jobs. The financial sector does not employ a great deal of labor compared to the greatly diminished manufacturing sector. Consequently, steering too much money into the financial sector may hurt the economy as a whole. After all, it diverts money away from the economic activities that directly benefit most Americans. Growing economic disparity, stagnating and shrinking wages, and lackluster job creation as the capital gains tax has been cut hint at the validity of this argument. People need well-paying jobs to sustain strong consumer spending, i.e. the lifeblood of the economy, and build their investment portfolios, i.e. get access the benefits of economic growth and supply the economy with capital, i.e. while enjoying a comfortable lifestyle. When people lose their ability to both afford a comfortable lifestyle and invest for their futures, the economy is in trouble.
From the 1970s until about 2008, average income Americans were able to compensate for diminishing wages and lost financial opportunities by working longer hours, living on multiple incomes, decreasing family size, forgoing certain luxuries, relying on state support, and, in the case of the growing poor classes, forgoing necessities, thus ultimately hurting themselves in the future. Today’s economy is built on increasing returns to those who can afford to be investors. For wealthier Americans, a lower tax rate for unearned income is not an incentive to invest. It essentially affords them a windfall for money they would have invested anyway. This translates into a situation where an excess of capital is driven toward investments with the highest payouts, thus creating economic bubbles. In turn, Wall Street firms and affluent individuals have been increasingly able to use extremes in the markets to siphon capital out of the economy, especially with their use of exotic financial instruments.
Consequently, U.S. policymakers should embrace and cap the benefits of a lower capital gains tax rate, so it can act primarily as an incentive for middle-income households. In turn, governments might consider subsidizing another type of capital through tax cuts that would drive growth where it is most needed, i.e. intellectual capital. Innovations and the spread of new technology can create good paying jobs by sparking novel industries. Coupled with improved patent laws, offering a tax discount on par with current capital gains tax deductions for royalty payments on novel technologies and other innovations would make them far more valuable. By making patents and other intellectual property more valuable, financial capital would be steered toward innovation, thus ultimately cultivating new industries and jobs.
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