Staying Competitive in the World Economy
Our modern, global economy generates important policy challenges related to competition among jurisdictions. But the most essential ingredients for competitiveness are found at home. These fundamental factors are essential to an economy’s success, regardless of their degree of economic openness.
A Revitalized Rust Belt: Pittsburgh 2.0
Pittsburgh, Pennsylvania has transformed itself from a rust belt industrial town into a revitalized, diversified city. After the steel industry’s decline sapped the region of fifty thousand people annually, Pittsburgh was forced to reformulate its identity. Relying less heavily on manufacturing, the city partnered with its universities and healthcare companies to diversify employment prospects and attract citizens and capital.
Investments in education and infrastructure were key to Pittsburgh’s transformation. Carnegie Mellon and the University of Pittsburgh played enormous roles in the city’s revitalization: the University of Pittsburgh Medical Center (a healthcare provider valued at more than $8 billion) became Pittsburgh’s biggest employer. The city also collaborated with tech firms, and made important investments in public spaces (including a new convention center) and inexpensive housing. Pittsburgh’s burgeoning health services industry, cutting-edge robotics research, and economic resilience have earned it commendations. In 2014, The Economist deemed Pittsburgh the most livable city in the continental United States.
The United States economy has benefited from many historic advantages. Our large immigrant community has been a constant source of entrepreneurship and innovation. Our steady increases in educational attainment over the period of 1890 to 1970 helped develop a highly-skilled workforce suited to the demands of the time. Our institutions of higher education, together with our public investments in basic science, generated the innovation and ingenuity that kept our industries at the world’s frontier of knowledge. Our investments in infrastructure, from the interstate highway system to the internet, paid large dividends. Our inclusive political institutions provided for a strong, stable democracy. And our leadership in world affairs gave the United States an advantage in setting up a global trading and financial system that privileged the US dollar, that made US assets a highly desirable store of wealth, and that generally benefitted US workers and companies.
Many of these advantages are still intact, but there are also reasons for concern. Educational achievement has failed to keep pace with technological change, and our investments in public infrastructure have fallen short of our needs. Our politics have become increasingly polarized, and policy-makers increasingly suggest harmful solutions to our economic problems, such as restricting immigration and trade. We need to counter these harmful trends to keep American workers competitive in the world economy.
Foremost, we need to do no harm, avoiding policy “solutions” that are more akin to shooting oneself in the foot. But we also need to fortify traditional sources of American strength. Three fundamentals that particularly need strengthening are education, research, and infrastructure.
Our education system needs vast improvements and increased funding. As discussed in Chapter 4, our K–12 educational achievement is lagging, and we need greater investments in people from early childhood onward. Investments in early childhood reap large rewards. An influential study of two preschool experiments by Nobel laureate James Heckman reveals that comprehensive birth-to-five programs had a 13 percent return on investment; these returns far exceed the average return on stocks.8
Free community college would help workers build new skills and also provide students who do not plan to invest in a four-year college education with education and training resources. Keeping our higher education system strong will require continued funding as well as openness to the talent of the world, including foreign-born students who want to study in the United States. Welcoming these students to stay and work afterwards would compound these advantages.
Increasing funding for basic science and research would pay large dividends, and investments in education and basic research funding work well together. Workers will be better prepared for competing in the world economy, and for using technological change to their advantage, if they have the skills to make computers their assistants rather than their rivals. American companies will provide good job opportunities for workers if they are on the frontier of innovation and progress. Of late, federal R&D spending has been declining relative to the size of the economy. That trend should be reversed.9 There are also ample opportunities for new investments in green energy technology. Given the large challenge of climate change, these investments are overdue.
Good public infrastructure is an important ingredient for making US workers productive. Well-functioning roads, bridges, ports, airports, and computing and internet access help ensure the smooth transport of goods, services, and ideas. Public investments are likely to pay large dividends, especially given our recent underinvestment in these areas.
The NIH and the NSF
The National Institutes of Health (NIH) and National Science Foundation (NSF) are responsible for giving America’s researchers, students, and scientists the resources they need to go from hypotheses to revolutions. Across these organizations’ histories, 223 NSF researchers, and 148 NIH researchers, have been awarded Nobel Prizes. The $7.5 billion under the direction of the NSF is an essential source of scientific, engineering, computer science, and mathematics funding, contributing to our innovation-driven economy. Many of the country’s most successful businesses were helped by strong research spending; even the student researchers who founded Google were supported by an NSF grant.
The NIH provides more money to biomedical research than any other public institution on the planet. Each year, the NIH invests over $30 billion in medical research. Recipients of NIH funds are responsible for the first FDA-approved treatment for the most common type of stroke, the first human liver transplantation, and recent innovations in Zika, Ebola, and Marburg treatments. NIH research results in the introduction of life-saving drugs and vaccinations, providing investment returns many times larger than the long-term average return on stocks. These investments are essential to America’s highly successful biotechnology sector, a sector responsible for about seven million jobs.1
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1. See National Institutes of Health, “Our Society,” https://www.nih.gov/about-nih/what-we-do/impact-nih-research/our-society.
Past investments in the nation’s infrastructure have paid off. For example, the Federal-Aid Highway Act of 1956 created our system of interstate highways, now covering 46,876 miles of highways. The Interstate System supported and transformed a booming American economy. Researchers have found that highway investments resulted in many benefits; about thirty percent of the productivity growth in the late 1950s could be attributed to road infrastructure.10
However, in 2017, the American Society of Civil Engineers gave the country’s infrastructure a grade of D+, and estimated that raising that grade one level would require a total investment between now and 2025 of $4.5 trillion. Given current budget proposals, it’s unlikely that even America’s fifty-six thousand “structurally deficient” bridges will be repaired. At present, the vast majority of infrastructure funding comes from local and state governments; only 25 percent of spending in 2014 came from federal sources.
In contrast, China has made enormous investments in infrastructure. The government’s contributions to infrastructure constitute 9 percent of its economy. (The figure for the United States is 2.5 percent.) Chinese infrastructure efforts will soon link eight Asian nations under the auspices of the $1 trillion One Belt, One Road project. While some of these enterprises are highly indebted, Chinese infrastructure investments have also yielded impressive results.11
Education, research, and infrastructure are all areas where government funding could be usefully increased. And there are other fundamental factors that are inexpensive, yet essential. Sound macroeconomic polic
y can help steer the country clear of the harmful effects of recessions or unsustainable booms. The central bank plays a vital role here, but so does the US Congress (and the president), by avoiding deficits and debt in good times, so that deficit expansion is more feasible when recessions arrive.12 Adequate financial regulation is important to avoid systemic vulnerabilities and risk. And our legal and political institutions should be carefully looked after, with the enduring goal of assuring that they serve all Americans and not just elite groups.
The importance of solid fundamentals is difficult to overstate. People often argue that the mobility of international capital makes it difficult for high-wage countries to attract jobs and economic activity when they are competing with lower-wage countries. But the data tell a different story. For example, when US multinational firms send jobs offshore, a third of them go to high-wage countries in Europe, and many more in Canada, Japan, Australia and other rich countries.13
Why do US multinational firms send jobs to other high-wage, high-standard countries, when there are so many low-wage choices out there? In short, high-wage countries have high wages for a reason. Rich countries are home to productive workers, large consumer markets, stable institutions, and well-functioning infrastructure. If we keep these advantages, we need not fear losing the high-paying jobs that go with them.
Living in a modern, technologically sophisticated, global economy presents challenges. This chapter shows how to preserve the strengths that have made our economy so vibrant and successful. It is important to engage our trading partners and work toward improved trade agreements. But even more important, we need to give American workers tools to succeed in the global economy, we need to invest in our communities, and we need to nurture our fundamental strengths.
We also need to set rules of the game that are suited to a modern economy. The next chapter turns to one crucial aspect of these rules: the tax code.
Ten
A Grand Bargain for Better Tax Policy
Tax reform is long overdue. It has been more than thirty years since the last major US tax reform, and there is ample room for improvement. Our tax code is rife with inefficiencies and loopholes, it is not responsive to changes in the world economy, and it does not generate the revenue that we will need in the coming years.
The recent Tax Cuts and Jobs Act (TCJA), signed into law in the waning days of 2017, does not address these deficiencies.1 Despite being marketed as a tax reform, the TCJA was focused on tax cuts rather than reform. Because of the TCJA, deficit forecasts are larger, the tax system is less progressive, and in many respects the tax base is narrower, with more distortions and loopholes. The final section of this chapter will discuss this legislation in detail. In short, the need for tax reform is even larger after the TCJA.
It may seem puzzling to devote a chapter to taxation in a book about the global economy. Yet the tax system is a crucial tool for responding to the dramatic changes that have affected the American middle class in recent decades. Many forces have buffeted American workers, but diminishing those forces directly is often undesirable or infeasible. For example, both technological change and international trade come with large benefits for the middle class; restricting international trade, or discarding innovation, would more likely harm than help American workers. Also, countering market power, or changing social norms, would undoubtedly be a slow process.
The Budget Pressures of Our Aging Population
Prior to the TCJA, the Congressional Budget Office forecast that deficits will increase substantially over the next decade, from about 3 percent of GDP to over 5 percent of GDP, increasing debt to GDP ratios from 77 percent in 2017 to 91 percent in 2027.1 Such high debt levels raise the prospect of negative consequences in terms of worsening foreign accounts imbalances, higher interest rates, and reduced investment.
The upcoming increases in government budget deficits are attributable to greater outlays for Social Security and Medicare, due to demographic changes that have increased the ratio of retired citizens to workers. Spending on each program rises by more than 1 percent of GDP over the next decade.
The TCJA has worsened these budget pressures. The bill adds $1.5 trillion to deficits over the coming decade, as well as an additional $300 billion in debt service. As a result, the Congressional Budget Office forecasts that the debt-to-GDP ratio will rise to 98 percent in 2027.2
Figure 10.1: US Budget Deficits Are Growing Steadily Over the Next Decade, Due to Spending on the Elderly
Data source: June 2017 Budget Outlook Report, Congressional Budget Office.
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1. Congressional Budget Office, Update to the Budget and Economic Outlook, Report, June, 2017.
2. Congressional Budget Office, “Estimated Deficits and Debt under the Conference Agreement of H.R. 1,” January 2, 2018, https://www.cbo.gov/publication/53437.
The tax system is a large, consequential tool that affects the after-tax incomes of all Americans; it also shapes the economic incentives motivating all businesses and individuals. The tax system therefore provides a powerful means to respond to those in economic pain. Further, an improved tax system will lessen the distortions caused by our present tax system, making it easier to raise the revenue that is needed for the urgent investment priorities discussed in Chapter 9.
In this chapter, I describe a possible tax reform grand bargain that achieves several goals simultaneously. First, it helps Americans consistently benefit from the economic challenges of technological change and the global economy, ensuring that after-tax incomes rise for most Americans as GDP increases. Second, it reduces the distortions in the current tax system by taxing all types of income received by the same taxpayers in the same way. This reduces the gimmicks and shenanigans that litter our present tax system, raising revenue, reducing waste, and curtailing international profit shifting. Third, it includes a carbon tax; this key feature of the bargain will simultaneously respond to revenue needs, keep other tax rates low, and help save the planet. These three pillars will ensure a US tax system that is ready for the twenty-first century, and that is fair, efficient, and competitive.
Responding to the Challenges of the World Economy and Technological Change
As Chapter 2 described, US workers have not sufficiently benefited from the economic growth of the past thirty-five years. While GDP per person has increased by 60 percent, typical household income has increased by only 16 percent over the same period. This increase has fallen short of long-held American expectations about improving standards of living. While 90 percent of children born in the 1940s outearned their parents, only half of those born in the 1980s do.2
There are several ways in which the tax system can respond to these economic challenges. The federal income tax, unlike the payroll tax and most state sales taxes, is strongly progressive. But more could be done through the tax system for low-earning workers. At present, low-wage taxpayers qualify for the earned income tax credit (EITC), which is fairly generous if one has children; for example, a single taxpayer with two children qualifies for a maximum tax credit of about $5,600. However, earners without children get much smaller tax credits.
The earned income tax credit has strong political support from thinkers and policy-makers on both the right and left; for low-wage workers, it increases the incentive to work, and for firms, it provides a stronger inducement to hire such workers. At low incomes, the credit provides additional rewards for working, as a worker with two children receives forty cents for every dollar earned. Past a certain income level, however, the credit is phased out. A parent of two children earning income between $18,340 and $45,007 loses about 21 cents of their prior EITC for each dollar earned.
As the figure shows, the EITC is far more generous for earners with children than for childless workers. This additional generosity may be justified by the higher costs of raising children and the higher poverty rates for children than for the population as a whole. The EITC has been effective at reducing poverty for f
amilies—as has the child tax credit, which allows most tax filers to reduce their tax bills for every child they claim as a dependent.
Figure 10.2: The Earned Income Tax Credit is Far More Generous for Parents
Data source: 2017 EITC parameters, Tax Policy Center.
Still, the earned income tax credit could assist more workers living in poverty if it were more generous toward the childless. The earned income tax credit could usefully be expanded in several ways: by increasing the credit percentage for workers without children, by increasing the thresholds up to which the earned income tax credit can be earned for all taxpayers, and by limiting the phase-out of the tax credit, helping middle-class taxpayers who are higher in the earnings distribution.
These changes would make the tax system more suited to our modern global economy. On its own, our economy has not ensured that all groups benefit from economic growth. Over the past thirty-five years, gains in GDP have mostly accrued to those in the top 10 percent of the income distribution, while those in the bottom half have faced wage stagnation and unfulfilled expectations. We have tax policy tools that are capable of countering these increases in inequality. A more progressive tax system can help society share the prosperity associated with economic growth.
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