taxes

To fix economy, must all share in pain?

John GrahamThe presidential election has come and gone, but the nation's economic challenges remain. The pressure is now on President Barack Obama and Congress to resolve important tax and spending disagreements before the nation plunges over a "fiscal cliff," which experts say could bring on a new recession.

John Graham, the D. Richard Mead Jr. family professor at the Fuqua School of Business at Duke University in Durham, N.C., believes the nation's economic woes will not be solved unless everyone shares the pain. He outlines his thoughts in this interview.

From an economic perspective, how do you view the tug of war between raising taxes to cut the deficit on one side, and the risk that higher taxes will jeopardize the economic recovery on the other side?

Higher taxes on those with income greater than $250,000 probably would slow economic growth a little. But the bigger problem is that many small firms now operate as "pass-through entities," which means that they are taxed as individuals. Thus, raising personal tax rates will hurt those businesses. This would hurt growth prospects and hiring, but probably only moderately.

How do you solve the tax dilemma of 'the rich need to pay more' in taxes while nearly half of U.S. households pay no federal income taxes?

You can't really solve this -- everyone has to pitch in. (A) few important points:

  • You cannot possibly tax the rich enough to fix the budget deficit. There are not enough of them, nor do they earn enough in aggregate. Yes, the rich have to pitch in by paying more in taxes, but that is only one prong of the solution.
  • You probably can't tax low-income people -- those not paying taxes now -- much, if at all. Their "contribution" to the solution will be in the form of reduced benefits that everyone has to accept -- that is, broad-based spending cuts and entitlement reform.
  • The only solution is aggressive spending cuts along with tax revenue increases. Everyone has to share the pain. Something along the lines of Bowles-Simpson. (Editor's note: "Bowles-Simpson" refers to the National Commission on Fiscal Responsibility and Reform, an entity established by Obama to find solutions to the nation's most pressing fiscal challenges.)

Is there merit to a flat tax?

Not much. In theory, a flat tax that reduces taxes would boost economic growth. Would it boost growth enough to make up for lost tax revenues? Probably not.

Would cutting corporate taxes boost employment and the economy?

Yes. Corporations pay little tax now, so cutting taxes would not result in too much lost revenue. Yes, it might create enough economic growth, business spending and hiring to more than compensate for these lost revenues.

We would like to thank John Graham, the D. Richard Mead Jr. family professor at the Fuqua School of Business at Duke University in Durham, N.C., for his insights. Questions for this interview were contributed by Greg McBride, CFA, senior financial analyst for Bankrate.com.

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