Economy needs both reform and investment

One way President Obama can begin to put the IRS scandal behind him is by proposing comprehensive tax reform. Beyond the usual Washington theatrics, the real problem is that the U.S. tax code is unbelievably complicated, clocking in around 74,000 pages, with all rulings, regulations and other material. The greater the complexity, the broader bureaucrats’ powers to determine the status of an individual, corporation or association. A radically simplified tax code, even one that raised more revenue, would be good politics and good economics.

The U.S. tax code is at the heart of a system of institutionalized, legal corruption. The code is so vast because companies, industries and lobbying groups receive special preferences in return for campaign contributions, a cash-for-favors scheme that Washington would denounce as crony capitalism in any Third World country.

You can see the corruption at work in the fierce opposition to efforts to lower the corporate tax rate. After demanding this reduction for years, companies are now lobbying hard — and spending heavily — to retain their own special tax breaks, which is what drove rates up in the first place.

Corruption aside, consider the economic costs of the gargantuan tax code. At 4 million words, it is multiple times larger than those of France and Germany. In 2010, Americans spent $168 billion to comply with the code. Last year taxpayers made 90 million calls to the IRS toll-free telephone number asking for help.

In the World Bank’s 2013 “Doing Business” report, the United States ranks a woeful 69th in the category of paying taxes. In Michael Porter’s survey of 10,000 graduates of Harvard Business School, published in January 2012, the U.S. tax code was named the biggest drawback to doing business compared with other countries. Respondents recommended “simplifying the code” five times as often as they suggested “reducing taxes.”

In our ongoing, spirited debate about austerity programs, the data are increasingly convincing that the Keynesians have been right. As someone who has long been advocating big investments in infrastructure, job-training and science, I’m delighted. But the case against austerity is turning into the case against reform. Some of the most eloquent anti-austerity voices — including Paul Krugman in his influential blog — are dismissing the idea that there is any need for structural reforms, that these are effectively plans that will hurt workers and help greedy capitalists.

But the record of the past several decades shows that structural reforms — often induced by a crisis — have been a crucial path to growth. After the Asian economic crisis, the countries that opened up their economies grew strongly. Chile’s reforms in the 1980s and 1990s set the stage for its long boom. Mexico’s reforms over the past decade are paying off. One of the reasons that rich countries such as Canada, Germany and Sweden are doing so well these days is that, in the wake of their own economic crises in the 1990s, they undertook major, market-friendly reforms and made their welfare states more sustainable. Surely these changes in policy were relevant to the countries’ subsequent success.

In Europe, countries such as Greece and Italy will not get sustained growth simply from stimulus spending and easy money. Most have rigid labor markets, high labor costs and inefficient and protected industries and guilds. Without change, these economies might get a temporary boost but will remain uncompetitive in the long run. Italy ranks 73rd on the “Doing Business” survey — behind most emerging markets. In Greece’s vast state-owned industries, workers used to labor for 35 hours a week but were paid for 14 months a year and could retire with full pensions in their 50s. Did none of this have to change?

The story of Japan’s stagnation over the last two decades is complicated. But some part of Japan’s failure to sustain growth was that it never reformed its protected industries, agriculture and retail chief among them. Between 1991 and 2008, the Japanese government spent $6.3 trillion on construction, more than the total size of its economy. That’s why Prime Minister Shinzo Abe has been clear that to enable Japan to sustain its current revival, he wants to make the changes that his nation was unwilling to make in the last decade.

It is true that many of the people urging austerity programs were also urging countries to engage in structural reforms. But the two are not connected. Is it possible to be in favor of investment andreform. In fact, that’s exactly what the United States needs to ensure the next generation of growth.