Tax Policy, Deficit Reduction Keys to Strong US Economy

EVEN with recent good economic news leavening the bad, the pressure will still be on for the new administration and Congress to implement quick measures to boost the American economy.

The problem with many of the actions that could be taken is that they would raise the already horrendous deficit, spook jittery financial markets, and actually reduce long-term economic growth and creation of high-paying jobs.

The United States can't afford more deficit-creating, anti-growth policies. Our economy's rate of productivity growth is half what it was 20 years ago. Real wages have virtually stagnated, and many families have had to scramble hard just to keep up. The failure after 1973 to match our historical long-term productivity growth rate costs Americans about $1.4 trillion, or $5,400 each year - and that's per capita. This has happened because we - governments, businesses, and individuals - have used too much of

our income and resources to consume today rather than invest for tomorrow.

The current taxing, spending, and deficit-creating policies of the federal government have diverted resources that could have been used for productive investment. In the private sector, we have not increased the stock of equipment, plant, research, and technology enough to both raise real wages and remain competitive internationally.

Ironically, we can craft a sensible, workable, and politically acceptable program that reverses the long-term economic slide. With signs of recovery picking up speed, and with President-elect Clinton focusing more squarely on deficit reduction, we can take bold actions.

Such a comprehensive program should first take into account what every business knows: Investment must be affordably financed. So the first part of a national economic-recovery strategy should increase national saving, which is the difference between what we produce as a country and what we consume. Our national saving collapsed in the 1980s from more than 8 percent of national income to about 3 percent. We need to get it back up through long-term deficit reduction.

I'm concerned about a newly fashionable argument that it is appropriate to finance investment (as opposed to consumption) through larger deficits, without increasing saving. Current long-term interest rates of 4 percent to 5 percent - twice the level of the 1950s and 1960s - signal the futility of that policy.

Larger long-term deficits, even to finance investment, mean swollen trade deficits, high-cost money, trouble for our export industries, and renewed calls for protection. We should not repeat the mistakes of the early 1980s.

TO increase saving we need to reduce government spending by cutting back federal entitlements - Social Security, Medicare, and Medicaid. Social Security benefits should be taxed equivalently to private pensions, and the scheduled increase in the retirement age should be phased in more rapidly.

The growth of the major health-care programs (Medicare and Medicaid) must be slowed in the context of comprehensive health-care reform, and we must only consider reform proposals that are fully and credibly financed.

Entitlement programs in such areas as agriculture should be terminated if they don't fulfill a real need. Defense spending can and should be reduced without endangering national security, and the resulting savings should go directly to deficit reduction.

A presidential line-item veto, or enhanced recession authority, would help to hold down domestic spending. But if spending cuts are not enough, we will need to increase revenue. Such increases should be directed as much as possible at consumption rather than at private saving and investment, and should be levied on the broadest base possible.

Freeing resources for investment is only the first step. These scarce resources must then be effectively used to invest in growth. We should take a hard look at tax subsidies for residential housing. Currently our capital markets tend to over-allocate resources to housing investment through generous mortgage interest deductions.

Policymakers should consider the possibility of coupling a tax credit on incremental equipment investments with a gradual reduction in the home mortgage interest subsidy and eliminating interest deductibility on second homes and home-equity loans. This would help level the playing field on which investment decisions are made.

Since economic growth depends on investment in research and technology, the research and experimentation tax credit should be made permanent, R&D investments should be depreciated more rapidly, federal support for basic research increased, and government support for "generic," precompetitive research continued.

Our investment in human capital cannot be emphasized too strongly. The quality of schools and work force will determine whether the other investments we make create productive and well-paying jobs.

The problems are solvable if the required spending cuts and tax increases are enacted. Get the priorities straight and prosperity can be restored.