Taxes, Patents, and Money: Three Proposals

November 17, 2014 • Cato Online Forum

I have no prejudice against silver bullets. It is conceivable that in some times and places, one simple reform would work wonders for an economy. It is even conceivable that ours is such a time and place. I just can’t think of any such reform. So instead of proposing one I will make three suggestions that I think would raise average growth rates over the next few decades. We should reduce the taxation of business investment, rein in the abuse of patents, and adopt a level target for nominal income.

Our tax system discourages companies from investing in the U.S. Our corporate tax rates are a particular problem: the statutory rate is high for the developed world, and my colleagues at the American Enterprise Institute tell me that the effective average and effective marginal rates on investment are high relative to the developed world even after accounting for loopholes.

My top priority in reforming business taxation would be to allow companies to write off the full cost of an investment in the year it incurred the expense, while scaling back the tax break for corporate interest payments. That step would reduce the tax code’s bias toward debt over equity in corporate finance, while also making the U.S. a more attractive destination for capital. More investment in the U.S. should make our workers more productive and better paid.

It would also be worthwhile to bring the corporate tax rate down to the extent budget constraints allow it. Indeed, I would favor any steps to reduce the tax code’s bias against investment and saving. The goal should be to move toward something like the “X tax,” because it would do less to discourage saving and investment than our current code, and thus increase growth, and less to distort the allocation of resources as well.

Protections for intellectual property are supposed to promote innovation. While debate among specialists over the proper contours of that protection continues, it appears that aspects of our system are perversely reducing innovation. Low‐​quality patents on software and business methods appear to have generated a lot of rent‐​seeking litigation, diverting resources away from productive activity. Scholars suggest that patents in these areas are particularly conducive to this kind of abuse because of their inherently “fuzzy boundaries.” We have inadvertently created a system that creates an incentive to acquire vague patents for the purpose of opportunistic litigation.

It is a growing problem, and it is not easy to see how the abuse of these patents can be fixed. Barring such a solution it would be best to return to our earlier practice of not recognizing patents in software and business methods. Pieces of music can be copyrighted but not patented; the same should be true of programming code. Congress could, for example, exclude from patent protection those industries where it is hard for companies to discover what patents they might be infringing.

In thinking about the country’s long‐​term growth prospects, we tend to distinguish between cyclical and structural issues, concentrate on the latter, and group monetary policy with the former. That habit is inappropriate today, because we have an approach to monetary policy that seems likely to increase the probability and severity of recessions and to slow down recoveries—and thus to make growth over long periods lower, on average, than it could be.

The Federal Reserve seems to want to keep inflation between 1 and 2 percent annually. When the economy experiences a negative shock or the Fed tightens policy in what turns out to be an excessive manner, that means nominal interest rates have to go significantly below zero. And the experience of the last few years suggests that the Fed faces, or feels, serious constraints in rescuing depressed economies using means other than lowering interest rates.

One way of reducing the risk of getting into this situation is for the Fed to adopt—or be instructed by Congress to adopt—a target path for nominal spending. It would commit, that is, to ensuring that nominal spending rose by, say, 4.5 percent a year, and to return to that path after any deviations from that trend in one year (so that a 4 percent year would be followed by a 5 percent one).

The expectation of a return to trend would help, in the case of a shock, to set a floor under spending, interest rates, and inflation. Indeed, that expectation would reduce the risk that a serious demand shock would happen in the first place. (A level target for prices could accomplish that goal as well as a level target for nominal spending, but the latter is preferable because it implies more appropriate responses to supply shocks.) That target would be compatible with keeping the average inflation rate over the business cycle within the narrow band the Fed currently favors, but the rate would move up and down counter‐​cyclically.

Increased macroeconomic stability and monetary predictability should have modest microeconomic benefits as well, making it easier to make and co‐​ordinate long‐​term plans.

So: changes in tax policy, intellectual property law, and the monetary system. It is a grab‐​bag of different ideas, two supply‐​side reforms and one that could be characterized as a shift in demand management. Perhaps that’s just as well. We need to attack the problem of too‐​low growth on as many fronts as possible.

The opinions expressed here are solely those of the author and do not necessarily reflect the views of the Cato Institute. This essay was prepared as part of a special Cato online forum on reviving economic growth.

About the Author

Ramesh Ponnuru is a senior editor for National Review and a visiting fellow at the American Enterprise Institute.