How Does U.S. Tax Policy Affect Our National Competitiveness Strategy?

The U.S. tax code enables the federal government to collect nearly $5 trillion in revenue each year. Its structure creates incentives that influence the financial and economic decisions of individuals and companies from small to large. Those actions in turn shape the country’s relative global competitiveness. To enhance competitiveness, changes to the tax code must:

• Foster domestic economic growth;
• Provide support for workers and their families;
• Bring in revenue to meet the nation’s spending needs; and
• Be both administrable and equitable.

These priorities are difficult to balance and indeed can clash. We evaluate each below in the broader context of global competition for U.S. workers and investments. Important considerations include tax rates and tax bases and the creation or reform of tax expenditures, provisions of the code such as credits, deductions, or exemptions that deviate from what experts consider a normal tax system and reduce tax liabilities.

Growing the Domestic Economy

As technology improves, business investment shifts toward easy-to-move but difficult-to-price intangible assets, and a significant proportion of Americans continue to work remotely, which alters how the tax code affects growth.

Economic growth has slowed in the U.S. in recent decades and is projected to slow even further in the coming years. According to the Congressional Budget Office, U.S. annual real gross domestic product growth averaged:

• 4.4% per year from 1950-1969;
• 3.2% per year from 1970-1989;
• 2.6% per year from 1990-2009; and
• 2.1% per year from 2010-2022.

Concerns about U.S. competitiveness and economic growth drove passage of the bipartisan CHIPS and Science Act in 2022, which provided a 25% tax credit for domestic manufacturing of semiconductors critical to computers, cars, and energy infrastructure, among other incentives. Senators have begun work on follow-up legislation to invest “in domestic industries, including small businesses, that can reduce reliance on China” and increase U.S. competitiveness.

Policymakers must square these kinds of supports—which often involve expanding business tax incentives to capture more private investment than economic allies or adversaries—with the need to address America’s sizable fiscal challenges. After all, persistent federal budget deficits and a ballooning federal debt also threaten U.S. competitiveness.

Congress can support growth and make a dent in the deficit by reforming narrowly targeted tax incentives, splitting the savings between deficit reduction and an array of broad-based policies to support workers and businesses.

Providing Support to Working Families

The tax code also plays a critical role in providing financial support to American workers and their families, from the Child Tax Credit (CTC) and Earned Income Tax Credit (EITC) to child care supports like the Child and Dependent Care Tax Credit (CDCTC) and tax-advantaged dependent care assistance programs (DCAPs) to incentives affecting child care access, housing supply and health care affordability.  These supports are critical to U.S. competitiveness: the spillover effects can create societal benefits beyond the households they serve, such as improving health and educational outcomes, incentivizing participation in the labor force, and even generating an increase in tax revenues over time to partially offset the tax credits’ cost. Such improvements to society can also contribute to long-term economic growth and worker productivity.

Tax credit expansions can push labor supply in the opposite direction, disincentivizing work, so policymakers must balance proposals to significantly expand these credits with potential effects on labor supply. As lawmakers debate expanding the CTC, for example, they should consider reforming the credit to boost financial support for low-income families while retaining incentives for caregivers to work. Maintaining and expanding these credits, in tandem with pro-growth policies, can grow the economy and improve U.S. economic competitiveness in the long term.

Minding Fiscal Responsibility

According to CBO’s latest budget and economic baseline, federal revenues are projected to average 18% of GDP over the next decade (Fiscal Years 2024-2033) while federal spending is projected to average 24% of GDP. This gap (6% of GDP) will exacerbate budget deficits and grow the federal debt by more than $20 trillion (from 98% of GDP to 119% of GDP) over the next decade alone.

There are political obstacles to cutting spending and increasing revenues, but federal lawmakers will need to do both if they are to comprehensively address long-term fiscal imbalances.

As BPC previously wrote, a growing national debt threatens U.S. global competitiveness by limiting private investment, depressing labor market productivity, curtailing public spending on critical programs necessary to drive competitiveness, and handcuffing our ability to respond to the next global challenge, be it a public health emergency or threat from a geopolitical adversary.

Improving Administrability and Equity

Too often, policymakers design tax policy with economic or social goals in mind and pay little attention to the administrability of and complexity in the tax code. According to the National Taxpayers Union Foundation, taxpayers (both individuals and businesses) spent 6.5 billion hours complying with the tax code and filing their taxes in 2022, with a combined out-of-pocket and opportunity cost burden of $364 billion.

Credits, deductions, exemptions, and cost-recovery provisions add to this compliance burden and could harm U.S. competitiveness, affecting businesses’ decisions on where to invest and hurting economic productivity. In general, policymakers should design tax policy that simplifies the tax code and makes filing taxes as easy as possible.

Policymakers should also mind equity in the tax code. Progressivity in the tax code is the notion that taxpayers with higher income should pay a higher proportion of their income in taxes than taxpayers with lower income. The individual side of the tax code has generally adhered to this principle for decades, and should be maintained in years to come.

It will also be important for lawmakers to pursue initiatives—from reducing the nation’s tax gap to retaining current immigrant workers and attracting more high-skilled immigrants—that can enhance federal revenues and grow the economy with fewer downsides than new or increased taxes.

Conclusion

A competitive U.S. tax code should foster economic growth, support workers and their families, bring in enough revenue to meet the nation’s spending needs, and ensure tax provisions and benefits remain administrable and equitable. Adhering to these four principles—or balancing them as best policymakers can—will be difficult, but key to ensuring the U.S. continues to compete for workers, investments, and innovations that will define the remainder of the 21^st century.