Stimulus 4.0 needs to kick off a real, sustainable recovery. Here's how to make it happen

The first three “stimulus” packages from the federal government were necessary to provide a safety net to the U.S. economy but were insufficient from the perspective of stimulating sustainable growth.

The government can (and likely will) write more checks to households and small businesses to help keep liquidity issues from becoming solvency crises, but this approach inherently remains a short-term fix to a longer-term problem.

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So, what should we do if, in fact, the main goal of a potential fourth stimulus package is to stimulate a sustainable recovery? Assuming the government is willing to increase its already substantial debt and deficit, how can it optimize the benefits of its spending?

A more sustainable approach is to give the private sector the support it needs to create real growth by stimulating hiring, investment, and spending – and the tax code may provide the mechanism of action.

Stimulate hiring

In March, the CARES Act established an employee-retention tax credit for businesses that have been adversely affected by the pandemic.  The $3-trillion HEROES Act, passed by the House in May, seeks to expand on that credit, though it would remain limited in magnitude, timing, and, most importantly, the set of employers that can claim it, i.e., those that have been adversely affected.

The problem with this approach is that it’s focused solely on employee retention by struggling employers and may just kick the can of unemployment down the road for a few months.

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Another approach would be to focus both on retention of those employees and on hiring the millions of other employees who are now unemployed.

A broad-based effort to lower and/or suspend (not just defer) employer payroll taxes would reduce the costs imposed on all organizations to keep their people, and, for many organizations, to hire the people who no longer have jobs.

To prioritize hiring those most in need, workers earning over a certain threshold could be excluded.  To prevent a windfall for larger companies that are not hiring, the benefit could be tied to net increases in their workforces.

Stimulate investing

Our economy needs broad-based investments that create long-term jobs and opportunities.  A large-scale, job-producing infrastructure bill would be helpful, but the government seems opposed to passing one.  From a tax perspective, then, we must create incentives for people to invest their own dollars in the future of our economy.

To do this, we need to free up capital and ensure that it is invested in new or existing businesses through a reduction in a main cost of investing – capital gain taxes.  People will always hesitate to deploy and redeploy capital if the tax on doing so is high.

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Conversely, by reducing the cost, we not only encourage investing but also allow for the redeployment of capital that cannot be freed up because of the cost of doing so.  To ensure that a reduction in capital gain taxes does not become a windfall for passive investors, a structure similar to, but broader than, the existing one for “qualified small businesses” could be established, applying a lower rate structure only to purchases and sales tied to investing in active U.S. businesses, however organized, under a certain size.

Stimulate spending

In addition to stimulating hiring and investing, we must stimulate spending.  This can again be done using targeted tax policy, some of which involves reversing provisions of the Tax Cuts and Jobs Act of 2017.

Most obviously, the deductibility of business-related entertainment expenses must be restored.  As it becomes safer to congregate in entertainment venues, it will be important to stimulate this industry, which has been among the hardest hit.

We must also restore the deductibility of interest on home equity loans and on mortgages up to $1 million.  Eliminating the deduction for interest on home equity loans and on newer mortgages over $750,000 may have been appropriate in 2017, but it’s not now.  If stimulus is what we want, we should enable and encourage more responsible debt-financed spending by those who have sufficient assets to back up their debts.

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Next, we must restore the ability to claim miscellaneous itemized deductions.  The loss of these deductions was widely felt, burdening many, from employees with unreimbursed expenses to taxpayers who need help completing their tax returns.  It also forced many into the standard deduction, eliminating their ability to itemize deductions (and their incentive to incur previously deductible expenses).  A similar argument can be made for eliminating the cap on deducting state and local taxes, as proposed by the HEROES Act.

Finally, there’s a need to reverse a position taken by the IRS that businesses qualifying for loan forgiveness under the Paycheck Protection Program cannot deduct the expenses funded by these loans. (The HEROES Act does attempt to reverse the IRS.) This might seem like a double benefit, but by disallowing these deductions, the IRS is imposing an unnecessary burden on the small businesses that have been hit the hardest.

How big and how long?

The magnitude, scope, and term of these policies can only be established by the elected officials who are responsible for the consequences of adding to our debt and deficit.  But enacting targeted tax provisions that are stimulative and not just remedial will put us all in a better position to address those consequences, hopefully when the economy is strong once again.

Michael Nathanson is chairman & CEO of The Colony Group.

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