To create growth, unleash the invisible foot

March 1, 2013

Across the political spectrum, there is a growing recognition that while short-term battles over government spending are important, they would be far less ferocious and intense if our economy were growing at a faster clip. But while conservatives and liberals alike clamor for more growth, they disagree about how to produce it. The key is unleashing what the economist Joseph Berliner once called the “Invisible Foot,” the neglected counterpart to Adam Smith’s “Invisible Hand.”

Before we turn to the Invisible Foot, let’s think through the prescriptions for growth offered by Democrats and Republicans. President Barack Obama and his Democratic allies often argue that substantial increases in public investment will deliver robust growth. Republicans, in contrast, emphasize the notion that reductions in marginal tax rates will spur growth by increasing the incentives to work and invest. These approaches are obviously far apart, yet they face at least two common obstacles. First, the aging of the population and the high cost of health entitlements severely limit the government’s ability to increase spending or cut taxes. Second, advanced economies have by definition already taken advantage of the most obvious sources of productivity growth and so are forced to innovate to find new sources of productivity growth. And innovation is a trial-and-error process that is far more expensive and arduous than simply following the leader.

So the question of the day isn’t whether we want growth (yes, we want it badly) or whether we can dramatically increase public investment or dramatically cut taxes (neither strategy is in the cards). Rather, it is whether there is anything we can do to make the American economy friendlier to the kind of risk-taking and innovation that will eventually yield productivity gains without breaking the bank.

Enter the invisible foot. Despite sluggish growth, large U.S. business enterprises have fared reasonably well in the post-crisis years. Corporate profits after taxes have hovered around 10 percent of gross domestic product, almost twice as high as they were during the Reagan years. High corporate profits aren’t an intrinsically bad thing. Yet we’d normally expect that they would over time be reduced by competition from new entrants enticed by the prospect of making their own fortunes. This invisible foot of new competition is what drives incumbent firms to either step up their games ‑ a process that often involves burning through stockpiles of cash and shrinking profits ‑ or go out of business.

Unfortunately, this reallocation of resources ‑ from inefficient incumbents to innovative upstarts and the incumbents that manage to keep up with them ‑ stops when incumbent firms succeed in erecting regulatory and legal barriers to shield themselves against competitors, which is why regulatory reform and patent reform are so important. It is also why we ought to take care not to give large incumbents any undue advantages in our tax code.

As it turns out, the U.S. tax code does give large incumbents an enormous advantage over start-ups by subsidizing corporate debt. When businesses want to raise money for operations, they can pour their profits back into the business, they can sell shares or they can borrow. In an ideal world, we’d want business enterprises to make these decisions on the basis of what makes the most sense based on underlying economic conditions. But in the United States, we allow companies to deduct interest expenses from their taxes but not dividends on their stocks. This makes it far cheaper for companies to raise money by borrowing than by selling shares.

One reason this debt bias is a problem is that it leads companies to take on large amounts of debt, which raises the risk that they will go bankrupt. Yet there is another problem: It is much easier for some companies to borrow than for others. Specifically, well-established firms ‑ for example, large incumbents with pricing power that have been around for years ‑ find it much easier to borrow than new, unproven firms with high-growth potential, which have little choice but to rely on selling shares to finance investment. And so the tax-deductibility of interest expenses and not dividends gives the entrenched corporate Goliaths that have the option to borrow a big boost, while doing nothing for the would-be corporate Davids eager to take them on.

With this in mind, Robert Pozen of the Brookings Institution and Harvard Business School and his research associate, Lucas Goodman, have devised an ingenious plan to level the playing field. First, they call for cutting the corporate tax rate from 35 percent to 25 percent. This lower statutory rate will make the U.S. a much more attractive destination for profitable investment projects, particularly since our current corporate tax rate of 35 percent is the highest in the industrialized world. To finance this substantial cut, Pozen and Goodman propose a modest 60 percent to 85 percent cap on the amount of interest companies can deduct from their tax bills, sharply reducing debt bias and keeping the proposal revenue-neutral. Firms that rely heavily on debt would cry foul, and for some the process of reducing debt levels would be painful. Yet start-ups that don’t have the option of raising money by taking on enormous amounts of debt would find themselves at far less of a disadvantage. The end result could be an entrepreneurial renaissance, as lumbering corporate dinosaurs that had used cheap credit to scare off competitors are forced to reckon with innovative new rivals.

And if reducing the debt bias really does encourage start-up activity, the implications for employment levels could be significant. As the economists John Haltiwanger, Ron Jarmin, and Javier Miranda have observed, start-ups and young firms make a substantial direct contribution to creating jobs. Yet they can also make an indirect contribution to job creation by forcing incumbent firms out of their defensive crouch and into a fight to retain and gain market share. Consumers will also stand to benefit from this kick of the invisible foot as competition forces down prices and gives rise to entirely new products and services.

There is obviously no guarantee that reducing the tax code’s debt bias will be a silver bullet for economic growth. But Pozen and Goodman’s plan has enormous upside potential and, if designed with care, wouldn’t add a dime to the deficit. It would be foolish not to give it a try.

PHOTO: Footprints mark a snow-covered field in Warngau January 26, 2012. REUTERS/Michael Dalder


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The big foot can also be seen in action when corporations are not saved by free money from the Fed or bailouts from Uncle Sam and the Fed. It would be nostalgic to have companies exist in a capitalist environment and not a crony capitalist one. You know – let real companies be formed and prosper because risk is offset by reward for those that are determined and smart vs. those who are lazy, stupid, and corruptly connected.

Posted by keebo | Report as abusive

To create growth, force the wealthy to reverse the past 30+ years of tax, trade and banking legislation that benefits only their own class at expense of this nation.

As to the “invisible foot” mentioned in your article, perhaps a better term might be “invisible bullshit” of this grossly inaccurate comment.

“The key is unleashing what the economist Joseph Berliner once called the “Invisible Foot,” the neglected counterpart to Adam Smith’s “Invisible Hand.”

This is nothing more than a self-serving distortion of the truth, which is what the wealthy prefer you believe.


From Wikipedia, solely for ease of access:

“Smith used the term “the invisible hand” in “History of Astronomy”[75] referring to “the invisible hand of Jupiter” and twice – each time with a different meaning – the term “an invisible hand”: in The Theory of Moral Sentiments[76] (1759) and in The Wealth of Nations[77] (1776).

This last statement about “an invisible hand” has been interpreted as “the invisible hand” in numerous ways.

It is therefore important to read the original:

As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can.

He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it.

By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other eases, led by an invisible hand to promote an end which was no part of his intention.

Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.”


“Those who regard that statement as Smith’s central message also quote frequently Smith’s dictum:[78]

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.

We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.

Smith’s statement about the benefits of “an invisible hand” … shows Smith’s belief that when an individual pursues his self-interest, he indirectly promotes the good of society.

Self-interested competition in the free market, he argued, would tend to benefit society as a whole by keeping prices low, while still building in an incentive for a wide variety of goods and services.

Nevertheless, he was wary of businessmen and warned of their “conspiracy against the public or in some other contrivance to raise prices.”[80]

Again and again, Smith warned of the collusive nature of business interests, which may form cabals or monopolies, fixing the highest price “which can be squeezed out of the buyers”.[81]

Smith also warned that a business-dominated political system would allow a conspiracy of businesses and industry against consumers, with the former scheming to influence politics and legislation.

Smith states that the interest of manufacturers and merchants “…in any particular branch of trade or manufactures, is always in some respects different from, and even opposite to, that of the public…

The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention.”[82]


In other words, Adam Smith warned us about the very people who are promoting a gross distortion of what he meant by capitalism.

EVERYTHING the wealthy are telling you about capitalism is a LIE.

Posted by PseudoTurtle | Report as abusive

The American playing field is definitely warped against small businesses and in favor of large corporations. There can be no doubt about it.
Big US corporations are more successful than smaller ones due to globalization as well: Bigger US corporations can find more business opportunities abroad (including workers, contractors, markets, partners, etc.) as well as hide more of their profits from the IRS in offshore ‘subsidiaries’, ‘affiliates’, etc.
There is some political awareness to this major economic problem, and the new laws making it easier for smaller companies to raise capital should help, hopefully. If they don’t, economic growth would continue to be hampered.

Posted by reality-again | Report as abusive

If you want to encourage start-ups you need to remove the expenses unrelated to operating the business. The biggest is employee medical. There is no reason your employer should be involved in your medical, it would be much better handled by the government (as nearly every industrialized nation has realized). The lawyers need to be reigned in. The threat of burdensome lawsuits is a major drag on firms and one slip and fall jackpot can put a business under. Then there is student loans; you have a whole generation that is forced in to the employment marketplace and locked out of entrepreneurship because they can’t take a chance due to their massive loan payments that cannot be written off in bankruptcy. If we made education less burdensome for even the 10th percentile of every graduating HS class it would create a bigger pool of potential business owners.

Posted by anarcurt | Report as abusive

First consider this.

Largest Ten Countries ranked by population:

1. China 1.3 billion people
2. India 1.2 billion people
3. United States 315 million (growth is now skyrocketing due to immigration)
4. Indonesia 237 million (Obama lived there in his grade-school years)
5. Brazil 193 million
6. Pakistan 182 million
7. Nigeria 166 million
8. Bangladesh 152 million
9. Russia 143 million
10.Japan 127 million ntries_by_population

This article by Reihan Salam conveniently ignores the largest force affecting America today: globalization and immigration.

You keep assuming, in a treasonous way, that economic growth is the desired end.

But a Hypothetical question: What if growth were to come at the expense of every American family, hypothetically, being evicted from their home, and in their place, a Chinese, or Indian, or Indonesian, or Brazilian, or Mexican family is given the home?

Certainly, all the economic indicators of America would skyrocket if we moved just half of the 1.3 billion Chinese people, half of the 1.2 billion people of India to America, and half of the 237 million people of Indonesia, into America and granted them citizenship.

Yes, Mr. Salam, the official economic indicators of America, e.g. GDP, and national income, and new jobs created, would indeed go way up. And many of America’s wealthiest would even profit from the mass immigration, because wage rates would plummet and rents would skyrocket.

But for the vast majority of American-born citizens, their families, lives and careers would be destroyed by the unlimited pool of impoverished workers who would work for any wage.

This is what articles like this one by Reihan Salam neglect to mention.

And by diverting the American people’s attention away from the current tidal wave of immigration, the massive purchase of American real estate by wealthy foreigners, the rapid outsourcing of American jobs, the planned great expansion of immigration next year, and the continuing H1B visa program, articles like this assist in the process of the conquest of America from the outside.

Posted by AdamSmith | Report as abusive

Or, looked at from a different, more proactive viewpoint, the American people need to use their “invisible feet” to kick all these greedy bastards out of our country, no matter what it takes.

Posted by PseudoTurtle | Report as abusive

There seems to be no limit to the goofy places that economists’ tortured logic will take them. The “Invisible Foot?” Here we are in the 21st century and this is what we get from the field of economics – the “Invisible Foot?”

The real problem has, for many decades now, been economists’ inability to distinguish true, healthy economic growth from macroeconomic growth, a large component of the latter being a malignant growth fed by nothing more than population growth. If the macroeconomy grows by 1%, but the population has grown by the same amount, no one is better off. In fact, all are worse off.

Because of their self-imposed blindness to the economic ramifications of population growth (no self-respecting economist dares risk being labeled a “Malthusian”) the field of economics is blind to the very real inverse relationship between population density and per capita consumption, and its implications for worsening unemployment, poverty and global trade imbalances. Economists can’t see that, beyond some critical population density, while population growth continues to stoke total sales volumes and corporate bottom lines, the cost of dealing with rising poverty while maintaining an illusion of prosperity through deficit spending is bankrupting local and national governments across the globe.

Instead, the field of economics maintains its “see no evil” posture and dreams up things like the “Invisible Foot,” an idea that might have played well during the dawn of economics in the 18th century. Are we really to believe that a revenue-neutral reshuffling of the tax code will spawn some sort of economic renaissance? Has no one noticed that the economies of those countries with lower corporate tax rates are still dominated by the same global mega-corporations as the U.S.? Are we to believe that these corporations grew as they did by being sloppy and inefficient, instead of mercilessly boosting productivity by cannibalizing the competition and slashing redundant workers?

The cowardly refusal of the pseudo-science called “economics” to even consider the most dominant factor driving economic trends today makes it the laughing stock of the 21st century. This nutty idea is just one more example of why.

Pete Murphy
Author, “Five Short Blasts”

Posted by Pete_Murphy | Report as abusive

Or we could have the 47% pay their ‘fair share’.

Posted by Cogs | Report as abusive

great column with advice Obama will never follow since he hates the rich and business

Posted by jschmidt2 | Report as abusive

The far simpler solution is to lower corporate income tax rates to ZERO
Then tax dividends (and capital gains) at normal personal income tax rates.

Posted by BCanuck | Report as abusive

I suspect if we move as far as we can without sending the military into the streets to end such things as deductions for interest TO HOME OWNERS as well as to businesses; deductions for TAXES; unfunded entitlements of all kinds; public regulation not directly related to serious risks to life or health of humans; and then seeking to provide publicly funded anything by competitive means with beneficiaries choosing the means – in short everything we can do to make anyone with much stake in society as insecure as possible – we will all get off our behinds and work, and allow others to.

With sufficient abundance, most will win a satisfactory hare and the society as a a whole could actually support a VAT to keep the least well off in dignity.

Posted by johnwerneken | Report as abusive

An even better corporate tax plan would be a tiered tax rates by EBITAD levels.

Federal Income tax should be based on Earnings before Interest, Taxes and Depreciation. And it should be tiered just like individual tax rates. The first $million in EBITDAD at 10%, $10 million at 10% all the way up to over $1 billion 25%.

Most companies create accounting losses (and thus no income tax) by using debt and depreciation (also here depletion allowance). The beauty of this tax plan is that very few companies will be able to avoid taxes, and those that don’t leverage up, don’t over pay for acquisitions (writing off goodwill), and don’t push revenues into off-shore tax havens (supposed foreign tax) will be on the same playing level tax wise as the GEs, Mercks, Exxons, etc. of this world.

Corporate Income tax used to provide over 1/3 of Federal tax revenues in the 1950s but today it is less than 15% – more than 50% drop. IT has been the middle class that have picked up the tab. Plus in the 1950s many corporations provided pensions which have nearly disappeared. Another cost push to the middle class. IN the meantime, executive pay has skyrocketed (even the Swiss can’t take it anymore).

When large multinationals pay more in lobbying DC than they do in Federal Income tax, then we all understand who really runs our government and tax policy. It has nothing to do with economics but with greed. The result has been a US economy that is too leveraged, too reliant on old entrenched industries (oil, mining, agriculture, autos, and finance) to the detriment of the small entrepreneur who is really creating jobs of tomorrow.

Posted by Acetracy | Report as abusive

Corporate Federal Tax of 15% for the first $50K earned should be raised to $250K. Top Corporate rate should be 30%. Most states tax us another 10%+ (e.g. California).

Posted by robb1 | Report as abusive

Wise up all the things the consumer buys that can kill or hurt him that he has little knowledge of need regulation. We need building codes as shown by death tolls in areas with reasonable ones and enforcement during earth quakes, medicines is another example.

We can make the market place more completive by trust busting firms more than double economic scale and giving firms less than half economic scale incentives to merge.

The question is who determines what economic scale is in any line of bossiness.

Posted by SamuelReich | Report as abusive

As more things get more technical than consumers or salesmen who became a CEO knows about, there needs to be regulation to make sure people do not get killed, hurt or bankrupt.

Examples: Nuclear energy, toxic material (remember asbestos), medicines and medical devices, Building or all sorts need building codes so they do not fall in earth quakes, catch fire from bad wiring, the radio spectrum needs to be regulated or just have noise not cell phones. As the salesmen think up more odd securities and deals they have to be regulated.

Posted by SamuelReich | Report as abusive

Lowering the corporate tax would be a good start, but true tax reform is really needed. I would suggest that a massive simplification of the system with flow through taxation (no deductions) may help. If capital gains and income were taxed at the same rates and there were no deductions allowed, you could possibly talk about eliminating corporate taxes. A flat tax would seem to me to make sense, but will likely never see the light of day. I may be wrong, but if corp taxes were dramatically lowered, you would see a huge influx of companies into the US and significant new business growth.

But there are many other issues besides taxes, not the least of which is the incredible level of regulations that businesses must deal with. Leveling the playing field for small business will take more than tax reform.

Posted by AuAgExpl | Report as abusive

Excellent article. Sometimes the simplest ideas are the best. And while not a cure-all, it represents a step in the right direction.

Posted by changeling | Report as abusive

A little “Deflation” would be good for everyone and the economy.

Posted by 1MTLMAN | Report as abusive

This idea is silly. It’s just another tweak to the current tax code. If you want real change/reform, eliminate all taxes on commercial activity, eliminate all flat taxes, eliminate all deductions and exemptions for individuals or sole proprietorships eliminate the distinction between so-called capital gains and ordinary income, and tax individuals progressively on a very steep tax rate schedule like the schedule in 1954.

These changes would increase tax revenue, stimulate economic growth, end the distortion of economic decision-making that the interest and depreciation deduction cause, eliminate or reduce “financial engineering” as a form of entertainment for the wealthy, simplify the tax code, streamline the IRS (which is already very efficient, if not very effective – but that’s about Congress’ tax code). Such changes would attract businesses and, contrary to some arguments, not drive wealthy individuals away. Where would they go? Columbia? Jamaica? The Caymans? Chad? Kenya? Please… These changes would also eliminate of non-productive work for such highly skilled and intelligent professionals as lawyers and accountants, thereby, driving them into productive employment and enormous economic waste that this work entails. They would reduce significantly or eliminate the need for the IRS to sue companies for tax avoidance (they do this a lot, btw) and redirect their efforts to collecting taxes in a straightforward way. Last, they would reduce significantly or eliminate incentives for businesses to lobby Congress, the Executive Branch and the Judiciary (yes, the Judiciary…) for favorable tax treatment under the tax code. Think about the productivity improvements you would see in Congress. Think about the how these changes would reduce the advantages that established companies have over new competitors and small businesses who can’t lobby for special treatment or that can’t take advantage of the interest deduction until they’ve established credit. The imbalance between the cost of debt and the cost of equity would shrink to a small premium for debt (no benefit of ownership or control with debt).

So, that’s it: eliminate taxes on business, flat taxes and tax individuals without exemption or deduction at aggressively progressive rates.

Posted by thoughtful02 | Report as abusive