25 Jul 2011

Countdown in Washington


As the August 2 deadline for resolving the debt- limit crisis draws ever nearer, Harvard Business School senior lecturer Robert Pozen offers a proposal that would cut spending and raise revenues in a way that would still appeal to many Republicans. At the same time, Professor of Management Practice Robert Steven Kaplan urges politicians to keep an open mind about the financial issues they face rather than take a blind but binding pledge not to increase taxes or close loopholes, no matter what.

Robert Steven Kaplan, Professor of Management Practice and author of What to Ask the Person in the Mirror: Critical Questions for Becoming a More Effective Leader and Reaching Your Potential

This blog originally appeared on www.hbr.org on July 22, 2011.

As we hear each day in the news, numerous politicians have taken a "pledge" not to increase taxes (this apparently includes closing tax loop holes). The presidential campaign is getting into full swing and each Republican candidate is being asked whether they have signed the "pledge." This is all in the context of a pivotal moment in our history — the culmination of many years of increasing federal government debt (including entitlements) as a percentage of gross national product.

I am not a political expert. I am a business person and a leadership professor. However, I do know this — successful business and non-profit leaders are not afraid to ask tough questions and face reality. They look at facts and adjust to them as things change. Globalization, technological innovation, and changing demographics are just some of the changes that private sector leaders must adapt to if they hope to succeed. A rigid adherence to a particular approach and refusal to adapt to changing reality ultimately leads to failure in the private sector.

Great leadership is not about having all the answers — instead, it is about asking the right questions, debating and being open to learning, and adapting as needed to achieve the vision and key priorities of your organization.

Why would we not hold our government leaders and ourselves to this same standard? Why would we want our leaders to presume in advance that certain key policy options are off the table? If a business did this, it probably wouldn't be around very long. Private sector leaders — the ones who are able to sustain success over the long term — know that being willing to ask uncomfortable questions, learn the truth, and avoid pre-ordaining the answers, allows them to stay in business and excel. They know that facing reality can cause them to change their minds — and that they must remain open to doing so.

I have a great deal of respect for our elected officials. I also have a lot of respect for any candidate throwing their hat in the ring to run for president. Because of my respect for these government leaders, I would like to urge all of us to hold them to a much higher standard. I expect them to face the facts, ask questions, keep an open mind, use their best judgment, and avoid ruling in or out key policy options. I have enough confidence in them that if they do their homework and use their best judgment, they'll make the right decisions for our nation. This is the proud legacy of our country — our leaders have historically faced reality, done their best and courageously made decisions based on their best analysis and assessment of facts.

I believe our leaders are up to this job. As a result, I would suggest that the next time you are assessing whether to vote for a leader who proudly says they took "the pledge," make sure it's The Pledge of Allegiance. Our country needs leaders who will strive to remain open to asking questions, facing reality, and finding solutions to tough problems — without worrying about who gets the credit or the blame.

Robert C. Pozen, Senior Lecturer of Business Administration and co-author of The Fund Industry: How Your Money is Managed

This blog originally appeared on www.washingtonpost.com on July 19, 2011.

In the negotiations on the debt ceiling, Vice President Biden initially pushed for a $2.4 trillion deal — with $2 trillion in spending cuts and $400 billion in revenue raisers. Although President Obama recently suggested a larger deal with higher tax rates for the wealthy, Republicans have uniformly rejected that idea.

Some moderate Republicans, however, seem willing to consider a package of revenue raisers that would reduce the economic distortions of the tax code by closing corporate loopholes and limiting expansive personal deductions. In a $2.4 trillion deal, here's how to put together a reasonable package of $400 billion in such revenue raisers over 10 years.

On the corporate side, Congress could raise a total of $150 billion over 10 years by adopting four measures:

First, Congress should eliminate the $60 billion tax subsidy for producing ethanol. This loophole has driven up the price of corn and other foodstuffs without decreasing the use of energy. It would be much more efficient for the United States to import low-cost ethanol from Latin America, where it is made from sugar cane.

Second, changing corporate accounting standards from LIFO (last in, first out) to FIFO (first in, first out) would raise $70 billion over 10 years. The rest of the world uses FIFO, which matches units sold by a company with the cost of the units it received first into inventory. This usually increases corporate profits because the price of inputs tends to rise over time. But the change in accounting methods would significantly benefit U.S. multinationals by harmonizing U.S. and global standards.

Third, Congress could raise $17 billion by taxing "carried interest" earned by investment professionals at ordinary income rates (35 percent) rather than capital gains rates (15 percent). Managers of hedge funds typically receive a base fee plus a carried interest equal to 20 percent of the fund's realized gains. Such carried interest constitutes incentive pay for these managers and should be taxed at ordinary income rates like other forms of compensation.

Fourth, Congress should eliminate the allowance for accelerated depreciation of certain capital expenses such as corporate jets. Although this is a rhetorical favorite of Democrats, it would raise only $3 billion over 10 years.

On the individual side, Congress could raise substantial revenue by imposing several limits on the mortgage interest deduction. Taxpayers are currently allowed to deduct mortgage interest on second or vacation homes. This, obviously, does not promote home ownership since these people already have first homes. Similarly, we allow mortgage interest deductions on home equity loans — second mortgages on existing homes. These deductions do not promote home ownership because these loans are typically spent on consumer goods or services unrelated to home improvement.

Congress could raise $150 billion in revenue over the next decade by ending mortgage interest deductions on second homes and home equity loans, as well as restricting such deductions to mortgages of as much as $500,000 per couple — instead of the current limit of $1 million per couple. By offering interest deductions on $1 million mortgages, we are not promoting home ownership; these people would have bought homes in any event. Rather, we are providing government subsidies for the purchase of large homes by wealthy taxpayers.

To raise the final $100 billion of revenue, Congress could modify the approach to insurance premiums in the recently passed health-care legislation. That legislation imposed a "Cadillac" tax, effective in 2018, on any insurance company offering health-care plans with premiums of more than $27,500 per year. Instead of the "Cadillac" tax, Congress could cap the currently unlimited exclusion for employer-based health-care premiums at $23,000 for families (and $8,500 for singles), effective in 2013. For example, a family with health-care premiums of $24,000 per year would pay income tax only on the last $1,000.

This cap would have a narrow impact; approximately 80 percent of workers would not be affected. Yet the cap would help constrain health-care expenditures by limiting the tax subsidies for the most expensive plans.

In short, Congress could include a revenue component of $400 billion in a $2.4 trillion deal on the debt ceiling without violating the Republican commitment not to increase tax rates. Instead, Congress could eliminate special-interest provisions for corporations and restrict overly expansive deductions for individuals. The inclusion of these revenue raisers would not only resolve the debt-ceiling debate in a more balanced manner but also would reduce some of the economic distortions resulting from the federal tax code.

About Harvard Business School

Founded in 1908 as part of Harvard University, Harvard Business School is located on a 40-acre campus in Boston. Its faculty of more than 250 offers full-time programs leading to the MBA and PhD degrees, as well as more than 175 Executive Education programs, and Harvard Business School Online, the School’s digital learning platform. For more than a century, faculty have drawn on their research, their experience in working with organizations worldwide, and their passion for teaching, to educate leaders who make a difference in the world. The School and its curriculum attract the boldest thinkers and the most collaborative learners who will go on to shape the practice of business and entrepreneurship around the globe.