Policy Implications
What can the United States do to promote further productivity growth? First, the most important way to encourage capital deepening is to maintain the smallest possible difference between the before-tax and the after-tax rates of return to investments. Capital deepening makes workers more productive and leads to higher wages in the long run. Making the tax cuts on capital gains and dividends permanent would help in this regard.
Second, policies must encourage investment in skills. One way to do this is to keep the tax rates on wage income low. If individuals see little return to going to college, vocational school, or graduate school because of high tax rates on moderate- to high-wage earners, their incentives to invest in skill will be dampened. Strengthening K-12 education, reducing our dropout rates, and ensuring that all children receive high-quality education will increase the skills of our workforce and better prepare our citizens for further skill investment as adults. The President's efforts over the past several years to improve education and training with the No Child Left Behind Act, community college initiatives, and job training reforms will help. Furthermore, because learning begets learning, the returns should continue into the distant future.
Third, we must remain open to foreign investment. Openness to foreign capital has given the United States the flexibility it needs to deepen its capital stock and improve its productivity without necessitating a corresponding increase in domestic savings. To maintain current growth rates we must keep pushing for freer trade, especially in the area of services, which has become a significant part of our economy.
Fourth, we must encourage innovation and entrepreneurship. The President has outlined a competitiveness initiative that increases public investment in basic research-an important complement to private sector innovation-and strengthens math and science education to provide the skills needed for technological innovation.