A debt-laden U.S. economy has a hidden secret: 'Tons' of underinvested capital that could get put to work if the federal government reforms the tax code and solves its budget woes, Pimco CEO Mohammed El-Erian told CNBC Tuesday.
As the debate quickens over the "fiscal cliff," El-Erian called for Washington to institute "fundamental fiscal reforms" that include both broadening its base of revenues while eliminating distorting tax provisions that encourage companies to shelter income offshore.
(Read More: Limiting Tax Deductions: What It Might Cost You.)
"It's important to acknowledge there's a ton of cash on the sideline," El-Erian told CNBC's "Squawk Box." There is money "that's sitting on balance sheets that should be invested, and we'd all be better off."
Many observers have faulted the U.S. tax code for being too bloated and riddled with inefficiencies, which simultaneously subsidize certain corporate activities, while providing perverse incentives for them to park cash offshore in an effort to avoid paying even higher taxes. (Read More: Business Chiefs Step Gingerly Into a Thorny Budget Fight.)
El-Erian added that any moves to reform how the federal government raises and spends money should make tax reform a central focus. He added that it could be the "downpayment" on a virtuous cycle that helps feed into job growth and economic expansion.
"If you make that your objective, you'll move not only just on fiscal reform but labor market reform, credit market reform, and housing reform, and that's what this country needs," the fund manager added.
There is an overwhelming need for both the government sector and consumers to reduce their debts, El-Erian noted, which is a legacy of the pre-2008 crisis era.
Citizens and Washington policymakers "overdid it during the great age of debt, of leverage and of credit entitlement and now we've got to deal with the consequences," El-Erian said.
He added: "It's a balance sheet element. The corporate sector is fine…[and] the household sector is doing better. Now all these excesses have been shifted to the government sector. The best way to de-lever the economy is through economic growth."
—By CNBC.com's Javier E. David