We can land a man on the moon and use a smart bomb to hit a target 3000 miles away with a high degree of accuracy but we can't decide what macroeconomic model to use in finding a way out of our economic mess. Economist Alberto Alesina recently wrote in article for the Wall Street Journal where he said "American firms today are profitable and have large unspent resources. But their uncertainty over regulation and taxes discourages them from risk-taking, investment and consumption. In Europe, governments would strengthen the banking sector if they cut spending and reduced their default risk. This, in turn, would ease the flow of credit into the private sector. Peter Coy of Business Week countered by saying"Alesina's historical research, though, doesn't shed much light on what might happen if the U.S. adopts an austerity budget, because current circumstances don't resemble most of those in Alesina's database. It's rare for a nation to suffer such a big shortfall in demand that it cuts interest rates to zero, as the U.S. has. It's even rarer for a government in such circumstances to tighten its fiscal belt. Japan's experience is a cautionary tale. Japan attempted to tackle its deficit in the late 1990s during a period of weak demand and near-zero rates. Many economists say the move prolonged the slump that became known as Japan's Lost Decade. To be sure, Japan tried to balance its budget mainly by raising taxes, which is not Alesina's preferred solution. Paul Krugman of the New York Times agrees with Peter Coy but in much more detail. This is America, so it's a pretty good bet that we will use a hybrid method, a little bit of austerity with some tax increases.
Now that we're all confused, Congress is trying to make us believe that the tax cuts they're fighting about, is a necessary component for a sustained recovery. Last night, I heard Simon Johnson, former Economic Counselor and Director, Research Department,IMF (March 2007-August 2008) say that he agrees with the Congressional Budget Office,that extending all the Bush tax cuts would add $2.3 trillion to the total 2018 debt. The single biggest step our government could take this year to address the structural deficit would be to let the tax cuts expire. Such a credible commitment to long-term fiscal sustainability should reduce interest rates today, helping to stimulate the economy. He said that the money would be better spent on infrastructure, education, and research and development. He said unemployment compensation should not be part of the tax cut framework package because the $56 billion will be spent in helping stimulate the economy.
I'm pretty sure we all agree that we're facing a long-term fiscal crisis and we're running out of rabbits to pull out of the hat. Americans will have to realize that we're coming dangerously close to a point at which spooked markets will send interest rates on new borrowing, to levels that will stifle our growth. Someone will have to come forward, preferably the president of United States, to tell us that a $13.8 trillion debt will reach $20 trillion by the next decade, unless we do something about the home- mortgage interest deduction, Social Security and defense spending because they represent about 40% of the 2010 budget. We can no longer sustain the costs. The home- mortgage interest deduction represents $131 billion of lost revenue (mainly on millionaires homes), Social Security draw $703 billion from the treasury, and the defense department spends about $664 billion, a lot of it on defense contractors and big weapon systems. Even if we exclude Afghanistan and Iraq, the defense budget has grown 80% since the year 2000. Social Security will be hard to tackle because nearly 2/3 of U.S. retirees now count on Social Security for more than half of their income and one-sixth rely on it entirely.
Americans hate the length of the United States tax code (17,000 pages) but they love the $1.1 trillion of exemptions, deductions, credits and other loopholes. We were always led to believe that our home was a good investment but if you're in it for the tax deduction, and then you're probably in over your head. A flat tax, national sales tax, or the Fair Tax would not be a good solution because it would be unfair for poor people because the rates would have to be set up high enough to bring in the revenues we need today. In 1986, Congress eliminated $300 billion in loopholes and lowered rates across the board. The bipartisan commission on lowering the debt has a similar proposal but they go a step further and tax capital gains and dividends at ordinary income rates.
We can do this but it would mean that the politicians would have to go against the National Association of Realtors who spent more than $20 million lobbying Congress last year and another $11 million on the 2010 elections. Politicians are probably going have to gamble that they won't be elected out of office for taking the necessary steps to reduce the cost of Social Security and making it solvent for the next 75 years or so. That's going to be difficult because most of the 53 million Americans who collect Social Security are senior citizens who happen to be the most reliable voters. Since Defense Secretary, Robert Gates has already taken steps to reduce to defense budget, democrats and republicans are actually coming together on this project. Oklahoma's Tom Coburn, one of the senate's most conservative members, wrote recently" we need to protect the nation, not the Pentagon's sacred cows."
We’re way past gimmicks like freezing Federal worker salaries, reducing pork, eliminating waste, fraud, and abuse because we should be doing that anyway but we need get serious and go after the big bucks and not fall for the same old rhetoric. That’s part of the reason we’re in this mess.
December 13, 2010 edition of Time Magazine.
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