Solutions to the looming fiscal problem

My column for today's FT looks beyond the stimulus to what comes later.

It is safe to assume that in his address on Tuesday, Barack Obama will invoke the need for shared sacrifice. The idea is a banker, forgive the expression, for any inaugural, but especially now. Equally predictable is that he will develop the theme with a certain inattention to detail. It is inspiring to call for sacrifice but something of a downer to tell people too precisely what that sacrifice is going to be. Allow me to shoulder this burden.

The US economy's perilous condition calls for extreme fiscal activism. The new administration's stimulus plans are by no means over the top. If anything, a fiscal injection of $800bn over two years is too modest. But the implication of so strong a fiscal boost is a swift and severe worsening of the country's long-term fiscal position.

During his eight years in office - fat ones, for the most part, from a fiscal point of view - President George W. Bush moved the budget balance from surplus to structural deficit. Demographic and other pressures will worsen the position over the next decade or two. Now comes a fiscal expansion that will be only partly counter-cyclical: some of the new president's spending will not reverse automatically as the economy recovers. A structural deficit of the sort taking shape is unsustainable and will be corrected one way or the other - if not by a timely change in policy, then by a new and potentially even worse financial calamity.

What would it take for the milder of these alternatives to prevail? The short answer, once the economy has recovered, is this: higher taxes.

You can read the rest of it here.

Comments

Jake January 20, 2009 11:03 AM

Equally predictable is that he will develop the theme with a certain inattention to detail. It is inspiring to call for sacrifice but something of a downer to tell people too precisely what that sacrifice is going to be.

Indeed: the same could be said of the proposed stimulus package, as seemingly _no one_ is reporting how the money will actually travel from Washington to the street. You can read about some of the ways the government might logistically distribute the money—and how some of those ways might be gamed—in our post Getting Your Piece of the Infrastructure Pie: A How-To Guide for the Perplexed.

Some economists have noted that, by the time the stimulus takes effect, the recession (or depression, which I hear increasingly frequently) will be already over. But the overall reporting on the issue hasn't been impressive, and even most the economists I've read haven't shown in detail why the stimulus is likely to be tardy.

Gordon January 20, 2009 3:11 PM

Really good stuff Clive. You've got at least one supporter for at least the first three proposals (need to read your earlier piece before commenting on the VAT proposal).

DaveinHackensack January 24, 2009 2:18 AM

There's a simpler way to tax consumption and broaden the tax base than using a VAT: raise the employee portion of the payroll tax by 2% up to the Social Security wage limit (~$107k in 2009), and refund up to 100% of that amount at tax time, provided the tax payer has contributed an equivalent amount to a retirement plan. For example, a worker making $40k per year will have an additional $800 deducted from his salary over the course of the year. If he contributes $800 to his 401k or IRA for that year, then he'll get a refund check for the extra $800 that came out of his paycheck. If he saves nothing, than he forfeits that $800 and the government keeps it.

One virtue of this approach is that it will encourage more savings from the bottom 40% of earners, for whom the income tax advantages of contributing to IRAs and 401ks are less compelling because they already have no net federal income tax liabilities.