If the U.S. is going to be able to solve its serious economic and fiscal problems, there needs to be a realistic understanding of what they are. My last post, “Is the U.S. Economy Really in Good Shape?” discusses a recent Op Ed in the Wall Street Journal by Martin Feldstein. Mr. Feldstein makes the case that it is in pretty good shape right now even though there are big problems on the horizon. Unfortunately, such an assessment is likely to lead to complacency and inaction towards our long term problems. Let’s look at the overall situation.
Our Economic Strengths:
The world’s largest economy, twice as large as our nearest competitor, China. The 2.2% GDP growth since the Great Recession ended in June 2009 is not especially robust but it’s among the best in the developed world.
World leadership. The U.S. dominates international finance, technology, higher education and popular culture. Everybody else wants to emulate us and to have what we have.
The U.S. Dollar dominates world currency because of its strength and stability. This protects the value of the dollar relative to other currencies.
Our Economic Weaknesses:
Massive Debt. The public debt (on which we pay interest) now stands at 74% of GDP, the largest since right after the end of WWII. As our currently low interest rates inevitably continue to rise, interest payments on the debt will skyrocket creating a huge burden on future generations.
Demographic Challenges. Payouts for Social Security, Medicare and Medicaid are continuing to grow rapidly, thereby putting upward pressure on annual deficits as well as accumulated debt.
Slow Growth Environment. The economist Robert Gordon makes a persuasive case that the explosive economic growth which the U.S. enjoyed from 1870 – 1970 will be very difficult, perhaps even impossible, to duplicate in the future.
The big picture is that we are going to have to work hard to achieve the degree of economic growth which will be needed to propel American society forward in the future as it has in the past.
Harvard Economist, Martin Feldstein, has an Op Ed column in yesterday’s New York Times, “Saving The Fed From Itself”, which gets our current economic situation half right. First of all, Mr. Feldstein says that the Fed’s quantitative easing policy is inadequate because “the magnitude of the effect has been too small to raise economic growth to a healthy rate. … The net result is that the economy has been growing at an annual rate of less than 2 percent. … Weak growth has also meant weak employment gains. … Total private sector employment is actually less than it was six years ago. … While doing little to stimulate the economy, the Fed’s policy of low long-term interest rates has caused individuals and institutions to take excessive risks that could destabilize the economy just as it did before the 2007-2009 recession.” So far he’s right on the button!
But then he goes on to say, “To get the economy back on track,” Congress should enact a five year plan to spend a trillion dollars or more on infrastructure improvement and that this would “move the growth of gross domestic product to above three percent a year.” An artificial stimulus like this might work temporarily but then it ends and we’re back where we started. We need a self-generating stimulus that will keep going indefinitely on its own. How do we accomplish this?
The answer should be obvious. We do it by stimulating the private sector to take more risk in order to generate more profits. In the process they will hire more employees and boost the economy.
How do we motivate the private sector? By lowering tax rates and loosening the regulations which stifle growth. Closing tax loopholes and lowering deductions (which will raise revenue to offset the lower tax rates) has the added benefit of attacking the corporate cronyism which everyone deplores.
We really do need to put first things first. If we can jump start the economy by motivating the private sector to invest and grow, we will have more tax revenue to spend on new and expanded government programs as well as shrinking the federal deficit.
Why is this so hard for so many people to understand?
As I discussed in my last post, the Congressional Budget Office has shown very clearly that the U.S. is on an unsustainable fiscal path which must be reversed in order to avoid calamity. We are spending too much money and not taking in enough tax revenue. In a recent Wall Street Journal Op Ed column, the economist Martin Feldstein describes “How to Create a Real Economic Stimulus”. “A successful growth and employment strategy would combine substantial reductions in the relative size of the future national debt with immediate permanent tax rate cuts and a multiyear program of infrastructure spending…….The only way to reduce future deficits without weakening incentives and growth is by cutting future government spending.”
Mr. Feldstein proposes slowing the growth of benefits of middleclass retirees by gradually raising the full benefit retirement age for Social Security from 67 to 70 and also raising the age of Medicare eligibility to the same level. This would create a budget savings of 1% of GDP, or $200 billion, by 2020. Rather than eliminating such popular tax deductions as the one for mortgage interest or the exclusion of employer payments for health insurance, he recommends limiting the amount by which individuals can reduce their tax liabilities to 2% of adjusted gross income. This single change to the tax code would, for example, reduce the 2013 deficit by $140 billion.
In addition to lowering tax rates for individuals, corporate tax rates should be cut from 35% to about 25% in order to be competitive with other industrial countries. We should also adopt the internationally common “territorial” system which doesn’t tax foreign earnings brought back home.
In short, we decrease spending and raise revenue with entitlement reforms and a limit on tax expenditures thereby creating a framework for tax rate reductions and infrastructure spending. These are the sorts of bold measures needed to produce a real stimulus and thereby get our economy back on track!