Tuesday, January 13, 2009

I.O.U. an Answer

I.O.U.S.A, a film about the U.S. debts and deficits, has been playing in theaters and on television. I saw it on CNN. The film’s website is http://www.iousathemovie.com. The producer, the Peter G. Peterson foundation, has the web site www.PGPF.org, where you can view 30 minutes of the film. The movie explains how the U.S. government debt has escalated, and also discusses the trade deficit and touched on the savings deficit and the "leadership deficit."

With many visual effects and interviews, the show explained how the unfunded liabilities for Social Security, Medicare, and Medical are the biggest elements of federal debt, and these deficits - promises not backed by funding - threaten the viability of the U.S. economy.
Despite the show featuring prominent economist and past government officials, the film lacks answers to the deficit problems. The only specific remedies are on Social Security, in which the answers suggested were to raise the age for full benefits, reduce the rate of growth of payouts, and increase taxes.

The film does not discuss the alternative of replacing Social Security with private accounts that would hold U.S. treasury bills. Such accounts would provide a greater retirement payout, and since the funds would belong to the individual, he would be able to borrow against it in an emergency. Today’s Social Security account is not your money until you actually receive it, and how much you receive depends on how much Congress wishes you to get.

There were no remedies provided for the biggest entitlement problems, Medicare and Medicaid. As the population ages, the Medicare costs of treating the elderly is escalating, and without changes, will dominate the federal budget. The film also had no answers to the trade deficit and the savings deficit. Maybe the new administration will at least end the leadership deficit.

One can ask, why no answers? Over and over again, the film talks about the problems, but provides no solutions other than for Social Security. The aim of raising awareness of the deficits is good, but the film fails when the viewers are left hanging there with no remedies.

It seems to me that possibly I.O.U.S.A. lacks answers because the producers don’t have them. Another reason for the lack of remedies is that they would be unpopular. To reduce the Medicare deficit, one needs to reduce the benefits, to change it to only insurance for catastrophic expenses. But that would be unpopular with those receiving Medicare benefits, and might result in criticism for the film. So they are silent on the remedies.

The film has been compared to the movie "An Inconvenient Truth" by Al Gore, about climate change. It is a good comparison, because "'An Inconvenient Truth" also lacks meaningful remedies such as pollution charges. Perhaps there too, answers would reduce the popularity of the film.

Of course the general answer to a budget deficit is to reduce spending and raise revenue. But that is not a real answer. We need to analyze which programs would be reduced, and which would be the sources of new revenue. Without specifics, there is no real answer.

The effectiveness of remedies depends on how radical you want to get. The more effective the remedy, the further one needs to go away from the status quo. For example, one can reduce benefits in Medicare, but that leaves the elderly with insufficient medical care. The elderly do not have sufficient funds for care because of the high expenses and lack of savings. They lack savings because taxes have drained their wages of funds that could have been saved. If taxes for Medicare go up, then that leaves even less for savings, and can reduce the incentive to work.

These deficits come from deep flaws in the structure of taxation and government, ultimately from flaws in the constitutions of the federal and state governments. The incentive of government chiefs is to please the voters and the special interests that fund their election campaigns. People like benefits such as medical care, and they don’t like to pay taxes on their wages. So the inexorable incentive is for government to provide benefits and push the cost into the future. The special interests provide needed campaign funds in exchange for favors such as trillions of dollars to bail them out of their failed financial speculations.

The U.S. Constitution endows Congress with the general power to tax and to borrow. That was a big mistake. Congress should have authorized Congress with the power to tax only land value and harms such as pollution. The Constitution should authorize Congress to borrow only for productive investments, not for consumption spending including military expenses.

With no taxes on wages, folks can then save much more, and they would have more incentive to save with no taxes on interest and dividends. Higher wages would enable folks to buy their own medical insurance and retirement insurance. Federal entitlements could then be scrapped. But such remedies are radical, and I.O.U.S.A. did not seek radical answers. Indeed, the film favors keeping Social Security. But status-quo thinking is what got us into the deficit mess.

So, unfortunately, this well-intended film will become part of the problem rather than the solution, because without answers, the film crowds out attention that could have been placed on the remedies. The deficits are deep problems, and only radical remedies can extirpate deep problems.


Thursday, January 01, 2009

How to Make the new Year Better

Many economists and financial analysts are making conjectures about when the recession will bottom out and how strong the recovery will be. The speed of recovery depends on the policies of government world wide. With the best policies, the economy could recover within three months. With bad policies, such as occurred during the Great Depression, the economy could stay down for years.

One bad policy that made the depression worse was the erection of trade barriers. The US enacted a high tariff in 1930, and other countries also restricted imports, and world trade broke down. Companies that sold goods abroad could no longer stay in business. Farmers suffered as foreigners could not buy their crops.

Unfortunately, many countries today are repeating this policy error. The German philosopher Hegel was right when he observed that governments do not learn from history. Indonesia is requiring new licenses and taxes for imports. Russia has raised tariffs on imported cars and food. India has levied a tariff on imported soybean oil. The chiefs of each country think that they are protecting their home industries, but they are ignoring the lessons of the Great Depression, as trade limitation is contagious. If political pressure induces them to do something, a money subsidy is preferable to a trade barrier, since that does not distort prices as much.

Another policy failure during the Great Depression was higher taxes. Government revenues are down during the recession, but raising income taxes just makes more companies fail, and then more workers are thrown out of work. Governments stupidly raise their existing income, sales, and value-added taxes, instead of following the economic wisdom of taxing bad things such as pollution.

Governments can make the new year better by enacting optimal supply-side and demand-side policies. Supply side policy seeks to increase the supply of goods by reducing government-imposed costs. Governments can reduce excessive regulations such as the Sarbanes-Oxley law that imposes millions of dollars of costs on company accounting for little benefit. Governments can also reduce marginal tax rates, the tax rate on additional earnings.

In Obama’s presidential campaign, he sought to tax the rich more. Those with higher incomes do much of the investing and hiring of workers. Such tax increases should be avoided, and the tax cuts of the early decade should be made permanent. Aside from pollution taxes, if government chiefs seek more revenue, they can levy a tax on land value. The tapping of land rent for public revenue would, contrary to other taxes, push the economy towards greater production, since an underused plot of land would pay taxes based on its most productive use. A tax on land value is the ultimate in supply-side policy, especially when combined with a reduction of taxes on wages, goods, trade, and value added.

Critics say that since a tax on land value would make the price of land fall, this would make the real estate crash even worse. Many more properties would be worth less than the mortgage. But the best time to do this is when land values have already fallen, not when they are rising and peaking. During a boom, real estate interests oppose a land value tax spoiling the party. So there is nothing to gain by waiting for land values to rise before levying a tax. Do it now.

In an efficiency tax shift, eliminating taxes on wages, profits, sales, and value added, replacing them with taxes on pollution and land value, most folks would have net gains. The greater tax on the land value of a typical house would be less than the eliminated tax on the building, wages, and income from savings and investments. Those with net losses could be compensated with either money or bonds. The bond would be repaid by the volcano explosion of output as the unshackled economy would sprout up at rates we cannot imagine today. It would make the recent growth of China look like a snail’s trek.

But economic emergencies may well also warrant demand-side policies. The usual policy of money expansion does not work in a depressed economy. The central bank buys bonds and creates the money to pay for them, but the money just sits in the banks as reserves or government bonds, as the risk of lending is high. The usual policy of government spending also does not work well. Public works such as highways bridges take time to plan and only employ particular types of labor, often at the expense of other projects. The best demand-side policy is "money to the people." Print currency and distribute it equally to everybody. People will then buy stuff, pay off debts, and add capital to banks. Moreover, printing the money would be debt free.

As to monetary policy, enough already! When will central bankers understand that their policies are futile and create more trouble down the road? There is no scientific way to know the precise optimal money supply or interest rate. The manipulations of central banks and governments do not allow interest rates to do their job of allocating funds between consumption and investment, between the future and the present, between savings and borrowing. Central banks should freeze the national currency and let private banks and other institutions expand the money supply in the future, with bank notes and deposits convertible into the national currency.

Car makers are losing billions of dollars, and seek subsidies so that they can continue to loose money rather than recognize their bankruptcy. This may seem shocking to free-market guys, but better than pouring unlimited money down the drain, better than loans that cannot possibly be paid back, would be to nationalize the automobile firms. Folks would then not be scared off from buying cars, and millions of workers would stay at their jobs. Let the value of the shares and bonds fall to zero. Then the government could restructure the companies and sell them off. These companies and unions committed deception in the past by promising pensions that were not funded. Nationalization would be their well-deserved punishment.

To make the new year much better would require radical changes. Now is the time when people want and expect change. The question is whether the new administration will offer small and ineffective change, or the bold, radical, volcanic changes that would quickly turn the economy around and provide not just hope but the reality of prosperity, social peace, and economic justice.