We’re Due

Alan Auerbach and William Gale, writing in the Los Angeles Times, point with concern to the growing federal structural deficit:

The deficits projected over the next 10 years will accelerate our arrival at a debt-to-GDP ratio that for most countries would signal impending fiscal collapse. Indeed, Britain, with a debt-to-GDP ratio not appreciably worse than ours, was just warned by Standard & Poor’s that its creditworthiness might be downgraded. The United States has traditionally enjoyed a favored status in this regard, as the supplier of the dollar, the world’s reserve currency, and as a perceived haven in times of financial stress. But for how long?

In March, Chinese Prime Minister Wen Jiabao publicly questioned the safety of U.S. Treasury debt. Over the winter, prices in credit-default swap markets implied a significant probability of default on U.S. debt in the next five years.

Default on national debt is what happens in failed states and banana republics; such a possibility for the U.S. would have been unthinkable in the past.

All of this will finally force difficult choices on policymakers. Healthcare reform, for example, is crucial if we’re to fix entitlement programs. But it alone won’t be enough. Spending will have to drop, and taxes will have to rise. And the choices could get harder still. If the economy recovers very slowly, those decisions will need to be faced in the context of a weaker economic situation with demands for further fiscal stimulus.

In the immediate future, policymakers will face a delicate balancing act between encouraging economic recovery and establishing fiscal sustainability. Short-term stimulus can boost an otherwise weak economy, so withdrawing stimulative policies and imposing fiscal discipline too soon could slow the recovery. But delaying fiscal discipline too long could be equally destructive. Success will take new ideas, some luck and uncharacteristic honesty and resoluteness — from our leaders in Washington and from the rest of us.

I would be remiss if I didn’t point to Fester’s post on the prospect of impending local tax revolts, riding the tide of the disconnect between local government revenue needs and waning property values.

The connecting thread between the article and the post is tax policy.

As if President Obama didn’t have enough on his plate, IMO we’re due, possibly overdue for a major revision in the tax code.

Over the period of the last century roughly every 20 to 25 years we’ve done a major overhaul on the tax code. In the 40’s it was the sharp increase in top marginal rates and the adoption of the withholding tax. Under Jack Kennedy in the 1960’s we dropped the top marginal rates along with a host of other reforms.

The last major overhaul was under Ronald Reagan and it saw not only a further drop in the marginal rates but a cut in the number of tax brackets along with other measures targeted, presumably, at simplification.

That last overhaul was more than 25 years ago. The forces that oppose tax reform are numerous, entrenched, and powerful—basically, everybody who benefits from the current system. However, it’s not completely clear to me that given the current state of political discourse and the manifest need for a realignment between revenue and expenditures, that we can achieve what needs to be done within the confines of the current tax code.

Most of the prospective alternatives aren’t particularly appealing. So, for example, I can imagine us imposing a VAT just as globalization makes it all but certain that a VAT would drive capital investment even more offshore than it already is. Or that we’d impose a national sales tax just in time to drive another nail into the coffin of the retail sales on which our economy is overly dependent.