Wednesday, February 24, 2010

Pet or meat?

Not clear what we would do with Anchiornis huxleyi if this chicken-sized, feathered, non-flying dinosaur (in the carnivorous troodon family) lived today, rather than 150 million years ago. Handsome fella, though, and (if small enough) I'm sure my cats would love to meet one.

Wyden-Gregg tax reform proposal

Senators Ron Wyden (D-Ore.) and Judd Gregg (R-N.H.) have introduced the "Bipartisan Tax Fairness and Simplification Act of 2010" (summarized here). They deserve a degree of praise for even trying this. But I suppose it's my job to examine the details critically without extending sympathy points for their need to keep in mind political feasibility issues.

Too many features to comment on all of them here. But some of the key ones include the following:

--3 individual income tax brackets (at 15, 25, and 35%) instead of 6. This is touted as simplification, but is entirely trivial in that regard. Presumably. most people simply look at the income tax tables to see how much they owe.

--Eliminate alternative minimum tax. Great, but the hard part is paying for it. According to the Congressional Research Service, despite base-broadeners they fall $230 billion short of revenue neutrality over 10 years (relative to an Obama Administration budgetary baseline that, needless to say, falls far short of long-term sustainability), and propose to pay for it by "cutting an average of $23 billion per year from corporate and business-related spending and transfers." These are of course unspecified, and good luck finding reductions that Congress would accept (although finding enough that ought to be cut would no doubt be easy). For a general list of their revenue offsets, see this.

--Near-tripling of standard deduction. In principle, a good way to lower tax burdens on the bottom of the distribution and to devalue itemized deductions that ought to be repealed but are politically embedded. I believe they don't phase it out, which might make little difference at higher income levels (if people mostly switch to itemizing anyway). But with a much larger standard deduction and, perhaps, lower qualified residence interest deductions in the future (from reduced home values and borrowing), conceivably standard deductions would be used much further up the scale than is now typical.

--Itemized deductions, including bad ones such as the qualified residence interest deduction, are generally retained, and no longer phased out. In general, the phaseouts make no sense as such - they are better thought of as temporarily high "bubble" rates, and evaluated based on what one thinks of such a rate structure - but this does modestly increase the deductions' value among those who ARE itemizing. Lost opportunity to use tax reform as a way of scaling these deductions back, e.g., by converting them to a 15% refundable credit. Interestingly, they do apparently convert the exclusion for municipal bond interest into a percentage credit.

--Itemized deductions currently subject to the 2% of adjusted gross income floor are repealed. Some of these items actually are costs of earning income, however.

--Consolidated and expanded retirement savings provisions. I'm in favor (makes it more of a consumption tax), but am concerned about the issue (under current law as well) of deductibly borrowing on one's home to finance supposed retirement saving.

--Lowers the U.S. corporate rate to 24% (while eliminating the farcical rate graduation in current U.S. corporate tax law). Good for attracting more investment $$, or simply reported taxable income by multinationals with planning flexibility, to the U.S. in competitive world capital markets. But with the corporate rate at 24% versus a top individual rate of 35%, they need to address the problem of high-earners transmuting their earnings into corporate income from their closely held companies.

--Elimination of a variety of special interest tax breaks. Great, if one can do it. This is indeed what 1986-style comprehensive tax reform is supposed to emphasize. Most of the items they list (which you can find on the links I provided above) are well worthy of repeal; for a few this could be challenged.

--Limit corporations' interest deductions to real interest (i.e., nominal interest is reduced by the inflation rate in determining what's deductible). This is a bit odd, given that nominal interest and other inflationary aspects of gain continue to be taxable elsewhere. They tout it as reducing the debt bias of current corporate tax law. But that really is a distinct issue from the inflation problem, which in theory (i.e., subject to administrative concerns) calls for comprehensive inflation adjustments for everything. A bit cute to try to address the more general debt issue this way - not sure it makes sense unless one posits that this is more politically feasible than more straightforward approaches.

--Move towards a more worldwide system for taxing U.S. companies foreign source income. In particular, they repeal deferral for business income that U.S. companies earn through foreign subsidiaries, and reinstitute the per country foreign tax credit. No doubt they (or perhaps more Wyden on the Democratic side) think of this as a key tradeoff for lowering the corporate rate, but perhaps not the best direction to go in given the increasing electivity of U.S. corporate residence. The domestic tax rate for all corporations operating in the U.S. and the treatment of foreign source income earned by resident U.S. corporations really are different margins.

Considered as a whole, this bill is potentially a good conversation-starter, but somehow I doubt that the conversation will get very far. I remain skeptical about the political prospects of using base broadening to pay for rate cuts, higher effective zero bracket, etcetera. Perhaps we could do this for corporations - lower corporate rate plus base-broadening and provisions to prevent individuals from exploiting the lower rate through closely held companies. Insofar as academics and policy types are deciding where to concentrate their fire, I'd place more emphasis on the long-term fiscal problem and likely need for a VAT to help stave off actual or implicit default by the federal government. Plus, if the rise of the AMT becomes politically salient to voters, financing its repeal through curtailment of itemized deductions and other personal income tax benefits might make sense, but the time for that does not yet seem to have come.

In sum, rather than try a general 1986-style reform, I'd propose emphasizing (1) raising revenues through a VAT, as part of a broader deal that addresses entitlements growth and perhaps purports to dedicate VAT revenues to particular purposes, (2) a narrower trade of rate reduction for offsets (other than increasing U.S. worldwide taxation) specifically for corporations, and (3) a similar trade with respect to individuals' targeted tax benefits and AMT repeal, if and when voters become concerned enough about the AMT for this to be feasible.

Tuesday, February 23, 2010

Far be it from me to defend Thomas Friedman, but ...

While I find Friedman unreadable in style and uninteresting in substance, not to mention lacking in real knowledge of much that he discusses, this time around perhaps he deserves at least a halfhearted defense.

A recent Dean Baker blog post goes as follows:

"Thomas Friedman Competes for the Nobel in Ignorance

"Thomas Friedman told readers that: "But now it feels as if we are entering a new era, 'where the great task of government and of leadership is going to be about taking things away from people,' said the Johns Hopkins University foreign policy expert Michael Mandelbaum."

"Unfortunately, Mr. Friedman apparently doesn't talk to anyone who has ever taken any economics. There are no serious forecasts that do not project that productivity will continue to grow for the indefinite future, and many project that productivity will grow at a more rapid pace than it did in the years from 1973-1995. This means that there is no reason, except incompetent economic management and/or the continuing upward redistribution of income, why the vast majority of the population should not experience improvements in living standards. This would mean an increase in both public and private services."

In fact, Friedman is right although Baker is also right - one could even take the view that Baker's riposte is a non sequitur.

Consider Medicare. Over time, the law on the books seems to promise (against the background of the best available demographic and technological evidence) a rising expenditure level in Medicare that is fiscally unsustainable. (Parallel problem for employer-provided health insurance.) The projections thus strongly suggest that the government will have to "take things away from people" - that is, change the Medicare rules in the direction of denying best-available-care in circumstances where it would have been provided today.

But what about Baker's point? He is right that, under consensus projections, people's living standards will keep on improving. Indeed, so presumably will their healthcare, as the technology keeps advancing. Suppose Medicare in 2050 denies people the best contemporaneously available care as overly expensive, when it would have provided the best available care in 2010. The people who were being denied care in 2050 because the program had been scaled back might still be receiving treatment vastly superior to any that is available (even to the richest people in the world) today.

Worse in relative terms - compared to what is contemporaneously feasible - but better in absolute terms.

Baker's way of looking at it is preferable if one is actually trying to evaluate how well off people will be in 2050 (if today's projections are in the ballpark) compared to today. But Friedman is right about the existence of a problem in political economy and in managing expectations, when current policy seems to promise that outlays will grow unsustainably faster than the economy. And there is a reason for looking at it this way as well as Baker's way. For example, we may have a cataclysmic U.S. fiscal bankruptcy (affecting the degree of actual rise in living standards) because government is unable to "take things away" in Friedman's sense even when this involves taking away less than 100% of contemporaneous gains from technological progress.

Saturday, February 20, 2010

Death of Al Haig

The old warhorse Al Haig, effectively Deputy President for Nixon's last year, then Reagan's first Secretary of State who got himself in trouble by rushing in front of the TV cameras to assert that he was "in control" at the White House in the aftermath of the 1981 Reagan shooting, has just died.

Nostalgia time for former Nixon aficionados such as myself.

After the flap over his response to the Reagan shooting, I was moved to write a very short fiction or fantasy piece about Haig, which began as follows:

"In the beginning there was HAIG, brooding and preening and gathering data to be processed and shredded as silently and simultaneously as possible."

It went on from there to imagine him strutting around in the mirrored corporate boardroom one mile down from the acknowledged headquarters of United Technologies (where he had in fact been CEO either just before or after his Reagan Administration stint), plotting his secret campaign against the Department of Agriculture.

And I posited that the single most tormenting thing to him in the world was the fact that the same letters stand for both "commanding officer" and "comic opera."

But in retrospect, against the background of say, Cheney, what an innocent guy, and what innocent times.

Random thought while on the elliptical machine

While working out I listen to music, but set the TV screen to ESPN. This morning, less sports highlights than usual because yesterday was the latest Tiger Woods press conference.

It occurred to me - what would ESPN do if Tiger Woods had an affair with Brett Favre? (Favre is the other one they cover incessantly, with hours of wall-to-wall coverage of his latest re-retirement, un-retirement, etc.) So this is their ultimate dream story.

I think that would be it for actual sports coverage on ESPN. They would simply cover all angles of of the Woods-Favre story for months and months, 24-7.

Tuesday, February 16, 2010

On the road again

Weather permitting - a very important qualification this winter - I'm off to a session in Washington this Friday, and another at Northwestern Law School next Monday, in both cases to present my foreign tax credit paper.

I may shortly post a revised version of the paper, only 50% as long, which I believe makes the main points a lot clearer.

UPDATE: Good session, I think I've gotten the hang of how to present this paper.

NYU Tax Policy Colloquia Past and Non-Future

Last Thursday at the Tax Policy Colloquium, David Walker presented his paper, "Suitable for Framing: Business Deductions in a Net Income Tax System." In the paper, David extends ideas that many of us have written about, concerning the fiscal illusion reasons for politicians' frequent preference for "tax expenditures" over equivalent direct spending, to deduction disallowance.

Thus, consider the $1 million cap on non-incentive executive comp that Congress enacted in 1993 - widely regarded today as either pointless pandering or an affirmative blunder that accentuated the move in that era towards excessive and ill-designed "incentive compensation." At the time, President Clinton said it would repeal the "subsidy" for overpaying high-ranking executives at public corporations. But the deduction for paying compensation over $1 million was not a "subsidy" if one views it instead as simply a cost that needs to be taken into account in measuring corporate net income.

For this purpose, it doesn't matter if executives were being grossly overpaid and providing no commensurate value to shareholders. Still an expense from the corporation's standpoint (and thus that of the shareholders as residual claimants). The point in assessing whether an outlay should be deductible, from the net income measurement standpoint, is not whether it was a good deal, but whether it was associated with an offsetting and untaxed value flow. (This is in effect why, say, lunch at a nice restaurant, with no claim of business connection, is nondeductible - you truly are out the money you paid, but in return you got the value of the consumption.)

Anyway, returning to the theme of the paper, Walker argues that, just as tax expenditures can yield fiscal illusion from an optimally "smaller" government that is actually doing the same things as under the direct spending route, denying deductions that are simply inputs to net income measurement leads to "regulatory illusion."

I'm certainly generally sympathetic to the paper's account of this point. Discussion focused more on how best to frame the paper than on criticizing the "regulatory illusion" claim substantively.

For this week, less happy tidings. Jeffrey Brown of U. Illinois had been scheduled to present a paper entitled "Automatic Lifetime Income as a Path to Retirement Security." But he's been forced to cancel at the last minute for reasons beyond his control. For what I believe is the first time in the Colloquium's 15-year history, we have therefore been forced to cancel the PM session for this Thursday (Feb. 18).

I had been looking forward to this discussion. Jeff's paper argues that, given widespread myopia and financial illiteracy, contributing to under-annuitization by retirement savers notwithstanding Social Security, the pension rules should be changed to avoid discouraging employers who run retirement plans from offering, as a default with easy opt-out, 50% annuitization of one's defined contribution account at retirement.

I felt the proposal was a bit modest given the underlying critique. Once one invokes behavioral economics, e.g., to favor particular defaults, one gets into what remains, in the literature, a largely under-theorized world. Proposals in this area seem to me to need what I would call a theory of optimal induced annuitization.

Perhaps I'll write about this at some point (in general, not with regard to this particular paper), but it's likely to be a while.

Friday, February 12, 2010

Musical fan note

Two undeservedly obscure albums from the early 1990s, both by Robert Forster of the Go-Betweens (from during their long hiatus) are "Danger In the Past," and "I Had a New York Girlfriend." Dylan-Gram Parsons-early 70s Stones territory countrified, at times up-tempo rock, but with a really distinctive (offbeat and very dour) sensibility, also one of the great tuneless & deadpan (alternately sincere and ironic, if you can tell them apart) vocalists. "Danger" is all Forster originals, while "NY Girlfriend" is all covers and perhaps my favorite such album (along with Yo La Tengo's mostly-covers & in some ways similar "Fakebook"). I hadn't played them for a number of years, but lately they've been helping me get through the drudgery of the elliptical machine.

Wednesday, February 10, 2010


It's nature's way of reminding us how utterly indifferent to our welfare it is.

It also always reminds me that we're biologically a tropical species, living in a wider range of climates due to cultural adaptations. That's fine, but when you're out in something that you know would kill you in under an hour but for heat, clothing, and shelter, it makes you (or at least me) feel somehow unwelcome.

Tuesday, February 09, 2010

Paul Ryan's "shadow budget" for the House Republicans

Perhaps I should address Paul Ryan's shadow budget, proposed on behalf of the House Republicans (although in public they are keeping as far away from it as they can).

To see the details, check out the first 4 pages of this CBO letter scoring it.

Key features, with my reaction to them, are as follows:

1)REDUCE BENEFITS FOR PEOPLE BORN IN 1956 OR LATER - Hey, unfair, I just missed being grandfathered here. More seriously, while I don't see why older people shouldn't also share in cuts if they can afford it (unless they take their haircuts elsewhere), clearly that would be a political nonstarter.

I do believe that Social Security should share in the overall move towards budgetary balance even though, as Krugman et al like to point out, if it were the only problem things wouldn't be especially dire. I would say that it ought to be placed on a sustainable stand-alone path that addresses the aging work force problem and that aims for generational balance - not because that is a fundamental principle (at all), but as a sound political economy convention. In other words, if particular age cohorts get benefit enhancement then generally they should pay for it (unless things have turned dire for them and it's effectively cross-generational insurance to increase their net take from the program).

2) SHIFT TRADITIONAL SOCIAL SECURITY TO INDIVIDUAL ACCOUNTS (FORMERLY KNOWN AS PRIVATIZATION) - Although I generally like greater consumer choice, within Social Security (and taking account of other retirement institutions) it's truly pointless. Republicans' aim may be simply to re-label the same checks as not coming from the government. Good luck pushing this after the 2008 stock market collapse, guys. See more discussion of privatization here.

3) MINIMUM SOCIAL SECURITY BENEFIT - A new proposed feature, apparently guaranteeing all workers with at least 20 years of earnings at least the earnings of a full-time worker making the minimum wage. This strikes me as a desirable feature, establishing more of a floor. It weakens the tax-benefit link, but workers don't really understand this anyway (so it shouldn't do much to increase distortions from the payroll tax). A pro-immigrant feature, given the 20 years point? Don't tell other Republicans. Relevant to surviving spouses who only worked part-time and whose deceased spouses also had low earnings? Anyway, I don't know how significant this in fact is, but it sounds reasonably promising.

4) REPLACE MEDICARE WITH VOUCHERS - On balance, I don't agree with this fundamental change to how healthcare for seniors is provided. Note also that its design appears to suggest declining real subsidies over time. Then again, we have a huge sustainability problem in healthcare. Note also the lack of risk-adjusting to the vouchers, and of anything to make the health insurance market work better. But I give it credit for being an honest conservative, pro-market approach to the problem, although I consider healthcare too fundamentally messed up for that approach to work. It thus appears to be the work of a Plato or Socrates compared to nearly everything else Republicans have been spouting for the last 10 years.

5) REPLACE EXCLUSION FOR EMPLOYER-PROVIDED HEALTH INSURANCE WITH A REFUNDABLE (!!!) TAX CREDIT - I strongly favor this type of change, which eliminates the bias of the current healthcare exclusion in favor of people in higher marginal rate brackets. Refundability is also obviously right design. Dollar caps on the exclusion make it, I'm pretty sure, much smaller over time. I hate running such health insurance as there is today mainly through employer programs, but one doesn't want to weaken that too much without other devices in place. Note also nothing else addressing adverse selection problems in health insurance. Still, once again we have a sane and coherent conservative policy, rather than the usual garbage like "Cut taxes to zero, conduct 5 wars at once, offend no politically powerful constituencies (indeed, throw as much money at them as possible), yet denounce Obama for the budget deficit."

6) GOVERNMENT SPENDING FREEZE - I addressed this in an earlier link when Obama cravenly proposed it (though for 3 years, not 10 like the House Republicans). This feature also appears carefully designed to implement as extreme a Herbert Hoover policy to the recession as possible (with apologies to Hoover himself, who actually was more flexible than this).

7) AT TIMES IDIOTIC BUT AT LEAST NOT OVERLY REVENUE-LOSING TAX CHANGES - People would be allowed to elect between a simplified tax system and the actual one. Since taxpayers would need to consider both options and presumably would want the one that was more beneficial to them, this would actually make the tax system more complex. Stupid idea. Consumption tax, levied at the business level, in lieu of the corporate income tax. Again this is dubious design - one needs to eliminate the income tax generally in order to get rid of it at the entity level. But again, we are at least as close to Earth here as the planet Mars in this proposal (perhaps closer), whereas Republicans these days more often sound like they are in an alternative universe.

Bottom line, I generally disagree with it, but I respect it as startlingly honest by Washington standards. By that I don't just mean that it fesses up to planning nasty things that the voters will hate, hence revealing what one might argue is the Republican's true "if-only-we-could" agenda. I also mean that it accepts the long-term budget constraint and, at least to a degree, sets out an intellectually coherent and recognizably conservative (in the sense of pro-market and not wild about redistribution) path, rather than being rabidly dishonest and self-contradictory, like Republicans demanding tax cuts, hands off Medicare, and an end to budget deficits.

Standing alone, it would be evidence that the Republicans aren't insane after all, and don't entirely reject the idea of governing. I wouldn't want them punished for the politically dicey aspects of this, if they actually were on balance interested in governing, given that one wants to encourage, not discourage, intellectually responsible behavior.

But given how I nonetheless interpret Republican behavior overall, including what they would actually do with legislative majorities plus the presidency (in Palin's case, this might mean nuclear war abroad and repression of political opponents at home), I find myself hoping instead that the Democrats successfully demagogue it to death.

Saturday, February 06, 2010

More events at NYU Law School

On Thursday at the Tax Policy Colloquium, Michael Devereux presented his paper, Taxation of Outbound Direct Investment. He, my co-convenor Mihir Desai, and I all agree that, if you think about tax policy going forward on a fresh start basis, exemption is the most rational system for outbound investment by resident corporations, reflecting (in Michael's and my way of thinking about it, more than Mihir's) the point that newly becoming a U.S. corporation for tax purposes verges on being an election. But I suggested that the "transition" issue - i.e., the existence of resident U.S. corporations that are more or less trapped, and that would get a windfall gain from enacting exemption without a compensatory (for the Treasury) transition levy, makes the policy choice more difficult, if one assumes that such a levy will not be imposed. This may be the next topic I write about in the area, since the extent to which these are transition issues is not well understood.

Then on Friday NYU Law School was the site for a really excellent and informative conference, Rethinking the Taxation of the Financial Sector, that brought together people with tax, regulatory, and accounting expertise concerning that sector. My own thought, not just from attending this conference but more generally, is that, bad though the legal and accounting systems for banks may be, the real blame for the financial crisis goes (to the extent any of these systems are at blame), to the system for assuring adequate regulatory capital, which (obviously) failed catastrophically. What to do going forward is a harder question than this backward looking point, but one interesting idea that I have heard about recently concerns an "excess profits" tax when banks earn a great deal relative to the measure of regulatory capital they are forced to keep on hand (they like to keep this amount as low as possible so they will have more free equity to play with). Excess profits for this purpose would be calculated before subtracting high executive compensation.

Excess profits taxes are rightly viewed with skepticism in the academic literature (in keeping with progressive rates generally when applied to business entities rather than to individuals). For example, I gather that the excess profits taxes that applied in the past to oil companies have few defenders today, even among those who agree that this sector should pay higher net taxes (i.e., get fewer tax preferences and other giveaways0. But, as applied to banks and other such entities, there's an interesting ground for treating extra-high returns on regulatory capital as evidence that something nefarious, in the 2008 sense, may be going on.

Why would a bank earn unusually high returns relative to admitted regulatory capital? Pre-2008, bank managers would have said it's because they're so incredibly talented. Masters of the Universe and all that exploded rubbish. Seen from a 2010 perspective, one can't really keep a straight face upon hearing that. Second possibility, they are just lucky. OK, if the normal return would be 5% but they take a chance and end up getting 7% rather than 3% the excess profits tax has perversely asymmetric consequences (if it applies to returns above 5%). It discourages risk-taking in a setting where the downside doesn't arouse concern. But perhaps this isn't the most realistic and relevant scenario.

Third possibility, they are low-balling regulatory capital, which ought to be a regulatory concern. Fourth possibility is a variant of #2, but much more pernicious. They are making bets that have a high return when they pay off because of a severe downside / tail. In other words, the high return is evidence of making risky bets that reflect the moral hazard problem ("heads I win, tails you lose" for the manager or firm, whether because he moves on after getting a big bonus, or the bank has limited liability and/or is too big to fail).

I don't know enough about the possible design of this excess profit tax on banks, or about the sector itself, to offer anything approaching an outright endorsement. But it is an intriguing idea despite the skepticism I might usually have about excess profits taxes.

Thursday, February 04, 2010

Newly posted paper

I've just posted on SSRN my new paper, occasionally discussed here, called "The Case Against Foreign Tax Credits."

Here is the link.

Abstract is as follows:

In international tax policy debate, it is usually assumed that, if one chooses not to exempt residents’ foreign source income, the preferred system would offer foreign tax credits. This assumption is mistaken, given the bad incentives created by the credits’ marginal reimbursement rate (MRR) of 100 percent and the unpersuasiveness of common rationales for granting them, such as those based on aversion to “double taxation” or support for capital export neutrality. While taxing foreign source income at the full domestic rate with only deductions for foreign taxes would over-tax outbound investment, at least in principal creditability is dominated by a burden-neutral shift to deductions plus a reduced tax rate for such income. And even if such a shift is unfeasible or unwise, the incentive problems resulting from a 100 percent MRR for foreign taxes paid may illuminate various more practical tax issues, such as (1) the merits of shifting to an exemption system, which features implicit deductibility, and (2) the merits of various proposed reforms, such as removing disincentives in subpart F for foreign tax planning by U.S. multinationals.

Wednesday, February 03, 2010

UNC Tax Conference last week

One but not both of these photos is from the UNC Tax Conference last week. I prefer the rogue, which was distributed to the group by another conference attendee, not just for artistic and sentimental reasons, but also because the actual photo makes me look too short. I was down a step from people near me, creating the false impression that I have shrunk to perhaps about 5'3".

My e-mail interview with a Polish news magazine

Here are their questions and my answers, the latter composed more or less at the limit of my typing speed. My answers are shown here in italics:

1. USA has to deal with budget problems, so does Germany, Greece, Poland, France, Japan, Russia, etc… it seems the public finance is now the main interest of world’s politicians and economist. You probably know of various solution proposed by different countries (including USA, of course). How do you perceive them? Most of them are based on simple ideas of public spending cuts or more borrowing or tax cuts/increasing…

In the long run, all government spending has to be paid for. That isn’t a policy recommendation, it’s an unavoidable fact of life because there is no free lunch. Defaulting on the debt, for example, would just be another way of paying for it (in effect, by taxing the bondholders). Economists call this “no-free-lunch” problem the inter-temporal budget constraint. In the long run, it holds just as much for a government as for an individual’s budget, although governments differ from us in that they can raise taxes or, if they’ve borrowed in their own currency, devalue it through inflation (whch doesn’t really stop the taxpayers from bearing the burden, given what will happen the next time the government tries to borrow).
Given all this, there is absolutely no alternative to imposing, at some point, higher taxes and/or lower spending so that the two will be in long-run balance with each other.

Borrowing is a useful tool, for governments just like individuals, if one would rather pay later than now. But it doesn’t actually finance spending in the long run, and the day of reckoning comes at some point.

2. Is there any historical proof of a working effective solution? Can you provide historical examples of failures and successes in fighting budget problems (like Chile)?

The historical example I like goes a bit further back, to the eighteenth century. Think of England versus France, which were almost continually at war throughout the eighteenth century and until 1815. England spent more on the war than it could contemporaneously raise through taxes. But it had an outstanding public finance system, with borrowing through a bond market that was backed up by (a) a well-functioning tax system, (b) bondholders’ confidence that Parliament wouldn’t allow a default, and (c) bondholders’ belief that the wars with France would end at some point, whereupon England would be able to repay the bonds by taxing in excess of post-war expenditure levels. This is exactly what ended up happening.
In France, by contrast, the eighteenth century monarchy was unable to pay for the wars it fought. This was the direct cause of the French Revolution, which started when the King was forced to summon the Estates General to stave off fiscal collapse. I believe France then simply renounced the monarchical debts, counting on the change in regime to avoid being blamed for this, and established more well-functioning finances, but obviously at a high price.
Governments today have well-established borrowing systems like eighteenth century England, but they don’t have a credible basis for suggesting that expenditures will at some point drop. For example, large-scale government-funded retirement programs don’t have an assumed end-date like even the past era’s seemingly endless European continental wars.

3. What can be the solution for Poland? We have positive GDP growth, but tax revenues going down, the public expenditures very high (the most money-eating is the retirement fund)?

One way or another, the path of spending and tax revenues must be brought closer together. I don’t know enough to comment on Poland’s retirement system, but it presumably needs to be put on a sustainable path, meaning that at some point it ceases to grow faster than GDP. Ideally, in the long run, it might be switched to a prepaid model, where retirees have funded their own benefits during their working years, but obviously this can’t help current retirees. What makes the transition so difficult is the aging of population (so every more retirees per worker) and increasing life expectancy (which of course is a good thing, but makes retirement programs costlier).
In all likelihood, both sides of the budget – taxes and expenditure growth – need to be addressed. If Poland’s political debate is anything like in the U.S. (and I hope for your sake that it is far less distorted and dysfunctional), this would require a compromise between parties on the left and the right of the political spectrum. This has happened in the U.S. in the past. For example, throughout the 1980s the Republicans and the Democrats cooperated to reduce budget deficits and improve the long-term financing of Social Security, our retirement pensions program. In U.S. politics today, however, this is utterly impossible, mainly because the Republicans have turned completely destructive and irresponsible (which is not to say that the Democrats would do the right thing either, but at least in their case we don’t know for sure that they wouldn’t).

4. Is there any universal solution you recommend?

Higher taxes and lower spending growth. In the U.S., since we don’t have a VAT, adding one to our system and putting Medicare, our healthcare program for seniors, on a sustainable growth path would get us most of the way there. But for other countires the same basic story – taxes need to go up, and spending cannot grow so much faster than GDP – may need to play out with different institutional details.

5. What possible mistakes (overestimations, understimations…) can government do while reforming budgets?

A long-term measure is needed, with independent experts allowed to implement it while shielded from direct political pressure. Annual budget deficits are too easy to manipulate, such as by increasing taxes or spending this year in exchange for making them much lower in the future. In the U.S., we call this “smoke and mirrors,” and politicians have gotten ever more aggressive in playing these games.

6. There’s always a controversy between two ideas: free marketers say: cutting taxes and social expenditures should increase tax revenues in long perspective; their opponents: it’s a complete absurd, the fast developing economy generate revenues but it can go along with a big welfare state. Which option would you chose and why?

There is a legitimate difference of opinion between people on the left who want government to play a bigger role, and people on the right who want markets to play a bigger role. In the end, it is really a matter of degree, given how socialism on the one hand, and unregulated markets with no social welfare safety net on the other hand, have in my view both been completely discredited.
That said, “supply side” claims that by cutting taxes one can increase revenues, while theoretically true at some point (e.g., suppose a 100% tax rate was lowered to 50%), have been conclusively been shown to be false within the range of debate over tax rates that usually are at issue politically.
So conservatives are almost invariably wrong, within the parameters of current debate, if they make supply side arguments that cutting taxes will increase revenue. But liberals or progressives are equally wrong if they claim that it is possible for government programs to keep on indefinitely growing faster than GDP.

7. What can be the effects situation in which governments decide to delay the reforms? The first is – growing debt, but… what about a Jones or Smith – a taxpayer?

Postponing a solution to fiscal problems means two things for Jones or Smith. First, older generations are handing off the problem to younger generations. Second, the problems are growing worse over time, and fixing them gets ever costlier. This includes the risk of catastrophic fiscal default or radical belt-tightening that leaves the then-current generation of seniors in very bad circumstances.
That said, we do need to wait for the current global recession to pass before taking major steps through currently implemented policy changes to move back towards fiscal balance.

UPDATE: I'm not entirely sure how this will read in Polish translation, and presumably will never get to know. But they called to ask me what I meant by my reference to "smoke and mirrors." I said, circus tricks to fool the audience.

Tuesday, February 02, 2010

I'm just a boy who can't say no

Though over-the-top busy, I've agreed to two perhaps not terribly high-profile Media Appearances.

First, tomorrow (Wednesday 2/3) from 10:06 to 10:30 AM on the Kathleen Dunn show on Wisconsin Public Radio, I'm being interviewed live on such topics as "the broader implications of the current tax code, the Bush tax cuts, what tax cuts (if any) are a good idea right now, and the current/anticipated budget deficit."

UPDATE: Reasonably lively and enjoyable interview. I was pretty pessimistic about the fiscal outlook (due to my belief that the political system is failing), warning that current political trends suggest that, within the next 10 years, we may face a fiscal crisis that will make what's happened in the last 2 years look like a walk in the park.

Second, I'm being interviewed about debt and deficits by the Wprost Weekly Magazine, a Polish publication.

UPDATE: See the text of my e-mail interview in the next post, here.