(This piece appeared on Forbes.com on 1/23/09)
President Obama is eager to attack the economic crisis. Here is the speech I’d like to hear from him.
My fellow Americans, these are fearful times.
Through a set of public and private mistakes, our financial system is in disarray. The problems of Wall Street have spread to Main Street. Unemployment is on the rise.
Key sectors of our economy face unparalleled challenges. The auto industry is reeling. Housing and construction are in deep trouble. The financial sector has been hit with bankruptcy and layoffs. The retail sector is struggling.
Workers, investors, managers and entrepreneurs face a fog of doubt and uncertainty. When will the economy rebound? Will I lose my job? Will my products sell as they once did and at what price?
Investors and employers, consumers and entrepreneurs are sitting on the sidelines. Such caution is understandable. Until people are confident of the future, our economy is going to struggle.
What can the federal government do to unleash the forces of recovery?
Many are urging a massive increase in government spending coupled with tax rebates as a way to jump start the economy. But the economy is not stagnant because of a lack of spending. The economy is stagnant because of a lack of confidence in the future. Government spending on bridges, roads and new schools will stimulate the construction industry. But without confidence, the benefits will not spread to the rest of the economy.
The argument for a massive spending increase presumes that spending is the source of our prosperity. But it is the combination of prudent spending and prudent investment that creates prosperity.
I would like to guarantee that we in Washington would spend an additional trillion dollars or so wisely. I would like to guarantee that such spending would be free of pork and the influence of the powerful. But those guarantees would be empty promises. As a former senator, I know the temptations of power and influence that are unleashed when a trillion dollars are slopping around in the government trough.
And would a trillion-dollar increase in the federal budget deficit enhance investor or consumer confidence? What costs will a spending increase of that magnitude impose on not just future generations but on this generation next year and the year after?
Trillions of dollars of annual red ink puts at risk the government’s ability to keep its promises. That will discourage private investment and private spending, imperiling any recovery that might take place based on private initiative.
Finally, adding a trillion dollars to an already bloated federal budget is another sign that we in Washington are irresponsible and unable to live within our means. It is that failure of will and discipline that helped create the current situation–a belief that we could have cheap credit and ever-expanding home ownership without any consequences.
A massive increase in spending on hurried projects of uncertain value, financed by borrowing, is a promise to raise taxes in the future and to squander resources in the meanwhile. That is not the road to recovery. That is not the road to prosperity.
What is needed instead is a set of steps to stimulate the productive side of our economy. A tax rebate of either the payroll tax or the income does not stimulate investment. There is no evidence that rebates even stimulate spending. Rebates do not change the incentives of consumers to spend or savers to invest. Past rebates have consistently failed to encourage economic activity.
Instead, I’m proposing today a radical re-imagining of our tax system. I am recommending the elimination of the payroll tax. The payroll tax is a regressive tax that falls harshly on the poor. And it is deceptive, an unacceptable characteristic of a tax in a democracy.
Half of the payroll tax appears to be paid by employers. In fact, studies of the payroll tax show that the employer merely lowers worker compensation in response to the tax burden. So workers pay virtually the entire 15%.
Worse, the payroll tax gives the illusion that taxes are “contributions” toward future social security payments. In fact, the payroll tax is used to finance current recipients of Social Security and Medicare along with other government spending such as the war on Iraq and welfare for wealth farmers.
This fools workers into thinking such programs are cheaper than they actually are. This artificially encourages the demand for such programs.
Unlike a temporary rebate of payroll taxes, eliminating the payroll tax will change incentives facing firms and workers. The result will be job creation and increased worker compensation. The permanence of the change raises the effectiveness of that encouragement, again in contrast to a temporary rebate.
But eliminating the payroll tax without reforming the budget and entitlement programs would be irresponsible and would rob the tax cut of much of its kick.
The payroll tax currently generates about $700 billion. We will pay for that reduction with three other changes:
–Eliminating all corporate welfare. Corporate welfare rewards those corporations that excel at lobbying rather than serving their customers. Eliminating it will save $100 billion annually.
–Implementing spending reductions in all departments of 10%, saving over $250 billion. Such cuts in a federal budget heading toward $3 trillion are hardly draconian. They merely return spending to the level of a year or two ago.
–Making small across-the-board increases in the income tax rate, yielding $350 billion. The poorest workers will in fact see a significant improvement in their after-tax income because the elimination of the payroll tax will overwhelm the increase in income taxes. The richest Americans will see a slightly larger increase because their payroll tax contributions are currently capped.
At the same time, I will appoint two bipartisan commissions to reform the budget process itself and the Social Security and Medicare programs. The budget process is out of control. Signaling to the private sector that the public sector will live within its means and avoid the erratic behavior of the past year will go a long way toward rejuvenating the economy. So will reform of Social Security and Medicare.
Social Security and Medicare are not viable in their current form given our demographics. For 70 years we have pretended that they are insurance programs. In fact, they are welfare programs that also help the rich in the name of generating support for the system. It is absurd for wealthy Americans to be part of a retirement and health system when they have the wherewithal to take care of themselves without government help.
The system isn’t financially bankrupt–yet. But it is intellectually bankrupt. Why should today’s workers pay for today’s retirees in the expectation that future workers will do the same for them? Why should a poor worker of today send money to a wealthy retiree? There is a name for such schemes and it is not a pretty one. It would be far better to let those who are capable of taking care of themselves do so, while putting aside money for those unable to take care of themselves.
In short, I propose that Social Security and Medicare become means-tested safety nets for the truly needy, rather than a fake pension and insurance program with a hidden welfare component. The commission I appoint will design a gradual transition over time to such a transparent system, allowing today’s workers to plan honestly for the future.
One method of transforming Social Security and Medicare will be to make them means-tested and make the welfare components explicit rather than buried and opaque as they are now.
Ultimately, this will allow for lower tax rates. Those expected lower tax rates will help encourage current spending because consumers will not have to worry about future tax increases.
If we have the courage to implement this plan of fiscal responsibility and a more transparent tax system with improved incentives, it will let the private sector know that the grown-ups are in charge and that the government can be trusted to act responsibly.
This will in turn encourage the risk taking and investment that must take place before our economy can recover. And most importantly, we will set the stage for future prosperity.
Thank you and God bless America.
Russ Roberts is a research fellow at the Hoover Institution, a professor of economics at George Mason University, and the host of a weekly podcast, EconTalk. His latest book is The Price of Everything: A Parable of Possibility and Prosperity.