Fixing The US Budget – Straightforward Or The Hardest Problem On Earth?

Ethical Markets Reforming Global Finance

By Simon Johnson

The conventional wisdom is that we face a serious budget problem, ballooning debt and political deadlock that prevents any semblance of progress either in the short term or over the next 20 years. “The sky is falling — cut everyone’s wages, slash Social Security, buy gold!” summarizes the mood of this midterm moment.

But step back and look at American public finances from any angle — historical, comparative with other nations, from Mars — and the picture is very different. We have a simple economic problem — we need to fix our tax system, irrespective of how much revenue we want from it. And we continue to face the central American political problem of the last 200 years: how much inequality are we willing to accept as reasonable and fair?

On Sunday, The New York Times invited everyone to weigh in on the deficit, posting a deficit puzzle that lets you make spending cuts and tax increases in an attempt to wipe out the deficit by 2040. I accept the invitation.

The key technical point is this: our tax system stinks. That much you have probably figured out — think back to how you felt on April 15 — but most likely you only encounter the tip of the iceberg (unless you are a tax professional). In terms of what we tax and how we tax it, almost every dimension of government revenue feels as if it were cobbled together in the early 20th century (which it was) and never properly modernized.

At some level a clunky government revenue system reflects sensible American reluctance to pay tax, as well as the deep political polarization that we have always had about the size of government. (Anyone interested in how we arrived at this point should read Steven R. Weisman’s “The Great Tax Wars”; let me note that Mr. Weisman is a colleague at the Peterson Institute and also the editor of Daniel Patrick Moynihan’s letters.)

We’ve reached the point where modernization of our system is long overdue. It is relatively easy to raise significant revenue without having significant distortionary or discouraging effects. The New York Times budget exercise does not encompass the full range of tax reform — blame the chairmen of the bipartisan deficit reduction commission for not fully putting this on the table — but nonetheless you can find some solutions without higher rates, as I have.

The carbon tax proposal in the Times chart is too modest. Over the next 20 years we could phase in something much more ambitious, and reducing our dependence on imported oil would be a major contribution to national security. The “national sales tax” idea is a bit vague; a properly designed value added tax, which protects poorer people by rating essentials at zero, would be better.

I’m not in favor of raising rates generally, but as my proposed budget shows, I do raise tax rates for the highest paid and wealthiest people. The process of job polarization in the United States looks set to continue — the people at the top of the educational attainment ladder are going to do very well; others not so well (this is why median wages haven’t increased). Even the Peterson Foundation — not a left-wing group — points out that the richest are paying less tax today.

Note, however, that I’m less sanguine than even most self-proclaimed “fiscal hawks” about our current budget situation. Consequently, I would eliminate all the Bush tax cuts, and this substantially takes care of our short-term projected deficit. On my joint Web site with James Kwak, he makes the case regarding why this would also be good politics for President Obama. No one who claims to be focused on fiscal responsibility should want these tax cuts, we have said previously in this space.

My proposal takes $2 trillion from the budget deficit by 2030. Personally, I would go even further (with more comprehensive tax reform). By refusing to reduce risks around big banks, we continue to carry big contingent liabilities — the crisis of 2008-9 pushed up federal debt by 40 percentage points of gross domestic product, and the same thing will happen again.

We need a margin of fiscal safety (and to fix the banks, but that is not going to happen – talk to your politicians about that). For more on these points, see my testimony to the Senate Budget Committee in August.

There are some obvious spending cuts — even the Pentagon is willing to cut back on programs for weapons that are no longer a top priority.

We also need to control Medicare costs, irrespective of anything else. Again the fiscal commission and The Times do not lay out all the options, but from the numbers ($560 billion by 2030) you can see how important this is. It’s a tough problem — and don’t think about just shoving these costs (or the qualified people) back onto private health insurance; that’s just another way to ruin the economy. Either health-care costs become an ever-increasing share of G.D.P., without limit — which is not possible — or someone is going to be squeezed. We’ll see if that will be beneficiaries, payers (insurers) or providers, but those are your choices.

My final proposal is a 50/50 split between spending cuts and tax “increases,” but I do not endorse any cuts to Social Security. Again, think about job polarization and the hollowing out of middle-income jobs from this economy — mostly from the effects of technology but reinforced by the likely effects of trade. This problem is common to most of the industrialized world, but almost every other nation is better at buffering the effects with transfers.

We do this a little with unemployment insurance, and you’ll see the effects in terms of the numbers claiming disability insurance. But for most, Social Security is the only transfer program we have that works. (For the historical background on how the government came to provide this and other forms of social insurance, see David Moss’s “When All Else Fails”; the United States has generally only acted when the degree of perceived injustice became acute.)

Highly unequal countries tend to become unstable and dangerous places. How unequal do you want the United States to become?

This post previously appeared on the’s Economix blog; it is used here with permission. If you would like to reproduce the entire post, please contact the New York Times.