How to solve the fiscal dilemma

By Felix Salmon
June 8, 2010
Germany, UK) only to be told that they're still not big enough.

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How should governments deal with enormous budget deficits? In Europe, the playbook seems to be clear: announce enormous budget cuts (see Germany, UK) only to be told that they’re still not big enough.

Jeff Sachs today has a slightly different idea. He starts off by saying that the fiscal response to the financial crisis was a bit silly, and indeed that “stimulus measures such as temporary tax cuts for households or car scrappage schemes were dispiriting wastes of scarce time and money”. If the country was headed into recession, then it was the job of central bankers to “prevent depression” while actually allowing the recession to run its course: “the US, UK, Ireland, Spain, Greece and others had over-borrowed for a decade, so a decline in consumption after 2007 was not an anomaly to be fought but an adjustment to be accepted.”

OK, fiscal response is off the table now, so we’re all closing that particular stable door. The question is how to stabilize national finances going forwards. And Sachs says that’s pretty much impossible in the US:

America has absolutely no consensus on how to restore budget balance, as it is trapped between a federal government that provides too few public investments and services and a public that is almost maniacal in its opposition to tax rises.

His solution is to fly in the face of that maniacal public:

Governments and the public should insist that the rich pay more in income and wealth taxes – indeed, a lot more. The upward re-distribution of the past 25 years has made our economies into extravagant playgrounds for the super-wealthy. Politicians of both the mainstream left and right in the US and UK have fawned over those who pay their campaign bills in return for low taxation. Even playgrounds should collect tolls – when it is billionaires in the sandpit.

I don’t think this is possible, politically, in either the US or the UK. In the US, the middle classes are implacably opposed to tax hikes on people making more money than they themselves will ever make. I’m not entirely clear on the reasons for this, but I suspect it has something to do with the American Dream of becoming incredibly successful: no one wants to reach that gilded land only to find it full of taxes. And in the UK, the Tories have moved far enough to the left already, both before and after the election: there comes a point at which the parliamentary Conservative party simply won’t get dragged any further in that direction.

Still, the way that the UK fiscal situation plays out is going to be an interesting dress rehearsal for the fiscal politics which will surely come to the fore in the US over the next few years. US politicians can’t learn much from Germany: the two countries are too far apart, politically. But the UK is much more American, in many different ways, than Germany is. And if the current UK government somehow manages to stick together for the next three or four years, there will be a lot of important lessons to be learned on this side of the pond.

Update: Matthew Yglesias and Robert Waldmann say that in fact Americans are not opposed to higher taxes on the rich. Maybe it’s just American politicians who are.

19 comments

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It seems to me that if demand-side strategies cannot be pursued, supply-side growth is the only option going forward. Sachs sets up the problem this way – but goes in a direction 180 degrees for the solution.

Posted by cgotterba | Report as abusive

Does his comment about “a federal government that provides too few public investments and services” mean that Sachs thinks the fed gov is too small?

Unfortunately, the FT paywall is preventing me from resolving this question re: his mental competence.

Posted by Mega | Report as abusive

I don’t think middle-class opposition to tax hikes on the rich comes primarily from pecuniary self-interest; I think it’s primarily moral.

Posted by dWj | Report as abusive

Want to produce millions of jobs and reduce the federal deficit at the same time? Reduce the capital gains tax by three percent for every year that an investment is held until it is zero. That’s six years to get to zero tax on an investment. Immediately, this will cause the stock market to rally, assisting in reestablishing the wealth effect Greenspan so efficiently destroyed. Immediately, money will flood into venture capital, which, in turn, should spurn innovation and stimulate millions of jobs in America – jobs that are not so easily exported. This will bring back IPOs and a healthier stock market, resulting in tax revenues to help reduce the deficit. Simple, clean, efficient. And, oh yeah, put some regulations in place that prevent Wall Street from running amuck.

Posted by netvet | Report as abusive

This much is certain. In November, the GOP will win a lot of seats in the House, either a majority or near a majority. Even without a majority, there will be enough Blue Dog Dems to erect an antitax wall.

Meanwhile, Obama will still be in the WH and the Dems will likely still have the Senate. They aren’t going to want to to cut spending.

Can anyone say California, but with a printing press?

Posted by DanHess | Report as abusive

Unlike most nations, Americans blame the poor and powerless for the ills of society, rather than the rich and powerful. Common American knowledge holds that poor people control the banks and oil companies, while the rich dedicate themselves to philanthropy and good works.

Posted by Corvallis | Report as abusive

I don’t know that there really is a general middle class aversion to tax hikes on the rich. After all, they elected Obama, who openly planned to raise taxes on families making more than $250,000 a year. Rather, I think almost no one has any idea what their tax liability is, and so when they hear the inevitable attack that “X raised taxes,” they’re willing to believe their own taxes have been raised, even if they demonstrably have not been.

In the months after the stimulus, the only change to most Americans’ tax liability was the making work pay credit, which slightly reduced taxes. Yet there were plenty of polls showing that a substantial number of Americans (particularly the tea party types) believed their taxes had risen substantially.

Posted by AnonymousChef | Report as abusive

False dilemma. The deficit is really a non-issue – it rises and falls cyclically, growing as the economy contracts and narrowing as the economy expands. A few months of solid GDP growth and all this debt hysteria will look pretty foolish. The size of the deficit (in absolute or relative terms) shouldn’t scare us into adopting contractionary policies: slashing spending and/or raising taxes. Don’t push a drowning man.

The real deficit we should fear is the ever-expanding intelligence deficit in the economics profession. And the fact that press and politicians seems to take their foolishness as gospel.

Posted by Sensei | Report as abusive

My gut tells me that income tax raises don’t work because it’s too easy for the rich to get around it. I’m thinking that increasing capital gains tax on people with more than say $10m in play and reducing/eliminating it for people with less invested (maybe reduction in $1-10m range, elimination for under $1m)… that will see some real tax movement and allow the public at large to invest and see some meat on their investment and not have to chase risk so much.

Posted by CDNrebel | Report as abusive

No doubt you’ve already seen the poll data that Matt Yglesias posted. It is the case that raising taxes on the prosperous is unlikely to happen soon, but not because the people don’t want it. Politicians face a variety of pressures: fund raising, social milieu, and especially what kind of job they’ll get after they leave office. Blanche Lincoln didn’t prostitute herself for the Walton family because the voters of Arkansas demanded it, Evan Bayh doesn’t think the people of Indiana would cruficy him he advocated raising the top bracket rate, and Chuck Schumer isn’t looking at polling data when he chooses his position on the carried interest exemption. These people think that the voters are unlikely to punish them very much for doing things that will be richly rewarded in other ways.

Posted by Andy_McLennan | Report as abusive

The truth? There are a lot of stupid non-wealthy Americans.

A case in point: There was legislation designed to only tax the estates of America’s wealthiest people when they died. Savvy politicians working on behalf of the wealthy elite renamed the tax as the Death Tax and ran ads making it appear that that tax would effect everyone, rich and poor alike.

Poor, stupid Americans who would not have been affected at all by the tax fought vehemently to prevent it from becoming law.

And they succeeded because not that many people in Washington DC really wanted that bill to become law anyway.

Posted by breezinthru | Report as abusive

It’s always funny when leftists complain that the American public is too stupid to understand their own interests. They don’t get that these “dumb” Americans are smart enough to see how wealth redistribution worked in other countries and they don’t want any part of it. I wonder at what point do you guys abandon the socialist high-tax government-run utopia vision and say that there won’t be any money for anyone to spend unless we can put some pro-growth policies in place ASAP.

Posted by tyates | Report as abusive

The U. S. government is already in the Venture Capital business. We own 61% of General Motors which just launched its $100 million General Motors Venture Fund to support new transportation technology. The Government Services Administration could futher generate new jobs and businesses in America by transferring its billions in excess real estate to American entreprenuers that create new American jobs. This would not cost the GSA any new money, as they already own the real estate and need a creative new avenue to use it. What a concept!!!!

Posted by VENTURES | Report as abusive

Thanks for the link. It was especially generous as I was just adding more evidence to Yglesias’s post.

Posted by robertwaldmann | Report as abusive

MORALITY AGAIN!
‘I don’t think middle-class opposition to tax hikes on the rich comes primarily from pecuniary self-interest; I think it’s primarily moral.

Posted by dWj ”

Does dWj think that Eisenhaur — a republican — was immoral, when he raised the top tax rate to 90 percent. Funny, how morality comes in when you tell people not to default on their mortgages and not to tax the rich — not when teachers get fired and garbage in the street is uncollected or Americans simply die because they do not have insurance.

Posted by PaulV | Report as abusive

Are we not talking about something different than income taxes though? It seems to me we already have rather hefty income taxes especially after the Bush Cuts are removed. 39.6% plus 2.9% for medicare and State taxes adds up to a pretty high rate. I think an upper bound on income taxes is probably 50% before people cut back income production. We are talking about tax reform that broadens the tax base and raising middle class taxes which are virtually nothing (Except for the SS tax)

Posted by sditulli | Report as abusive

Think about how much good tax advice costs and how much organising your affairs to minimise your tax income costs. As long as the saving on tax is more than the cost of getting that saving “soaking the rich” isn’t going to work.

Also the “enormous” budget cuts actually turn out to be tiny. Remember the argument in the UK election was whether making a cut of less than 1% of government expenditure would collapse the economy or not.

The fact is that the governments can’t afford their social welfare system.

Posted by Danny_Black | Report as abusive

Sensei, in the UK the deficit this year is over 12% of GDP. To have that wiped out by 4 months of growth would imply an annual growth rate of over 30%. Hands up who thinks that is likely?

Off the top of my head the US federal government has been running a deficit for the last 30 years – with the exception of a few years under Clinton – during a general strong growth period.

Posted by Danny_Black | Report as abusive

Like it or not, the people are not going to consent to austerity measures, and the government is never going to allow a default. That leaves only the inflation route (i.e., “printing” money), which requires neither a public referendum or mandate. More about using inflation to reduce the deficit and rout entitlements at:

http://wjmc.blogspot.com/2010/05/using-i nflation-to-reduce-public-debt.html

Thank you for the opportunity to comment…

Posted by mckibbinusa | Report as abusive