Solution to economic disaster: Common sense

The new year and new Congress deserve some comment as to whether the U.S. can avert an economic disaster, as Europe seems to have done.

Last year, the world feared that Europe would suffer the dissolution of the euro zone. Germany did not want to bail out its less-fortunate neighbors unless they agreed to severe austerity and to what amounted to a surrender of sovereignty, ideas that other countries refused. What ensued was a series of summit meetings that seemed long on talk and short on substance. Agreements seemed to falter when the details got difficult.

The core of the European success was a common commitment to save the euro, and that politicians and central bankers would actually act to avert disaster. In July, the European Central Bank finalized a plan to enable banks and troubled governments to have access to money at reasonable rates. Governments agreed, if grudgingly.

So it may happen in our Congress. The outgoing Congress agonized to the bitter end before averting the fiscal crisis. Despite grumbling and deadlines, the essential point was that the House Republicans allowed a bill to pass even though their majority opposed it.

House Speaker John Boehner not only allowed the vote, but voted for the proposal. Whether this is truly a sea change or simply a case of the House Republicans being outmaneuvered is unclear. The debt ceiling issue is temporarily resolved. The curiosity is that raising the debt ceiling simply allows the government to pay the bills the Congress already approved. To approve spending bills, but then to refuse to raise the debt ceiling, is like refusing to pay the credit card bill while continuing to spend. That will destroy your credit.

The real question is how much should government spend and on what. Are we truly at risk of becoming another Greece? In reality the current budget deficit reflects two things: exceptionally low government revenue and the continuing problems caused by the financial crisis and recession that followed the bursting of the housing bubble. Restoring tax revenues to historical levels and improving the economy to further increase revenue and reduce spending is the goal.

In fact, the government can borrow at extraordinarily low interest rates. The world trusts us to pay our debts. Federal taxes, relative to the size of the economy, are at a low point. In 2000 federal revenue was 21 percent of GDP; today it is 17 percent.

High tax collections then were temporarily inflated by the bull market in technology stocks which led to taxable capital gains and abundant ordinary income for those who could cash in stock options. The government predicted such tax levels forever, but that seldom happens and, in fact, did not.

What we really need today is, as Adlai Stevenson once said, “talk sense to the American people.” We need our representatives to say, as N. Gregory Mankiw, a Harvard economist, did a week ago: “Ultimately, unless we scale back entitlement programs far more than anyone in Washington is now seriously considering, we will have no choice but to increase taxes on a vast majority of Americans. This could involve higher tax rates or an elimination of popular deductions. Or it could mean an entirely new tax, such as a value-added tax or a carbon tax.”

Another refreshing comment came from W. Glenn Hubbard, the dean of the Columbia University business school, who was chairman of the president’s Council of Economic Advisers when the Bush tax cuts were enacted.

“We need a tax system that can promote economic growth and raise the revenue the American people want to devote to government,” he said.

Perhaps the best summary comes from Greg Mankiw, “Fiscal negotiations might become a bit easier if everyone started by agreeing that the policies we choose must be constrained by the laws of arithmetic.”

Mark Sievers, president of Epsilon Financial Group, is a certified financial planner with a master’s in business administration from UC Berkeley. Contact him at mark@wealthmatters.com.