Should Taxes Be Raised?
An interesting question for me considering that I just got back from my tax preparers office (and it wasn’t fun this year), and one that Mark Schmitt answers in the affirmative. And as much as it pains me to say this, he may be right.
Everyone who looks at the numbers knows that taxes must go up. If we do nothing at all, the years 2007 through 2016 will bring deficits of $3.5 trillion outside of the surplus in Social Security. But doing nothing assumes that all the Bush tax cuts will be allowed to expire as scheduled in 2010 and subsequently. If the tax cuts are extended, and spending remains generally unchanged, the 10-year deficit will total $7.8 trillion. To balance the budget under these conditions would require cutting defense spending by 67 percent, Medicare by 54 percent, or every other program by a third, something that no one in politics has shown any willingness to do. The current path leads straight into a severe economic crisis.
Those are not nice numbers, and I’m assuming Schmitt has the numbers right.
The risk here is of putting too little on the table rather than too much. If the fight is just about extension of a particular tax provision, it will be hard to win. And if politicians aren’t willing to talk honestly about the magnitude of the changes necessary, the default will be excruciating: In a few years, we will enter a period of chronic crisis, scraping by each year with a painful series of budget gimmicks, fee increases, and disguised tax hikes—just enough to get by for the year before the dreary cycle begins again. After a few years, the public impression would be of a government that is constantly raising taxes, constantly cutting services, yet never solving either the fiscal crisis or other problems.
And if Schmitt is right about this, then this isn’t good either.
This brings me to a larger issue of rules vs. discretion, or using the terminology of the Nobel laureates Prescott and Kydland, time inconsistency. Discretionary policy–i.e. policy that is flexible and determined by politicians–is time inconsistent and this leads to sub-optimal outcomes. As such, policies that are determined by rules are preferable in that they are harder to change thus having a greater degree of “believability” by the public. A simple example of time inconsistency is a college course. The optimal policy at the begining of the semester is for the professor to announce a final that will make up the bulk of the final grade. Students, believing this policy, will study. But when the day of the final comes, given that the students have studied, the optimal solution is to cancel the final. The students have already studied and the professor doesn’t have to incur the cost of grading. A win-win situation. However, if the students are rational agents they will realize the professor will “deviate” from the announced optimal policy of giving the final and will not study. Thus the discretionary policy of leaving grading/testing up to the professor is not time consistent.
And the rules that are put in place do not have to be simple (although they could be). Policies that are based on a number of determinants could be fairly complicated and produce better results than discretionary policies. How does all of this tie into taxes, budgets and government spending? Well perhaps instead of letting politicians determine spending by proposing various type of legislation and then arguing over budgets, taxes and what not; suppose taxes and spending are determined by a rule and hence politicans have a fixed pot of money to spend and have to argue over how much goes to various programs? This might be a useful step in solving the problem of taxes and spending and the various obligations the country now faces. Of course, since it is something sensible and takes away the ability to engage in pork barrel spending form politicians I expect such an idea to go precisely nowhere.
In short our policies in this country are determined by short-sighted politicians who have trouble looking beyond the next election. Hence decisions made by politicians are constrained by each politicians next election. This is not the ideal recipe for good policy decisions.
Link via Greg Mankiw.