The Deficit Isn't Public Enemy No. 1

The recent report of the bipartisan Strengthening of America Commission, chaired by Senators Pete V. Domenici (R-N.M.) and Sam Nunn (D-Ga.), concludes that only a big dose of supply-side economics can restore the U.S. savings rate. Issued under the auspices of the Center for Strategic & International Studies, a centrist think tank in Washington, the report calls for abolishing the present tax code and replacing it with a consumption-based income tax, which would exempt from taxes any income that is saved or invested.

This supply-side solution to the tax bias against saving was first proposed in January, 1977, by William E. Simon and David F. Bradford, respectively the Treasury Secretary and Deputy Assistant Secretary for tax policy in the Ford Administration. Then, Blueprints for Basic Tax Reform was too radical for policymakers. We can be thankful that it has taken only 15 years for this sensible idea to become part of centrist thinking.

SCANT AWARENESS. The commission's report, however, is not without grave problems. Rather than presenting a straightforward case against the multiple taxation of investment income (for example, the double taxation of dividends), the report backs into tax reform through spurious arguments asserting that rising debt is crowding out investment and causing productivity to decline. It is as if the commission were unaware of the 1991 Commerce Dept. report showing that growth of U.S. manufacturing productivity tripled during the 1980s: When Reagan left office, such growth was on a par with Japan and Europe, and manufacturing's share of gnp had rebounded to the level of output achieved during the 1960s.

Defects in the commission's productivity assumptions are brought home by a newly released study of international productivity for the McKinsey Global Institute. The study by economists Martin N. Baily, Francis M. Bator, and Robert M. Solow--described by The New York Times as "all longtime Democrats"--concludes that the U.S. commands a significant productivity lead over Europe and Japan, with Germany and Japan reaching only 80% of U.S. manufacturing productivity and with the U.S. enjoying an even greater lead in service-sector productivity.

In merchandise retailing, for example, we are twice as efficient as Japan, and our telecommunications industry is twice as productive as Germany's. Moreover, the report finds that our relative performance was better during the 1980s than at any other time in the postwar era. Our competitive advantage is attributed to vigorous competition, which forces us to get more from our investments than do our protected and heavily regulated foreign competitors. In short, the "industrial policies" of our rivals have burdened their enterprises with insulated managements and work forces that have the characteristics of unproductive public bureaucracies.

LOSERS LOBBY. From 1985 to 1991--a period when pundits were pulling their hair out because of our alleged lack of competitiveness--the U.S. share of world exports increased from 19% to 27%. During the past five years, U.S. merchandise exports have grown 40% faster than Germany's and 75% faster than Japan's. As George Washington University's Henry R. Nau explains, we don't know about this because our successful companies are busy in the world marketplace, while the losing companies are in Washington complaining to Congress, think tanks, the media, and Presidential candidates.

The commission's report also errs in its mechanistic assumption that by solving the savings problem with what amounts to an unlimited individual retirement account, tax rates on consumed income can be as progressive as policymakers wish without doing economic harm--a sop to the continuation of excessive spending. But consumption is an incentive to production. If it is to be ruthlessly taxed, there are no rewards for saving and investing.

The investment rate reflects demographics, technological change, the aftertax rate of return, the security of property rights, opportunities abroad, and the liabilities associated with hiring people and producing a product or service. If these factors are encouraging, investors will find financing. If they are not, high savings rates will produce what Keynesians call "the paradox of thrift," leading to a downward spiral. The commission does not understand this, and concludes erroneously that reducing the deficit through higher taxes would boost savings and investment.

The red ink of the past decade is the product of unexpected disinflation and federally guaranteed deposits. Whipping inflation and standing behind federal guarantees have done more to help investment than the deficit has done to hurt it. However large the public debt now seems to the hysterical, it is small compared with 1946, when it was 127% of GNP--more than twice today's rate. Whatever one thinks about the debt, its mismanagement by government is good reason not to give this failed institution yet more control, as the commission proposes, over education, health, industry, and investment in the name of strengthening America.

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