Some Deficit Magic for the Supercommittee: Laurence KotlikoffLaurence Kotlikoff
Nov. 16 (Bloomberg) -- The Congressional supercommittee, charged with cutting federal debt by at least $1.2 trillion over the next decade, is deadlocked. Democrats and Republicans can’t agree on whose ox to gore. Both sides need a painless deficit-reduction plan.
I’ve got one.
Let’s double income taxes and lend each taxpayer’s extra payments right back to the same person. Then, when each taxpayer makes interest and principal payments on the loan, Uncle Sam will immediately hand back to that same person these monies in the form of new transfer payments.
Take Joe who is now paying taxes of $10,000. The government would double that to $20,000, but immediately return the extra $10,000 to Joe as a loan. And when Joe pays back the loan, every dollar Joe sends Uncle Sam in interest and principal would be immediately returned to Joe as a transfer payment.
Furthermore, we needn’t bother moving the money back and forth between the taxpayers and the government, because what’s handed over is always handed back. Not moving the money saves postage and processing costs.
This policy, although it does nothing real, does bring in enough new revenue to eliminate this year’s deficit, since this year’s taxes rise while this year’s spending doesn’t. Furthermore, I can use my plan to painlessly end deficits forever. Every year we’re short of taxes, we just announce that we’ve raised taxes and invested them in the American public and, later on, we simply announce that we’ve received principal plus interest and returned the funds to taxpayers.
By announcing really large and growing new taxes, we can start running massive surpluses, making our government, now and forever, look like the world’s most fiscally prudent. So, for that matter, can the Italians, the Greeks, and all the other struggling euro-area countries. The European sovereign-debt crisis can be eliminated overnight.
Won’t Republicans object to raising taxes? No. This isn’t tax and spend. This is tax and invest. And Democrats will be thrilled to establish a new transfer program.
If all this is making you queasy, it should. Here, you’ve been thinking that the deficit measured a real problem, and I’ve made it painlessly disappear.
Unfortunately, economics isn’t magic. No one can use words to overcome real economic problems. What’s turning your gut is the realization that the deficit is a figment of language, not a fundamental measure of our fiscal policy, which is why we can use words to make it vanish.
Physics has its conceptual imposters, namely time and distance. Economics has debt, deficits, taxes, transfers, disposable income, personal saving, government saving and much more. None of these measures refers to an economic fundamental. The size of each can instantly be changed by using different words to label the amounts the government takes in and hands out.
In my deficit-reduction plan, for example, I’m having the government label the extra funds it collects this year as “taxes” and the return of these funds as “loans.” If, instead, I labeled the extra funds collected as “borrowing” and the return of funds as “transfer payments,” I’d make this year’s deficit much larger. So the labeling -- the words used to describe the monies taken in and handed back -- matters. And nothing in economics tells us which words to use.
I call this the Economics Labeling Problem, and it’s a big one. At its core, economics consists of mathematical models featuring participants who are rational, meaning they aren’t confused by language. These so-called neoclassical models can incorporate all manner of economic problems, market failures, and government behaviors. But no matter the structure of the model and the actual fiscal policy assumed, one can always label the model’s variables to produce whatever time path of deficits one wants to proclaim.
Like the tailors in Hans Christian Andersen’s “The Emperor’s New Clothes,” economists are making a pretty living selling a fantasy. But unlike Andersen’s tailors, they have duped themselves into thinking their fantasy is real -- that “official” deficits and derivative measures of government cash flows, announced by and for our emperor, Uncle Sam, have meaning.
Also unlike the tailors in Andersen’s tale, the economists’ illusions can cause real harm. In fixating on economically meaningless measures of official debt, my professional brethren are diverting attention from our biggest policy problem: the ever-growing, enormous and unaffordable bill being foisted on our children.
There is a label-free way to measure this bill. It’s called the infinite-horizon, present-value fiscal gap. It tells us how much money (beyond the taxes projected to be collected over time) would be needed today to meet all our future spending commitments -- including such items as Social Security and Medicare -- without further damaging our children’s economic futures. Like space-time in physics, the fiscal gap is a fundamental concept, not a linguistic illusion.
Based on Congressional Budget Office projections, this year’s U.S. fiscal gap is $211 trillion, or about 14 times gross domestic product. By comparison, Greece’s is 12 times GDP. Germany’s is three times GDP. What’s more, our budget shortfall is growing rapidly. Last year’s value was $205 trillion. So the true measure of our nation’s insolvency grew in one year by $6 trillion, while the supercommittee is charged with saving a trivial $1.2 trillion over 10 years.
My bottom line? If the supercommittee “succeeds,” it will, in fact, fail by doing too little too late. It will win a word game and lose the big game: ensuring the economic well-being of our children.
(Laurence Kotlikoff, a professor of economics at Boston University, is a Bloomberg View columnist. The opinions expressed are his own.)
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