Monday, January 12, 2009

Making a deal with our future selves.

Alan Kreuger points out two separate challenges that must be solved at once: first is the "paradox of thrift", in which jobs are lost, causing people to cut back on spending, which causes more businesses to close, which causes more jobs to be lost, which causes... well you get the picture. The second is that the US long-term budget outlook is downright scary.  Stimulating the economy will likely help the first problem, but will greatly exacerbate the second problem. Conversely, cutting spending in an attempt to balance the budget might just send the economy off a cliff.  Fortunately, Kreuger has an idea:

"Here is a suggestion to address both the short-run and long-run problems. I pose it only as a suggestion for serious discussion; I’m not sure it is the best way to go. But here goes: Why not pass a 5 percent consumption tax to take effect two years from now?

...In the short run, the anticipation of a consumption tax would encourage households to spend money now, rather than after the tax is in place. Along with the rest of the economic recovery package, this would help jump-start spending in the economy and thereby increase production and employment.

In the long run, a 5 percent consumption tax would raise approximately $500 billion a year, and fill a considerable hole in the budget outlook. In addition, a consumption tax would encourage more saving in the long run. Many economists consider a consumption tax an efficient way of raising tax revenue, especially in a global economy. The prospect of greater revenue flowing into federal coffers would probably help lower long-term interest rates because the government would need to borrow less down the road, and further bolster the economy."
There's certainly something to this plan.  My main concern would be whether the government could credibly commit to a future tax increase.  It's like promising yourself you'll go on a diet starting tomorrow...err the next day.  Unless consumers really believe that a consumption tax is coming in a few years, they won't change their spending behavior.

It would be interesting if Congress could put a stipulation on a bill like this that any amendments would require a 2/3 majority vote, or some other provision that would make it more likely that the law would actually stand when it comes time to pay up.

1 comment:

Tom said...

Danman - i think it would need to be 10 pct... cause otherwise id pay more in interest than if i bought it 2 years down the line.. but maybe he's not talking about people like me. I guess the biggest problem is those damn rich people who hoard all the money instead of spending it- that way their kids don't have to work and complain about the rates they get on CDs or something...