A sensible economic policy proposal

Aug 31 2011 - 2:41pm

Professor Robert Barro, an economist at Harvard and the Hoover Institution, in his Aug. 8 column in the Wall Street Journal, made recommendations meant for stimulating the economy, solving the budget deficit and debt problems, and ultimately boosting the rating of U.S. government securities. Even though his recommendations are meant to improve the economy in the long run, they are relatively more balanced than most I have seen from the Hoover Institution and other conservative pundits.

Here I elaborate on Professor Barro's five recommendations and add some of my own. First, he wants to change the entitlement programs, starting with the increase in the age of eligibility. Most likely he is referring to Social Security and Medicare. This is the same recommendation made by the Simpson-Bowles Commission. He also adds that an "economically appropriate indexing formula" be used to calculate benefits. I assume he is advocating a shift from the Consumers Price Index for Urban Wage and Salary Earners (CPI-W)) to the Consumers Price Index for all Urban Consumers (CPI-U). Since CPI-W has been increasing at a higher rate than CPI-U, Social Security benefits are increasing faster than the inflation rate measured by CPI-U.

In addition, I propose an increase in the Medicare tax, an increase in the income cap for the payroll tax, and a decrease in Medicare benefits on a sliding scale as inflation-indexed income rises above $1 million. The Urban Institute calculated that a man with an average wage of $43,000 in 2010 dollars would receive total Social Security and Medicare benefits of $417,000 while paying only $345,000 over his lifetime. The difference is even greater for women at that average wage. Such a mismatch between benefits received and revenues generated is unsustainable. If Americans want these benefits to continue, they have to pay for them.

Second, Professor Barro wants to change the structure of marginal tax rates in the federal income tax system. This is similar to the Simpson-Bowles Commission's recommendation of three income tax brackets, 12 percent, 22 percent and 28 percent. Third, he will pay for the reduction in marginal income tax rates by reducing tax deductions for home mortgage interest, employee fringe benefits and state and local taxes, and elimination of the ethanol subsidy. However, I would propose to limit the tax deduction for home mortgage interest to the first primary residence with the maximum market value of $2 million indexed to inflation rates, and continue tax relief for home equity from the primary residence. This will cover states with the highest average market values for housing. I would also recommend taking away subsidies to oil and gas industries, ranchers, agriculture, sugar and other mature industries.

Fourth, Professor Barro wants to eliminate corporate and estate taxes. I have also proposed reducing and even eliminating corporate taxes. In this age of globalization, the U.S. does not have to compete in corporate tax rates with the rest of the world when it is increasingly becoming relatively easy to outsource businesses in low-tax countries. It is about time that we take away the excuse of high corporate tax rates that many corporations use for not investing and doing business in the U.S. I am not inclined to eliminate estate taxes because its elimination will provide no economic incentive for entrepreneurial and investment activities.

Fifth, Professor Barro proposes a broad-based tax, such as the value-added tax (VAT) with a rate around 10 percent, but exempting commodities like food and housing. I have mentioned such a tax in my writings before, but I recommended that its revenue be used to pay for universal health care. Given all the tax credits, deductions and loopholes in the current income tax code, it is imperative that all Americans have a responsibility to pay taxes for the benefits they receive from the federal government.

It is appalling that, according to the Tax Policy Center, 46 percent of households pay no federal income tax and taxes paid by some of the wealthiest Americans are between 0 to 10 percent. If marginal tax rates are lowered, then there is no need to treat capital gains and dividends any differently than ordinary income. Income of hedge fund managers should be treated as ordinary income and not as capital gains. VAT or any such national sales tax will also be able to tap Internet sales with an appropriate formula for sharing revenues with the states. It will stop the haphazard approach followed by states to implement sales tax on Internet sales.

Professor Barro's recommendations provide a long-term solution for growth and reduction in budget deficits and debt, but they will not solve the short-term problem of unemployment. Since consumers and private investors are not spending enough to lift up the economy to provide enough jobs, the federal government has to spend on public investment projects, including education, which will not only provide jobs but also add to the productive capacity of the nation.

Mathur is former chair and professor of economics, Cleveland Sate University, Cleveland, Ohio. His articles also appear at vijaykmathur.blogspot.com. He also writes original blogs for the Standard-Examiner at http://blogs.standard.net/economics-etc/.

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