Joseph Stiglitz: Principles and Guidelines for Deficit Reduction

principles-and-guidelines-for-deficit-reduction.pdf (application/pdf Object).

opening paragraphs:

In the next few weeks, the United States will be focused on deficit reduction. Analytically, the task of deficit reduction is simple: cutting expenditures and raising taxes. Politically, the task of deficit reduction is enormously difficult, for each cut in expenditure or increase in taxes hurts someone, and typically, some powerful group. Each, pursuing its own interests, has led the country into what is widely viewed as an untenable position. The hope is that a National Commission would devise an acceptable framework for shared sacrifice. It is more likely that that will be the case if there is an enunciated set of criteria against which we can judge proposals.

Different individuals may put more or less weight on different criteria, but behind them all is one core principle: at the head of the list of reforms are measures which increase both efficiency and equity; unacceptable are measures which decrease efficiency and equity. A few statistics provide some guidance to these deliberations.

• Median income has declined by some 5% over the past decade—and was even in decline before the recession.
• Poverty has increased from 11.9% in 1999 to 14.3% in 2009.1
• Median income of males with only a high school education has decreased some 13.5% from 1999 to 2009, as measured in 2009 dollars.2
• The upper 1% of Americans accounted for an average of some 22% of the nation’s taxed income during 2004-2008.
• 65% of the income growth during the Bush expansion was captured by the top 1% of families.3

Given the enormous increase in inequality that has occurred in the United States over the past three decades, any measure that harms those at the bottom should also be unacceptable, and measures that impose undue burdens on the middle class should receive careful scrutiny.

skipping forward:

Elaborating the Principles: guidelines for deficit reduction

These general principles have some direct implications, providing some seven guidelines, which should guide proposals for deficit reduction as we strive for equity as well as efficiency and growth.

1. Public investments that increase tax revenues by more than enough to pay back the principle plus interest reduce long-run deficits.
2. It is better to tax bad things (like pollution) than good things (like work).
3. Economic sustainability requires environmental sustainability. The polluter pay principle — making polluters pay for the costs they impose on others — is good both for efficiency and for equity.
4. Eliminating corporate welfare is good both for efficiency and for equity.
5. Given the increases in inequality and poverty and given the inequitable nature of the 2001 and 2003 tax cuts, the incidence of any tax increases should be progressive, and there should be no increases in the tax burden on the poorest Americans.
6. Eliminating give-aways of public-owned assets is an efficient and fair way of reducing deficits.
7. Eliminating distortions in tax and expenditure policies —with appropriate compensatory policies for lower and middle income Americans—can be an efficient way of reducing the deficits. Even if overall such tax expenditures are regressive, given the dire straits that so many poor and middle class Americans are in, eliminating those tax expenditures without appropriate compensation (e.g. in the reduction in tax rates on lower and middle income Americans) would be wrong.

hopping further,

This paper outlines a set of proposals which, while we have not provided a costing, should reduce the deficit by more than the goal of $4 trillion. Even more, because some of the proposals contained here increase growth, the deficit/GDP ratio will be further reduced (as the denominator is increased), putting the country on a more sustainable path.

and again,

Two categories of corporate welfare in particular deserve attention. Subsidies to agriculture and agrobusiness are bad for the environment, go disproportionately to those who are better off, hurt the poor in developing countries, and have been a major impediment in striking global trade agreements that might bring significant benefits to American businesses.

As in other areas, such subsidies are often defended on the grounds that they help a particularly deserving group of poor Americans. When agricultural programs first began, farmers were, on average, poorer than other Americans, and hence targeting assistance at them might have made some sense. Even then, there is a question of why poor farmers are more deserving of assistance than other poor Americans. Today, though, most of the money goes to corporations and Americans who are better off than average, often much better off. Again, as in other areas, if there is a compelling case that poor farmers need more protection than other poor Americans (a case which has not been made), there are easy fixes, e.g. by limiting the benefits to, say, those whose income is below $100,000, and limiting payments to, say, at most $100,000 per farm.

A particularly egregious example of a subsidy to agrobusiness is that for ethanol. Originally justified on grounds of promoting renewable energy, it is now widely recognized by environmentalists and economists alike that the ethanol subsidy is an unjustifiable form of corporate welfare. The subsidy was originally justified too, a quarter century ago, as a “temporary” subsidy to help get a new (“infant”) industry established. The ethanol industry is the classic example of an infant that has never grown up and is not likely to do so.

Subsidies to producers of fossil fuels also distort the economy and are bad for the environment. We should, in fact, be taxing the production (as we note further below). This is consistent with the general principle enunciated earlier: it is better to tax bad things than good things. Economists refer to the taxation of activities that exert negative externalities on others as corrective or Pigouvian taxes. Such taxes raise revenue at the same time as they increase economic efficiency, raising (correctly measured) national output.

and

D. Better auctioning/management of government owned natural resources and other assets

The government owns large amounts of natural resources and is responsible for managing other natural resources (like fisheries) and assets (like the spectrum). Efficient auctioning of the rights to use these resources (assets) can lead to greater efficiency (ensuring that they are used by those generating the highest (social) returns and greatest revenues). As we have learned from the sale of the spectrum, the amounts at issue are significant. Yet the government continues to dispose of many of these assets in a less than optimal way. While cell phone companies pay for the use of spectrum, broadcasters are often not charged.

Rights to extract some natural resources are still given away in a manner similar to that used in the nineteenth century. Even when there is an auction, the auction is not well-designed, and the terms of the lease contract are far from optimal. Auctioning off fishing rights can not only raise revenues, but reduce the risk of over-fishing.

2. Towards a Fairer and More Efficient Tax System

Our tax system is neither fair nor efficient. Taxes affect economic behavior in a variety of ways. Many provisions of the current tax system were put there, justified by one rationale or another, but pushed by one special interest or another. Much corporate welfare takes the form of special treatment within the tax code. Behind each of the examples of corporate welfare, there is typically an “argument.” But as the analysis of the examples given above illustrate, the arguments are typically bogus. Together, they erode the tax base and result in a tax system that distorts the economy.

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There is, moreover, no justification for taxing those who work hard to earn a living at a higher rate than those who derive their income from speculation.

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C. A Growth-Oriented Corporate and Individual Income Tax

Corporations complain that the corporate income tax discourages investment, but with interest deductible and with accelerated depreciation (relative to what economists call “true economic depreciation”11) it may be that the tax system actually is biased the other way.12

There is even some research that suggests that the preferential treatment of dividends may have had the effect of lowering investment.13 Much of capital gains is in real estate, so that preferential treatment of capital gains may do as much to encourage real estate speculation (which contributed to the recent crisis) as it does to increase real investments that enhance real growth, increased employment, and productivity increases.

Rather than an across-the-board reduction in the corporate income tax, far better would be a tax reform that would encourage investments in jobs in the United States (the current system encourages firms not to repatriate money earned abroad, i.e., to invest abroad rather than at home), and that would encourage investment in research and development (and discourage real estate speculation.)14

D. The Generalized Henry George Principle

One of the general principles of taxation is that one should tax factors that are inelastic in supply, since there are no adverse supply side effects. Land does not disappear when it is taxed. Henry George, a great progressive of the late nineteenth century, argued, partly on this basis, for a land tax. It is ironic that rather than following this dictum, the United States has been doing just the opposite through its preferential treatment of capital gains.

But it is not just land that faces a low elasticity of supply. It is the case for other depletable natural resources. Subsidies might encourage the early discovery of some resource, but it does not increase the supply of the resource; that is largely a matter of nature. That is why it also makes sense, from an efficiency point of view, to tax natural resource rents15 at as close to 100% as possible. The well-designed auctions described earlier enable government to capture most of the rents derived from government owned assets.

E. Generalized Polluter Pay Principle

The generalized Henry George principle identifies a class of taxes that does not impede economic efficiency. But there is a class of taxes that actually increases economic efficiency—taxes which discourage activities that generate negative externalities.16 The most important category of such taxes are those on environmental externalities. Within this area, the most important are those associated with carbon emissions, with their impact on global warming and climate change. It matters less whether those generating the pollution pay a carbon tax or buy emission permits that are auctioned; either can generate large amounts of money and simultaneously improve economic performance.

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Modern technology has allowed the creation of an efficient electronic payments system. It should cost almost nothing to transfer money from an individual’s bank account to the merchant’s bank account when a purchase is made. Yet the credit card companies charge large fees, as much as .6% to 2.4%.20 These fees act as a tax on every transaction, but a tax that goes not to public purpose but to enrich the coffers of the credit card companies, largely the banks. Other countries have curtailed the anti-competitive practices; but given the need for deficit reduction, an alternative is to redirect the revenues for public purpose, by, for example, setting the fees at 1.5%, with say 50 basis points going to the card companies, and the rest dedicated to deficit reduction. This is an example of an efficiency enhancing deficit reducing reform—consumers and merchants would be better off, transactions costs would be lowered, and so to would the deficit.

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Summary

This paper has outlined a series of expenditure cutbacks, reforms and increases as well as tax reforms and increases which can more than meet the goal of $4 trillion dollars in deficit reduction (i.e. reduction in the level of national debt from what it otherwise would have been) in the next decade.24 Indeed, the proposed actions would not only lead to a lower national debt, but also to a better environment, higher growth, and a fairer society.

Over the ensuing weeks, the nation will be debating how to achieve deficit reduction. Deficit reduction, it should be remembered, is not an end in itself, but a means to other objectives. If done the wrong way, our growth can be impaired, our society can become more divided, and the capacity of both our country and our government to deal with the challenges facing it can be impaired. If the Chairmen’s proposals are any guide to what might come out of the Commission, then it is clear that the Commission has identified some areas—like cutbacks on military expenditures—on which there can be broad agreement. But there are other areas that we have emphasized which are given short shrift, and still others —like some of the changes in taxation proposed by the Chairmen—which are totally misguided. The result would be a still less progressive tax system and a still more divided society.

The issue facing the country is, in the end, not economic, but political. From an economic perspective, we can easily meet the debt/deficit reduction goals, as the long list of proposals in this paper makes clear. The reason that we have, for instance, the myriad of the distortions and inequities that we have identified is because of the influence of special interest groups, who, so far at least, have been willing to sacrifice the national interest to their own. If they continue to do so, then the only way that we will be able to achieve these goals is at the expense of those who are less politically powerful. If we proceed to achieve the deficit reduction goals on their backs—for instance through the elimination of the earned income tax credit-- it will only contribute to the growing cynicism and skepticism about America’s democratic political processes.

Economics is the science of trade-offs. Normally, one can, for instance, achieve greater equity only at the expense of a loss of efficiency. We can achieve deficit reduction only by cutting back on expenditures or raising taxes. America is, perhaps, lucky: because of its underinvestment in the public sector and the extraordinarily low interest rates and the vast underutilization of human and other resources, it can increase public investment, increase output and employment, and simultaneously reduce the long term national debt. Because of its distorted and unfair tax system, it can reduce some of these distortions and inequities with the result that growth and efficiency will be promoted at the same time that the inequities are reduced.

The country does face a critical choice: to continue on the current course, slightly modified, which might succeed in reducing the long term national debt, but at great cost to the long term economic and social fabric; or to embark on the alternative agenda that this paper proposes.

Mason Gaffney (http://masongaffney.org/) has written about having both efficiency and equity.  See

• The Corruption of Economics, at http://www.wealthandwant.com/docs/Gaffney_Intro_TCOE.html
• How to Revive a Dying City, at http://www.wealthandwant.com/docs/Gaffney_HTRaDC.html

and this quote, about Progress and Poverty:

George refutes the commonplace idea that we must choose between equity and efficiency…. He rejects both price controls and progressive income taxation, and identifies a different tax policy that brings us both equity and efficiency together.   -- Mason Gaffney, University of California, Riverside