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10/19/93

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Consumption tax appeals to economists at conference on federal deficit

STANFORD -- Distinguished liberal and conservative economists agreed in buying only half of Paul Tsongas' message when he outlined the Concord Coalition's plan for a zero government deficit by the year 2000 at a Stanford University workshop Thursday, Oct. 14.

The aging of the baby boom, nearly all agreed with Tsongas, is a looming economic crisis, but merely wiping out the government's deficit isn't going to solve the problem, the economists said.

In fact, nearly all the economists on two discussion panels seemed to agree with Michael Boskin when the former head of the President's Council of Economic Advisers said that the size of the deficit was a very poor measure of what's really important - the economic legacy of assets and liabilities that one generation leaves to another. (Boskin returned to the economics department faculty and the Hoover Institution at Stanford this fall after serving in the Bush administration.)

Tsongas, a former Democratic senator from Massachusetts and 1992 contender for his party's presidential nomination, co-chairs the bi- partisan Concord Coalition with another former senator, Republican Warren Rudman of New Hampshire. They hope to build grass-roots pressure on Congress and the president to eliminate the deficit, which is estimated to be as much as 5 percent of the gross daily product in this end-of- recession year.

The Concord Coalition plan, released last month, includes calls for reducing Social Security, Medicare and other benefits paid to the 42 percent of families with annual incomes above $42,000. It calls for increasing the gasoline tax by 50 cents a gallon, limiting the size of tax deductions for mortgage interest, levying some federal consumption taxes, gradually raising the retirement age to 68 and adding a balanced budget requirement to the Constitution in order to keep the deficit at zero after the year 2000.

Most of the economists said there's nothing wrong, per se, with running a deficit. It is the ratio of the deficit to the domestic output of the economy that's important, or, as one panelist put it, "the ability of the economy to service the debt." Many of the economists suggested a deficit of 2 to 3 percent of the gross domestic product would be manageable.

Most, however, stressed that America - its individual citizens, government and business together - are spending too much and not saving enough for the long-term health of the economy.

Tsongas, who holds a law degree from Yale, was invited to Stanford by the student government's speakers bureau and by the Center for Economic Policy Research, which planned the professional panels that preceded the senator's public speech. His main job at Stanford, Tsongas told the economists, was to convince students that they had a vested interest in preventing their parents and grandparents from ringing up a larger national debt.

"My job," he said, " is to go up to young people and say, 'You ought to be furious.' "

The economists, many of them baby boomers or slightly older, didn't necessarily disagree with that message, but most had ideas other than a zero federal deficit for coping with what was characterized as a major economic challenge: the old-age entitlements anticipated for the "demographic tidal wave of the baby boom." Social Security and health care are the major entitlement problems.

As an ever-increasing proportion of the post-World War II baby boom enters retirement, an ever-growing percentage of the electorate is likely to oppose keeping the costs of their entitlements down, speakers said. The United States may reach a point when a majority of the voters are "net income recipients of the federal government," Boskin said. "We have this decade as a window" to make changes.

Paul Romer of the University of California-Berkeley economics faculty outlined two scenarios if the individuals, businesses and the government of this country don't invest more of their income. There could be "generational warfare," he said, or "implosion," as in Sweden, where two-thirds of the people derive their income from government and the government is running a deficit that equals 13 percent of the country's gross domestic product.

The U.S. budget deficit is an "imprecise measure of the changing legacy" of debt or savings one generation leaves to another, Boskin said, because it doesn't account for the government's capital assets; its unfunded commitments, such as the savings and loan bail-out; or the assets and liabilities of state and local governments and the private sector.

"We do have inadequate savings, but the federal deficit is one part of that problem," Boskin said.

Stanford economist John Shoven, dean of the School of Humanities and Sciences, restated the problem: "The issue is whether our net worth is growing fast enough to cope with the demographic tidal wave of the baby boom."

Ways to encourage saving

The federal deficit probably should be reduced somewhat, Shoven said, but a reduction plan will be counterproductive if it discourages private investment and saving through its tax and entitlement control mechanisms. The Omnibus Budget Reconciliation Act of 1987 discouraged pension savings, he said, and pensions are the major way the private sector saves.

Shoven praised the Concord Coalition for its efforts to get discussions going, but he said its particular plan "is not a plan with low taxes on savings." He suggested instead "going all the way to a consumed- income tax."

Consumption taxes, or taxes on what individuals and businesses buy, are the primary basis for taxation in Europe. They are generally criticized for being regressive, Shoven said, but can be designed so they do not disproportionately hurt the poor.

One "serious argument" for a consumption or sales tax, Shoven added, was its ability to capture tax money from people in the "underground economy" who currently avoid income taxes.

Stanford economist Robert E. Hall also advocates a federal consumption tax as an economically efficient replacement for income taxes. He and Alvin Rabushka, both senior fellows of the Hoover Institution, have calculated that a 19 percent federal "value-added" tax could replace the revenue the government receives now from corporate and personal income taxes.

A value-added tax requires businesses to pay taxes on the value of their sales after deducting the value of their purchases, which spreads the cost of collecting the tax to all businesses, not just retailers, as is the case with most state and local sales taxes. Families and individuals would get a rebate of some of the value-added tax they paid, which would make the tax less regressive, Hall said.

A switch from income tax to value-added taxes would not itself wipe out the deficit, Hall conceded, "but I'm not sure we should. The deficit enables Congress to say no to constituents, and I'm therefore a pro-deficit economist."

Tsongas said he was not opposed to such taxes.

"I think we're going to go within 10 years from today's income tax structure to a consumption tax structure," he said, because it may be the only way to improve Americans' saving rate.

Berkeley's Romer proposed instead "mandated savings" for individuals. "We have to have offsetting steps to encourage private savings. I don't think a consumption tax will do it."

Romer would require individuals to save part of their annual income and spend this personal savings in their retirement before collecting any support from the government.

Boskin said he supports the Concord Coalition's ideas on tax restructuring but also wanted to see trade liberalization and "market- based" health care, legal and educational systems to improve the long- term health of the economy.

John Taylor, a Stanford economist, recommended term limits for members of Congress as a way to reduce the political pressure on them to spend.

Most of his presentation, however, was devoted to what he said would be a better method for the government to use in projecting what budget deficits would likely be in the future. Instead of trying to predict both future government expenses and income, he said, economists should use history as their base for expenses. He would use the proportion of the gross domestic product that each major category of government expense took in 1969, the last year the government ran a surplus.

Political problems

Several speakers emphasized the difficulty of getting any reduced spending plan adopted, regardless of its merit. They focused instead on political structural changes that would make it easier for the president and Congress to say no to constituents' wish lists.

David Brady of Stanford's Graduate School of Business, an expert on congressional politics, said federal budgets were decreased twice in U.S. history as a result of congressional reform. In both cases - 1865 to 1880 and 1920 to 1933 - the pressure to cut came first from the public, not Congress or the president. People were weary from war spending, he said.

In both cases, Congress centralized spending authority in one committee, he said, which gave it a structural incentive for resisting pork-barreling.

A balanced budget amendment may not accomplish what it intends, Brady said, because many government expenses today are "off budget." He gave as an example the Americans with Disabilities Act, which creates regulatory expenses that are not part of the formal budget.

Rule-based reforms do not work to change behavior, agreed Stanford economist Roger Noll. To be successful, any structural reform must recognize that "Americans collectively behave in an irrational, schizophrenic way" when it comes to government spending, Noll said.

To illustrate, he described a school board meeting in a small California town in the wake of Proposition 13. Citizens and board members knew the rules required them to cut expenses, and so they agreed to cut athletics by 15 percent. When they tried next to allocate the overall cut to specific sports, they wound up preserving all sport budgets, and making no cuts at all.

"Public opinion polls consistently show that's the way we are," Noll said.

Noll suggested that the involvement of less democratic institutions - such as the Federal Reserve Board, which is somewhat insulated from the short-term concerns of voters - may be necessary to change the incentive structure.

David Rowe, an economist with the Bank of America, suggested giving line-item veto power to the president, adopting 10-year "sunset" requirements for all spending programs including spending programs, with no specific bottom line, such as loan guarantees. He would then require "a super-majority of both houses - 60 percent or more" - to enact new or renew old spending programs.

Taylor and others said they supported one-term limits on members of Congress because not having to face re-election would reduce the political pressure on congressional representatives to increase spending.

Shoven thanked Tsongas for staying to listen to the economists' critique of the Concord Coalition plan. Most keynote speakers deliver their speech and leave, he noted.

Tsongas, who took notes throughout the session, responded at the end of the workshop: "I don't agree with everything that was said, but I learned something - probably not to come back to Stanford."

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