The New York Times asked 7 economists to advise the Obama administration under the title of “What Now.” With one exception they all seemed to be addressing what they thought was a given assumption:How can we get back to where we were before the crash? This seems to me to be singularly unhelpful. If the only task of the Obama Recovery is to restore America to a state in which 70% of GDP is consumer expenditures driven by excess credit and advertising, then we will have neither accomplished not learned anything from this crisis. As Jeremy Grantham has written.
An amateur economist could summarize and simplify the Chinese economy as 39-37-37: an astonishingly large 39% of the GDP is capital spending, 37% is internal consumption, and an amount equal to 37% of GDP is exported. (These numbers do not sum to 100 as we are not using exports net of imports because we are concerned with the vulnerability of total exports to a weak global economy.) The U.S., in comparison, is 19-70-13, disturbingly on the other side of normal; 70% consumption compared with 57% in both Germany and Japan, for example, and nearly twice that in China.
Our ability to raise our export earnings (both in our two export champions Aircraft and Software/Entertainment and by leading in the Green Tech revolution) is totally dependant on our ability to raise capital investment (i.e. massive infrastructure investment in both digital and concrete highways). Some of the capex, especially in Green infrastructure, must come from the federal government in the same way the first internet and networked computers were funded by DARPA. But much of it must come from the investments of individual savings of formerly dedicated consumers. I have seen evidence of drop off in spending across all classes in the U.S. and the rise of saving. But as Tom Frank (the one expection I mentioned in the New York Times article) points out, our tax system doesn’t favor savings and so he suggests an alternative tax plan.
Most federal revenue now comes from the income tax. Because a family’s annual income equals the amount it spends each year plus the amount it saves, we are effectively taxing savings. And savings rates have fallen precipitously, often dipping into negative territory as families have used home equity loans and credit card debt to spend more than they earned. Because the country needs to save more, taxing savings makes no sense.
The first reform that Barack Obama should consider is replacing the progressive income tax with a progressive tax on consumption. A family would report its income to the Internal Revenue Service as it does now, and also its savings, as it now reports contributions to retirement accounts. Annual consumption would then be calculated as the family’s income minus its savings. Its taxable consumption would be that amount minus a large standard deduction — say, $30,000 for a family of four.
A family that earned $60,000 and saved $10,000, for example, would have taxable consumption of $20,000. Initial tax rates on consumption would be low, and would then rise steadily with consumption, topping out at higher levels than the current top rates on income.
Such a tax could raise more revenue than the current system, yet would be far less burdensome for families at nearly all income levels. Because of the large standard deduction, middle-income families would pay less than they did before, and high-income consumers could limit their tax increases by saving more.
As I have been saying for the last year, the transition to a savings/investment economy from a consumption/debt economy will be painful for the retail mall trade and their Chinese vendors and the associate fast food chains.
People will need to seek new status not necessarily tied to their latest purchase. Cars will need to last for 7 years. Automatic savings deduction at work will be the default setting unless you opt out. We will entertain ourselves at home playing our old guitars and pianos.
It should be a culturally and spiritually interesting time.