Sunday, July 15, 2012

Will America Become Detroit, Part 2: Popular Solutions That Are Bound to Fail

"For every complex problem there is an answer that is clear, simple, and wrong."
- H. L. Mencken
"In the book of life, the answers aren't in the back."
- Charlie Brown, from Peanuts by Charles M. Schulz
The U.S. government debt crisis has garnered enough attention that pundits from across the political spectrum have weighed in on the issue by proposed solutions that are pleasing to their core constituencies. As we look at these proposals, it is easy to see why they are crowd pleasers, but they all have one serious defect: they won't solve the problem.

Don't Worry, Be Happy: S&P Says We're OK

One popular solution to America's debt crisis is to contend that the problem does not really exist. CNN anchor Fareed Zakaria summarized this point of view as "America is not Greece". Debt crisis skeptics content that America is prosperous, competitive, and has a high bond rating, hence she should have no problem borrowing money at reasonable rates for the foreseeable future.

The problem with debt crisis denial should have become clear with the financial crisis of  4 years ago: bond ratings, along with other measures of credit worthiness, can change blindingly fast. Standard & Poor's rated Lehman Brothers AAA 72 hours before they filed for bankruptcy. And as late as December of 2009, Moody's rated Greek bonds a high A, only to drop that rating to Junk level in the following months. So three years ago, we could have argued that "Greece is not Greece"!

The ratings from firms such Moody's, Fitch, and S&P are merely numerical measures of human trust in the institutions being rated, hence they can change just as quickly as our emotions change. If creditors change their opinion of American credit worthiness, the ratings may change even faster than they did for Lehman Brothers and Greece, due to one disquieting fact in the back of investors' minds: the U.S. government is too big to be bailed out by anyone.

Denial of the debt problem is a temporarily comforting, but ultimately dangerous, solution. One needs to look at the Motor City to see how it plays out. America may not be Greece, but it may very well be Detroit.

Eat the Rich!

Michael Moore, among others, want us to balance the budget by raising taxes on the rich. This method has tremendous appeal, for everyone assumes that "rich" means "people who make more money than me". Wouldn't it be great if the debt could be paid off purely by stereotypical Thurston Howell III millionaires who need only sacrifice a few yachts and mansions?

Michael Moore's "Eat the Rich" solution plays well, but would it actually fix the problem? Michael Moore doesn't run the numbers, but Veronique De Rugy at George Mason university has. Her study of historical U.S. revenue data, from 1930 to 2010, shows that the government has generally has been unable to raise more than 19% of the GDP in taxes. The few times we have been able to raise 20% of the GDP in taxes has been a few years at the peaks of boom cycles. This data include the Halcyon days of the 1950's, when the highest federal tax bracket was over 90%. In short, our government is already raising close to the maximal amount of money it can raise, no matter what we do with rates.

Upping the tax rates on the highest earners can have some rather nasty negative consequences. The rich are not all Thurston Howell III clones; they also include some of the world's best developers and entrepreneurs. Excessive taxes might encourage these people to move elsewhere, and the economic activity that they would generate will move with them. This happened in 1960's Britain, where 95% tax rates caused the "brain drain", where the best British minds went overseas to protect their wealth. The "brain drain" phenomenon even inspired a Beatles song.

Well, desperate times call for desperate measures. Maybe we need to be even tougher on the rich than America was in the 1950's or Britain was in the 1960's in order to raise the money we need. Again, this scenario does not hold up once you run the numbers. Fellow blogger iowahawk computes what we could raise by the most extreme "Eat the Rich" tax schemes, including taxing 100% of all income above $250K, confiscation all the wealth of America's richest families, and all the profits of our largest companies; he finds that even these most extreme measures will just barely cover this year's budget, with no hope of covering next year's.
When you do the math, it turns out that the only way we could possibly maintain our current level of spending would be to tax the middle class so much that they would be forced to lower their standard of living. Don't hold your breath waiting for a politician to tell you that.

Next Time

In the next FatherBrain post, we look at the controversial Paul Ryan plan (I think Sen. Ryan had his first name legally changed to "controversial"). The usual complaint is that this plan cuts spending too sharply. This post will make the case that the real problem with the Ryan plan is that it does not cut enough.

1 comment:

  1. Frank, I hadn't realized you are writing again. Very interesting. I look forward to seeing why you think Paul Ryan is not cutting enough rather than he is not cutting in the right places.