Mark Zandi worries about the Long-term Fiscal Picture

We at the USC Lusk Center put on a retreat every year, and our opening keynote speaker was Mark Zandi. I have admired Mark for some time because he has the rigor of an academic economists and the timeliness of a business economist. The combination is rare.

Although Mark advised the McCain campaign, he has supported the Obama stimulus package, except to the extent that it is not large enough. But he has concerns about the long-term fiscal outlook of the country, where according to CBO the federal debt-to-income ratio could exceed 80 percent. While crowding out is almost certainly not an issue at the moment (Brad Delong explains why quite nicely), I do worry that large amounts of government debt would over the long run push up interest rates and reduce private investment. I also found that I felt a great degree of satisfaction (i.e., utility) when in the late 1990s the US was reducing its debt burden quite rapidly.

The question, then, is what to do. Like others, I don't think Social Security is that worrisome, and that commentators who conflate Social Security with Medicare are basically trying to scare people in an intellectually dishonest way. For those of us who don't need to use our backs for our work, raising the retirement age a bit should be perfectly acceptable. For those of us who are lucky enough to earn more than the maximum on which social security is taxes, a rise in that maximum should also be perfectly acceptable.

It seems to me (and a lot of other people) that there are two big issues: the cost of health care and the inadequacy of tax revenue. The first point is especially thorny, and I should disclose two things: I support a single-payer option (it seems to me that private insurance creates loads of deadweight loss) and I am married to a primary care physician. I am not sure how to reduce health care costs in a politically acceptable manner, but I do know: (1) the current medical reimbursement system encourages procedures and does not encourage preventative care and (2)we have done a lousy job of coming to grips with end-of-life care issues. The second of these points will require a great deal of soul searching on the part of us all, and I don't particularly see a political "win-win" situation for dealing with it.

As for taxes, the issue is how to raise revenue without screwing up capital formation, which is necessary for growth. I should note that the tax code during the Clinton era seemed to work just fine. But as part of a grand bargain for putting the country on a sound fiscal footing, it might be worth revisiting some of the principles of the Hall-Rabushka Tax.

I wrote a paper with Dennis Capozza and Pat Hendershott for a Brookings Book on Fundamental Tax Reform on the effect of a Hall-Rabushka tax on residential real estate (short answer: it would cream values for awhile). But the only thing I really disliked in principle about the proposal was its best known feature: its flatness. I am reasonably sure that there is diminishing marginal utility in consumption, so a tax based on ability to pay must be progressive. But other aspects of it--that it essentially eliminates deductions, that it taxes consumption (which reflects living standards), and that it treats all consumption equally, regardless of the source of income used for consumption--makes it more neutral than the current tax code, and better at encouraging savings. I think a Hall-Rabushka tax with an Earned Income Tax Credit, a large exemption, and a couple of brackets might work quite well.

[Update: some sort of grand bargain should also involve Pigou taxes on gasoline, sugared sodas, etc. To the extent that they are regressive, one could use the revenue to reduce the payroll tax at the bottom of the wage distribution, provide better transit, etc.]