Solution to Recession? Try a Bullet Approach Instead of the Shotgun

This is not a fun time to be a member of the tax-writing committees of Congress. They are under enormous pressure to “do something” about the recession. The outlook is uncertain, and the tension is high. The so-called experts are not much help because most of us are not sure what, if anything, ought to be done. The experts, however, will not be blamed for what happens. Congress will.

One reason the experts are so little help is that Congress is asking the wrong question: What should we do about the recession? The recession, agonizing as it is, is not the most important problem facing the U.S. economy. Compared to past recessions, especially the last two, this recession has been fairly mild. Unemployment has not risen very high, and output has not dropped very far.

The main reason the recession of the 1990s seems so severe is that it came after the recovery of the 1980s--a period when average incomes grew slowly, inequality increased and the whole country lived on borrowed money. The broad range of middle-income Americans experienced only a slow upward creep in their real income (on the average) through most of the 1980s.

Those who were poor, or close to poverty, found their situation deteriorating. Especially hard hit were young people with less than a college education. The only group that did well in the 1980s were those at the high end of the income distribution, typically people with college degrees and professional and managerial jobs. Moreover, almost everyone in the 1980s--consumers, corporations and the government--took on too much debt and exacerbated the problems to be faced in recession.

The really important economic challenge is not what to do about the recession but how to restore healthy, long-run growth in the standard of living and make sure that all groups share in that growth. Unfortunately, many of the policies that might be used to fight the recession will only make the long-run problem worse.

Restoring healthy growth in the standard of living for all groups will take high levels of investment--public and private, physical, human and intellectual. We must invest in new technology and modern plant and equipment and infrastructure. Above all, we must invest in the skills of the labor force, current and future, especially those least able to function productively in a modern economy.

The biggest contribution the federal government can make to the long-run health of the American economy is to turn the budget deficit into a surplus. A federal surplus (counting Social Security) would make the government a net contributor to national saving, channel the Social Security system’s savings indirectly into productive private investment, put downward pressure on interest rates and reduce the government’s interest bill.

Any tax change enacted in the name of easing the recession should pass two tests: In the long run, it should reduce (or at least not worsen) the government’s underlying deficit, and it should reduce (or at least not worsen) the disparity between very high income people and everyone else.

In the longer run, we are doomed to oscillate around a slow growth trend unless we make substantial productivity-improving investments. The short-run outlook, however, is more uncertain. The recovery will probably strengthen in a few months, but no one can be sure. Further declines in consumer or investor confidence could prolong the recession or even make it worse.

Unfortunately, there are few effective tools for strengthening confidence, and plenty of bases for skepticism that tax changes alter short-run behavior in major ways. Most of the tax changes being discussed are unlikely to stimulate the economy appreciably in the short run and fail one or both tests of long-run viability.

For example, a cut in the capital gains tax rate would not do much for the recession. (Who are these folks with huge capital gains they are eager to realize and reinvest--if only the tax were lower?) Slashing the capital gains tax would add to the deficit in the long run, create a whole new tax-shelter industry and benefit high-income rather than low-income taxpayers.

Encouraging private saving through IRAs or other deductions will cut spending if it is successful, so it is not an anti-recession measure. Moreover, in the long run, new private saving induced by the tax privileges will probably be small compared to the government’s lost revenue. Buying increases in private saving with larger decreases in public saving is a bad bargain.

A better idea is to shift the effective rate structure of the personal income tax so that it bears a bit less heavily on low- and middle-income groups and taxes high-income groups a little more. This idea, however, should be defended primarily because it benefits people in the low and middle ranges, not because it would do much to turn the recession around.

Such a change might stimulate consumer spending a little, because the less affluent are more likely to spend additional disposable income, but the effect is unlikely to be large.

The biggest danger is that Congress will resolve the problem by trying to please everyone. For example, they might cut the capital gains rate, add more deductions for savings, cut taxes for low- and middle-income groups and raise rates at the very top--all at the same time. The only sure thing about such a hodgepodge would be additions to the future deficit.

Perhaps the tax writers should go into some other line of work. There are times when nothing is better than something.