Public unwilling to pay grim cost of fiscal reform

By Wang Di
0 CommentsPrint E-mail Global Times, February 22, 2011
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Figures are formidable. They seem to suggest no compromise, no self-deception, but only the absolute facts. This explains the popularity of some devices like the US Debt Clock, which second-by-second monitors and displays the enlarging size of public debt online. But the US keeps ticking toward a financial demise.

Many economists keep telling the public that the model of spending more than what they earn is economically sustainable, and nobody should panic when US public debt as a portion of its GDP approaches 100 percent. They say this is actually not so severe compared with the historical level of 130 percent during World War II.

They won't tell you that in 1945 the top marginal income tax rate was 94 percent, which effectively cleared out most of the war debts in the following years after WWII. Today this level of tax is only possible if the president wants to promptly terminate his presidency.

The public debt crisis is worrying not because of its absolute value right now but because of its possible trajectory toward uncontrollability.

If the population of the US and other Western countries continues to grow older, the spending on entitlement programs like pensions, healthcare and welfare, could eventually exhaust all available revenue.

There is, of course, a last resort, defaulting on debts. Some US senators have been working on proposals to enable state governments to declare bankruptcy. This could be a bad omen for the bolder audacity of justifying the federal government's insolvency, although at present this is very much un-thinkable.

The fiscal sufferings of the US and other Western countries suggest that there is something deeply wrong in the design to monitor and control the debt level and deficit. Many reasons may account for this failure, and the crux is the inconsistency between the two sides of government fiscal management.

On the revenue or tax side, many governments are followers of the "efficient market hypothesis" and neoclassical economic doctrines where the government optimizes the economy by disentangling it-self from all economic activities as much as possible.

But on the expenditure side, governments adopt a Keynesian approach, believing that the economy cannot optimize itself or return to its long-term optimal growth path too slowly. They try to expedite the economy's reorganization by progressively spending rather than doing nothing.

These Keynesian band-aids are supposed to apply only at time of recessions and to be aborted once the economy regains confidence and momentum. But this has actually been daily practice in the US since the 1980s, and it's only been the growing global economy that's hidden this debt crisis.

This model is dangerous because it fails to incorporate the huge cost associated with its adjustment. Any changes to this model will spark massive political countermoves.

Tax rises cause accusation of failure to control the budget in the first place. But budget cuts are even more difficult as fiscal size is equivalent to power and both government departments and public interest groups block potential reform.

In January, the UK released its most recent economic performance data. Its GDP declined by 0.5 percent in the fourth quarter of 2010, during a time of general economic recovery. The culprit was widely regarded as the Conservative-led coalition government's plan to cut the budget, when it had yet taken effect. The coalition defended its position by saying the cut hadn't impacted the economy at all, but the Labour opposition claimed that even the news of cuts is enough to scare and dismay the economy.

Because the fiscal design is inconsistent and cannot incorporate the political indecisiveness, the current mode of debt management is inefficient. Without changing this, cosmetic reforms only deal with peripheral problems. The public will have to withstand partisan skirmishes, interest groups' lobbying, and a deteriorating economy because the government can't even save itself.

The author is a reporter with the Global Times. wangdi@ globaltimes.com.cn

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