Martin Feldstein Has An Excellent Recipe For Stimulating US Growth While Fixing The Debt Infrastructure spending, corporate tax reform, and entitlement reform are indeed necessary and doable. The problem is that our divided political system does not allow any of this to happen

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By Paolo von Schirach

September 18, 2013

WASHINGTON – In a very clear and cogent essay published by the WSJ, (How to Create  a Real Economic Stimulus, September 17, 2013), Harvard Professor Martin Feldstein provides a road map that would allow the US to finally develop sustainable fiscal policies, while at the same time promoting economic growth. The trick –he writes– is to stimulate the economy now, through tax reform and targeted infrastructure projects, while at the same time reforming federal entitlements programs so that the perennially upward spending trend will be credibly bent down.

Growth and debt reduction

Professor Feldstein describes a fairly simple process guided by twin goals: get back on our historic 3% growth rate while at the same time reassuring all economic players and bond holders that America is serious about containing federal spending, cutting down annual deficits and eventually reducing the national debt.

Short term spending…

And how would he do this? Well, for starters he would reduce the corporate tax rate, (currently 35%, one of the highest in the world), in order to encourage more business activity. In parallel he would launch a credible plan to fix and upgrade America’s obsolete and in some cases dangerously decrepit infrastructure. There are obvious economic benefits in improving, roads, bridges and ports that are in essence the national “arteries of commerce”. The more modern our infrastructure, (much of it was built in the 1950s and 1960s), the lower the cost of moving goods and people around. This is good for business and good for our overall national competitiveness.

…Long term debt reduction via entitlement reform

Still, reducing tax revenue and higher spending on new project would have an immediate toll on our still high deficit and therefore on the growing national debt. But this serious fiscal consequence can be taken care of, assuming that we can credibly reform US Federal entitlement programs, mostly Social Security and Medicare, keeping in my mind that entitlements constitute about 60% of all Federal spending. Indeed, they are the long-term ticking bomb. As the population ages, and more people become eligible because of the baby boomers retiring, the financial weight of these programs (especially Medicare) keep going up and up.

A very simple remedy is to postpone the age of full eligibility. The age used to be 65 and then it was pushed to 67 because people live longer. Well, if we could gradually push it to 70 this move would guarantee savings around 2% of GDP. By the same token, just reducing the tax exemptions that litter our tax code to 2% of adjusted gross income would result in increased revenue amounting to an additional 1% of GDP.

Feldstein assumed that such a plan would be phased in gradually so that drastic spending reductions combined with higher taxes would not shock the economy. At the same time, while we carry out spending reform, America would start revving up, on account of the stimulative impact of lower corporate taxes and higher infrastructure spending. 

Markets would be reassured

If this were a real plan, embraced by the national leadership on a credible bipartisan base, markets would have the reassurance that America is serious about both: pro-growth economic and tax policies and gradual but serious spending reduction.

In essence, as Feldstein writes, a credible plan for long-term entitlement spending reduction creates the opportunity for short and medium term higher spending on a real stimulus based on lower corporate taxes and a robust program to upgrade our infrastructure.

We need this plan; but US politics work against it

Feldstein is basically right. We need both components in order to revive the economy, while at the same setting the stage for long-term deficit and debt reduction. The problem is that, even though this is sensible, there is and there will be fierce political opposition to most of it.  Most Americans favor reducing public spending. But they usually think that eliminating “waste, fraud and abuse” would take care of the problem. Well, it would not.

The problem is the benefits that people do not want to relinquish. Even if we are talking only about future reduction, while current beneficiaries enjoy the system as is, any idea of reducing anything is immediately misrepresented as a plan “to throw grandma in the snow”. We have seen this script nicely rolled out during the 2012 presidential campaign. Likewise, tax reform would requite a degree of political agreement that just does not exist. Ditto for any sizable infrastructure spending program.

Feldstein concludes his essay by saying that unless something like this plan is adopted, “the US economy will continue to limp along with slow growth, declining earnings and weak employment”. I am afraid he is right. 

Sadly, unless our politics change rather dramatically, this is our destiny.

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