Plummeting Tax Revenues

It is natural, normal, and expected that tax revenues increase during economic booms and decrease during recessions. (For example, unemployed workers do not pay payroll taxes.) Yet, increasing tax rates during economic declines is not recommended usually because it discourages consumption and investment spending. And the primary cause of recessions and depressions is insufficient overall spending on newly produced goods and services. So if society collects too little revenue during economic declines, it should make up for it by collecting excess revenue during prosperous times. But that is not a message people want to hear. Indeed, when George W. Bush was campaigning for the U.S. presidency (and the U.S. federal government was running large budget surpluses), he justified tax cuts by claiming "it's the people's money."

The August 3, 2009 article "Federal tax revenues plummeting " by Associated Press writer Stephen Ohlemacher reports:

WASHINGTON – The recession is starving the government of tax revenue, just as the president and Congress are piling a major expansion of health care and other programs on the nation's plate and struggling to find money to pay the tab.

The numbers could hardly be more stark: Tax receipts are on pace to drop 18 percent this year, the biggest single-year decline since the Great Depression, while the federal deficit balloons to a record $1.8 trillion.

Other figures in an Associated Press analysis underscore the recession's impact: Individual income tax receipts are down 22 percent from a year ago. Corporate income taxes are down 57 percent. Social Security tax receipts could drop for only the second time since 1940, and Medicare taxes are on pace to drop for only the third time ever.

The last time the government's revenues were this bleak, the year was 1932 in the midst of the Depression.

"Our tax system is already inadequate to support the promises our government has made," said Eugene Steuerle, a former Treasury Department official in the Reagan administration who is now vice president of the Peter G. Peterson Foundation.
"This just adds to the problem."

While much of Washington is focused on how to pay for new programs such as overhauling health care — at a cost of $1 trillion over the next decade — existing programs are feeling the pinch, too.

Social Security is in danger of running out of money earlier than the government projected just a few month ago. Highway, mass transit and airport projects are at risk because fuel and industry taxes are declining.

The national debt already exceeds $11 trillion. And bills just completed by the House would boost domestic agencies' spending by 11 percent in 2010 and military spending by 4 percent.

For this report, the AP analyzed annual tax receipts dating back to the inception of the federal income tax in 1913. Tax receipts for the 2009 budget year were available through June. They were compared to the same period last year. The budget year runs from October to September, meaning there will be three more months of receipts this year.

Is there a way out of the financial mess?

A key factor is the economy's health. The future of current programs — not to mention the new ones Obama is proposing — will depend largely on how fast the economy recovers from the recession, said William Gale, co-director of the Tax Policy Center.

"The numbers for 2009 are striking, head-snapping. But what really matters is what happens next," he said. "If it's just one year, then it's a remarkable thing, but it's totally manageable. If the economy doesn't recover soon, it doesn't matter what your social, economic and political agenda is. There's not going to be any revenue to pay for it."

A small part of the drop in tax receipts can be attributed to new tax credits for individuals and corporations enacted in February as part of the $787 billion economic stimulus package. The sheer magnitude of the tax decline, however, points to the deep recession that is reducing incomes, wiping out corporate profits and straining government programs.

Social Security tax receipts are down less than a percentage point from last year, but in May the government had been projecting a slight increase. At the time, the government's best estimate was that Social Security would start to pay out more money than it receives in taxes in 2016, and that the fund would be depleted in 2037 unless changes are enacted.

Some experts think the sour economy has made those numbers outdated.

"You could easily move that number up three or four years, then you're talking about 2013, and that's not very far off," said Kent Smetters, associate professor of insurance and risk management at the University of Pennsylvania.

The government's projections included best- and worst-case scenarios. Under the worst, Social Security would start to pay out more money than it received in taxes in 2013, and the fund would be depleted in 2029.

The fund's trustees are still confident the solvency dates are within the range of the worst-case scenario, said Jason Fichtner, the Social Security Administration's acting deputy commissioner.

"We're not outside our boundaries yet," Fichtner said. "As the recovery comes, we'll see how that plays out."
The recession's toll on Social Security makes it even more urgent for Congress to address the fund's long-term solvency, said Sen. Herb Kohl, D-Wis., chairman of the Senate Aging Committee.

"Over the past year, millions of older Americans have watched their retirement savings crumble, making the guaranteed income of Social Security more important than ever," Kohl said.

President Barack Obama has said he wants to tackle Social Security next year, after he clears an already crowded agenda that includes overhauling health care, addressing climate change and imposing new regulations on financial companies.
Medicare tax receipts are also down less than a percentage point for the year, pretty close to government projections. Medicare started paying out more money than it received last year.

Meanwhile, the recession is taking a toll on fuel and industry excise taxes that pay for highway, mass transit and airport projects. Fuel taxes that support road construction and mass transit projects are on pace to fall for the second straight year. Receipts from taxes on jet fuel and airline tickets are also dropping, meaning Congress will have to borrow more money to fund airport projects and the Federal Aviation Administration.

Last week, Congress voted to spend $7 billion to replenish the highway fund, which would otherwise run out of money in August. Congress spent $8 billion to replenish the fund last year.

Rep. Richard Neal, D-Mass., chairman of the House subcommittee that oversees fuel taxes, is working on a package to make the fund more self-sufficient. The U.S. Chamber of Commerce, which doesn't back many tax increases, supports increasing the federal gasoline tax, currently 18.4 cents per gallon.

Neal said he hasn't endorsed a specific plan. But, he added, "You can't keep going back to the general fund."

Jacksonville's budget crisis

Across the United States, federal, state, and local governments are struggling to generate sufficient revenues to fund the services citizens expect. Jacksonville, Florida is struggling to pay for city services after state initiatives to reduce property taxes have lowered revenues.

The Jacksonville Community Council, Inc. (JCCI) published a study, "Our Money, Our City: Financing Jacksonville's Future" that reports:

the City of Jacksonville is facing significant financial issues which threaten its future financial sustainability. Managing these problems is particularly difficult because Jacksonville lacks a shared community vision of what the proper role of government should be… Jacksonville has not defined the core services citizens expect our local government to provide.

Solutions include building community confidence in local government by increasing transparency and creating benchmarking and measurement systems to assess our effectiveness. You can’t manage what you don’t measure. Increased public involvement in the process is important as the city faces the hard choice to increase revenues and/or cut services. These decisions must be made in an environment in which Jacksonville already spends less than the state average on nearly all services…and Florida ranks near the bottom nationally on its funding of services.

Click here for the full Spring 2009 pdf report.

Government policies to reduce the severity of recessions and reverse economic declines

The government has two broad options for managing the overall economy: monetary policy and fiscal policy.

In the United States, expansionary monetary policy is the Federal Reserve system´s use of the money supply, interest rates, and the banking system to encourage commercial banks to lend more money to the public in the hope that this will increase overall spending on newly produced U.S. goods and services. The collapse of credit markets in 2008 reduced most types of lending and will require a restoration of confidence (perhaps by improved oversight and regulation) before monetary policy can assist in economy recovery (by lending more money to encourage more overall spending).

Fiscal policy is taxation and government spending. The logic of using tax cuts to counter a recession is that if the government takes less money from individuals and businesses, they will have more money to spend. Remember the cause of the U.S. economic downturn is insufficient overall spending on newly produced American goods and services. In this regard, tax cuts are essentially identical to the federal government handing out money. The goal is to put more money in the hands of individuals and businesses in the hope that they will spend it on products that are newly made by U.S. workers. Many debates about tax cuts are essentially decisions about to whom the government should be giving money. Tax cuts and other increases in government handouts are relatively quick ways to inject purchasing power into the economy and increase the potential for increases in aggregate demand. There is no way to guarantee that these income supplements will result in purchases of newly made U.S. products, however. For example, much of the increased disposable income caused by the tax cuts of 2001 and 2003 resulted in paying down consumer debt rather than increased consumer spending. And even when spent, if the products purchased are not American-made there is limited benefit to the U.S. economy and its workers. Even though tax cuts or other government handouts can be done quickly, they may be poor choices if they do not significantly increase overall spending on newly produced U.S. goods and services.

An alternative fiscal policy to counteract economic declines is an increase in government purchases. The primary benefit of this choice is that government procurement policies can ensure that this increased spending goes to U.S. businesses that employ American workers. A difficulty with this approach, however, is that it may be difficult to spend sufficient quantities of money quickly enough on projects of long-term benefit. Infrastructure projects can take long periods of time to complete and thus may not inject additional income into the economy quickly enough. Similar arguments can be made for proposals to improve energy efficiency, develop alternative fuel sources, or reform the health care industry. Projects that can be quickly implemented, however, may be of questionable long-term benefit. Yet, if the result is increased purchases of new products made by U.S. workers and suppliers, they still may be preferable to tax cuts (if the tax cuts are used to pay down debt or buy used or foreign products).

Tax cuts and increases in government spending both increase budget deficits and the national debt. Criticisms of stimulus proposals on the basis of reluctance to increase public borrowing apply equally to tax reductions and increased spending programs. Running deficits is not always bad, however. For example, many students borrow substantial sums of money in order to attend college. This indebtedness is easily justified, however, because it leads to a college degree that increases earnings potential for the remainder of one´s career. Similarly, it can be reasonable for a society to borrow money from future generations if the funds are spent wisely on things that increase the productive ability of the economy and improve future living standards. Future generations may not mind if money is borrowed from them to develop alternative energy sources that result in less environmental degradation. It is less arguable to accumulate massive public debt based on willful ignorance, selfishness, or simple reluctance to pay one´s way. The 2001 and 2003 tax cuts were the first wartime tax decreases in U.S. history. Previous generations were willing to make sacrifices for causes they believed in.

Tax decreases are popular and are undoubtedly of short-term benefit to those allowed to pay less in tax. The dramatic increases in U.S. budget deficits and public debt since 1980 have been of great short-term benefit to many sectors of the economy. But they have done substantial harm to the long-term benefit of the U.S. and global economies (for many of the reasons cited by critics of current stimulus proposals). It is akin to allowing large numbers of people to go to the mall, stuff shopping bags with items, and walk out without paying. It is of great short-term benefit to those who get away with it. But these strategies are not sustainable in the long-term. Selfish and misguided choices over the previous three decades have left American policymakers with few, if any, desirable options. The more important question may be how long will it take before U.S. citizens become willing to make the sacrifices and tough choices necessary to correct the abuses of the past and demand more honest, reasoned leadership.

See also "Recessions & Depressions: Questions & Answers."

Fiscal Policy - Taxation and Government Spending

Fiscal Policy – Taxation and Government Spending

Fiscal policy is the use of taxation and government spending to manage the macroeconomy by either increasing or decreasing overall spending on newly produced goods and services (i.e., aggregate demand). 

Aggregate demand (AD) for domestically produced goods and services is comprised of consumption spending (C), investment spending (I), government purchases of newly produced goods and services (G), and exports of domestically produced goods and services to foreign buyers (X) minus the items in consumption (C), investment (I), and government purchases (G) that are imported from foreign producers (M).  Thus,

AD = C + I + G + X – M

Expansionary fiscal policy seeks to increase overall spending (i.e., aggregate demand) by either: (a) increasing government purchases of newly produced goods and services (G), which is a direct effect, or (b) decreasing taxes to encourage more consumption (C) or investment (I) spending, which is an indirect effect because tax cuts might not result in new spending (e.g., if an individual uses the tax benefit to pay down credit card debt).  It is appropriate to use expansionary fiscal policy to reduce unemployment and attempt to slow or reverse economic downturns (recessions and depressions).

Contractionary fiscal policy seeks to decrease overall spending (i.e., aggregate demand) by either: (a) decreasing government purchases of newly produced goods and services (G), which is a direct effect, or (b) increasing taxes to discourage consumption (C) or investment (I) spending, which is an indirect effect because tax increases might not result in less spending (e.g., if an individual uses a credit card to maintain consumption).  It is appropriate to use contractionary fiscal policy to reduce inflation.

Fiscal policy has a political bias.  Citizens like expansionary fiscal policy, but dislike contractionary fiscal policy.  Because of this bias, society tends to rely more on monetary policy to manage the economy.

 

Taxation Principles

Efficiency – How much of a burden is imposed on society by the tax?  Example:  A poll tax (head tax) causes no distortions to behavior.  By contrast, an income tax may reduce the incentive to work.

Equity – How fair is the tax?

 

Who should pay taxes?

Benefits principle – Whoever receives the benefit of the government service should pay the tax to pay for it.  (e.g., fuel taxes to pay for roads and highways)

Ability-to-pay principle – People with a greater ability to pay tax should indeed pay more tax.  (But how much more?)

 

Taxes in Relation to Income

	Income	Tax Paid	% of Income	Tax Paid	% of Income	Tax Paid	% of Income
Lee	$25,000	$5,000	20%	$6,250	25%	$7,500	30%
Sandy	$50,000	$12,500	25%	$12,500	25%	$12,500	25%
Tracy	$100,000	$30,000	30%	$25,000	25%	$20,000	20%
		Progressive – the tax is a higher percentage of income for richer people.  Example:  individual income taxes (usually – but tax reforms, such as the reduction in the capital gains tax, make the tax proportional or regressive for some people).		Proportional – the tax is the same percentage of income for everyone. Example:  property taxes to the extent that assessments reflect differences in income.		Regressive – the tax is a higher percentage of income for poorer people.  Examples:  Social Security taxes, sales taxes, most fee (driver´s license, car registration, park admission fees, sewer and water assessments.)

Fiscal Policy - Questions for Further Study

QUESTIONS FOR FURTHER STUDY

1. Is it fair for one generation to pass trillions of dollars in public debt to future generations? Under what circumstances might this be justified?

2. Is it theoretically possible for public debts to be passed on to each succeeding generation without ever having to be paid? What conditions would be necessary for this to work?

3. Are there any government services you benefit from that you would be willing to forego if it meant you would pay lower taxes?

4. Are there any new government services you would like to receive for which you would be willing to pay higher taxes?



ENDNOTES

[1] http://www.concordcoalition.org

[2] Fiscal years are not the same for all governments. For example, some might begin the fiscal year on July 1st, while others might begin on September 1st.

[3] These data do not include revenues of publicly owned utilities, liquor stores, or insurance-trust activities. They also exclude intergovernmental receipts and payments between state and local governments.

[4] Fiscal years are not the same for all governments. For example, some might begin the fiscal year on July 1st, while others might begin on September 1st.

[5] These data do not include expenditures of publicly owned utilities, liquor stores, or insurance-trust activities. They also exclude intergovernmental receipts and payments between state and local governments.

[6] This category includes expenditures for libraries, hospitals, health, employment security administration, veterans’ services, air transportation, water transport and terminals, parking facilities, transit subsidies, police protection, fire protection, correction, protective inspection and regulation, sewerage, natural resources, parks and recreation, housing and community development, solid waste management, financial administration, judicial and legal, general public buildings, other government administration, interest on general debt, and other general expenditures not elsewhere classified.

[7]http://www.publicdebt.treas.gov/opd/opdpenny.htm

[8] With a progressive tax, people with higher incomes pay a higher percentage of their income than people with lower incomes. The structure of the U.S. individual income tax system is progressive because high-income people face a higher marginal tax rate than those with lower incomes. This is often referred to as being in a higher tax bracket.

[9] Market failures occur when the market system fails to provide the socially desirable outcome. If the market system is left completely alone, it creates too much of some things (e.g., pollution, poverty, and market power) and not enough of other things (e.g., national defense, education, and basic research).

[10] The ability-to-pay principle states that taxes should be paid by those who are best able to pay them. A contrasting idea, the benefits principle, states that taxes should be paid by those who receive the benefits from the services provided by the government. Both principles are used in the U.S. tax structure. Fuel taxes are designed to generate revenue for the construction and maintenance of highways and roads. Since the people who use the highways and roads the most also buy the most fuel, fuel taxes are based on the benefits principle. Since welfare programs redistribute income, they cannot be based on the benefits principle. The people who receive the transfers of income cannot also pay for them.

[11] With a regressive tax, people with lower incomes pay a higher percentage of their income than people with higher incomes. Payroll taxes for Social Security and Medicare, often referred to as social insurance taxes, are regressive because high-income people pay these taxes on only a portion of their income while low-income people pay these taxes on all of their income. Sales taxes are also regressive because they are a represent a higher percentage of income for the poor than for the rich.

[12] Individual income taxes provide about 50% of the federal government’s revenues. Payroll taxes provide about 35% of the federal government’s revenues.

[13] Wishful thinking is probably part of it, too.

[14] Workers tend to earn the most income, and thus pay the most tax revenue, in the years just prior to retirement.

[15] Baby-boomers will add significantly to the Social Security and Medicare expenses of the federal government.

The Efficiency of a Tax System – the Administrative Burden

The Efficiency of a Tax System – the Administrative Burden

Some tax systems are also criticized because of their administrative burden. Individual income taxes, for example, place a large administrative burden on the government, businesses, and individuals. The Internal Revenue Service (IRS) of the United States uses many economic resources to collect taxes and enforce the tax laws. Each American business must devote resources to the calculation of payroll taxes for each worker, the submission of these taxes to the government, and extensive record keeping. Individuals in the United States also devote time and resources to record keeping, tax preparation assistance, and seeking ways to minimize their tax burden. If the United States had a simpler individual income tax structure, Americans might be able to spend less time and money on tax preparation. They might then spend this time and money on things that are more productive and provide a higher standard of living or quality of life. Taxes with a relatively high administrative burden are less efficient than those with a relatively low administrative burden.

In 1997, the Congressional majority leader Richard K. Armey, a Republican from Texas, announced that Americans spend 5.4 billion hours a year preparing income tax returns at a total cost of $200 billion, or $700 for every man, woman and child. During his 18 years in Congress, Rep. Armey was a strong advocate for tax reform.

Taxation

Part 1: Taxation

The primary purpose of taxation is to generate revenue for the government. Some taxes are designed to alter people’s behavior, however. The main purpose of import tariffs, for example, is to discourage people from buying an imported product in the hope that consumers will buy a similar product from a domestic producer. Taxes on cigarettes and alcohol are designed to discourage the consumption of those products by making them more expensive. (It may cost only a few cents to manufacture a pack of cigarettes.)

The most important taxes for the federal government are individual income taxes and payroll taxes for social insurance (i.e., Social Security and Medicare). The most important taxes for state governments are sales taxes. The most import taxes for local governments are property taxes.

People have various opinions about the best way to structure tax systems. Two important considerations are efficiency and equity.

Using Fiscal Policy to Manage the Economy

Using Fiscal Policy to Manage the Economy

Fiscal policy is taxing and spending by the government. At the federal level, it is primarily conducted by the U.S. Congress. The annual budget is proposed by the President, however, who has veto power over legislation. Fiscal policy can be used as a tool to manage the economy, but it has a large political bias.

Aggregate demand (AD), which is overall spending on newly produced goods and services, is composed of consumption (C), investment (I), government purchases (G), and net exports (X-M). Thus AD = C + I + G + X – M. Expansionary fiscal policy attempts to stimulate the economy by increasing overall spending on newly produced goods and services through (1) increased government purchases (G), or (2) decreased taxes to encourage more consumption (C) and investment (I) spending. Expansionary fiscal policy can be used to fight unemployment. It also promotes economic growth if it generates investment in physical capital, human capital, and technology, which tend to increase productivity.

Contractionary fiscal policy attempts to slow the economy by decreasing overall spending on newly produced goods and services through (1) decreased government purchases, or (2) increased taxes to discourage consumption and investment spending. Contractionary fiscal policy can be used to fight inflation.

Fiscal policy’s political bias is that politicians are reluctant to conduct contractionary fiscal policy because increasing taxes and reducing government spending on constituents are politically unpopular. Using fiscal policy to manage the economy is similar to driving a car with an accelerator pedal, but no brakes.

Fiscal Policy - Learning Objectives

After studying the portion of this blog devoted to fiscal policy, you should be able to:

· define fiscal policy and explain its political bias.
· define and explain the difference between expansionary and contractionary fiscal policy.
· define tax efficiency and explain its relationship to tax equity.
· define and explain the difference between marginal and average tax rates.
· explain lump sum taxes and discuss their efficiency and equity.
· explain flat taxes and discuss their efficiency and equity.
· explain consumption taxes and discuss their efficiency and equity.
· explain income taxes and discuss their efficiency and equity.
· explain sales taxes and discuss their efficiency and equity.
· explain property taxes and discuss their efficiency and equity.
· explain estate taxes and discuss their efficiency and equity.
· explain excise taxes and discuss their efficiency and equity.
· explain the difference between vertical and horizontal equity.
· explain the benefits and the ability-to-pay principles.
· explain the difference between progressive, proportional, and regressive taxes.
· explain the relationship between budget surpluses, deficits, and the public debt.
· evaluate the current budget of the United States. Is there a better way to collect taxes? Is there a better way to spend tax revenue?
· discuss the possible implications the current budget has for the future.

Fiscal Policy - Table of Contents

Fiscal policy is taxation and government spending.

Fiscal Policy - Table of Contents
Fiscal Policy - Learning Objectives
Using Fiscal Policy to Manage the Economy
Taxation
The Efficiency of a Tax System - Overview
The Efficiency of a Tax System – the Effect on Incentives & Behavior
The Efficiency of a Tax System – the Administrative Burden
The Equity of a Tax System
The Sources of U.S. Federal Government Revenues
The Individual Income Tax
Social Insurance Taxes
Marginal Tax Rates Versus Average Tax Rates
Alternatives to the Current Individual Income Tax
Lump-Sum Taxes
The Flat Tax
Consumption Taxes
Tax Burden in the U.S.
Central Government Tax Revenue as Percentage of GDP
Tax Revenue as a Percentage of Gross Domestic Product
Federal Government Taxation
State & Local Government Taxation
Government Spending
Citizens Against Government Waste (CAGW)
Federal Government Spending
State & Local Government Spending
Deficits & the Debt
U.S. Public Debt Since 1940
U.S. Public Debt Since 1940 - Adjusted for Inflati...

The Economics of Conservatives and Liberals
(Not) Paying for Government
Definitions - Fiscal Policy
Fiscal Policy - Questions for Further Study
Fiscal Policy - Taxation and Government Spending
The U.S. Federal Budget for Fiscal Year 2009
U.S. Federal Budget - Fiscal Year 2008

Fiscal Policy - Topics

The primary macroeconomic policy goals are economic growth, low unemployment, and low inflation. The main tools to achieve these goals are monetary policy and fiscal policy.

Fiscal policy is the use of taxation and government spending to influence the overall level of spending in the economy.

Click on the hyperlinks below to take you to a portion of the blog devoted to that topic.

Fiscal Policy - Learning Objectives
Using Fiscal Policy to Manage the Economy
Taxation
The Efficiency of a Tax System - Overview
The Efficiency of a Tax System – the Effect on Incentives & Behavior
The Efficiency of a Tax System – the Administrative Burden
The Equity of a Tax System
The Sources of U.S. Federal Government Revenues
The Individual Income Tax
Social Insurance Taxes
Marginal Tax Rates Versus Average Tax Rates
Alternatives to the Current Individual Income Tax
Lump-Sum Taxes
The Flat Tax
Consumption Taxes
Tax Burden in the U.S.
Central Government Tax Revenue as Percentage of GDP
Tax Revenue as a Percentage of Gross Domestic Product
Federal Government Taxation
State & Local Government Taxation
Government Spending
Citizens Against Government Waste (CAGW)
Federal Government Spending
State & Local Government Spending
Deficits & the Debt
U.S. Public Debt Since 1940
U.S. Public Debt Since 1940 - Adjusted for Inflation
U.S. Public Debt as a Percentage of Gross Domestic Product (GDP)

The Economics of Conservatives and Liberals
(Not) Paying for Government
Definitions - Fiscal Policy
Fiscal Policy - Questions for Further Study
Fiscal Policy - Taxation and Government Spending
The U.S. Federal Budget for Fiscal Year 2009
U.S. Federal Budget - Fiscal Year 2008

Macroeconomic Policy Tools

Macroeconomic Policy Tools

Monetary and fiscal policies are two tools that are used to manage the economy in attempts to achieve macroeconomic policy goals. Monetary policy is used more frequently to manage the economy because it has a smaller political bias than fiscal policy.

Monetary policy is the management of the nation’s money supply, interest rates, and banking system to promote economic growth, low unemployment, and low inflation.

Fiscal policy is taxing and spending by the government.

Strategies for Controlling Inflation

Strategies for Controlling Inflation

1. Break the cycle of expectations. This helps to control cost-push inflation.
2. Reduce the costs of production. This helps reduce cost-push inflation.
3. Reduce aggregate demand. This helps to control demand-pull inflation.

AD = C + I + G + X – M
where:
AD = aggregate demand
C = consumption
I = investment
G = government purchases
X – M = exports – imports = net exports = NE


Objective to help achieve low inflation
Fiscal policy
to achieve this objective
Monetary policy
to achieve this objective
Break the cycle of inflationary expectations.
Anything that convinces the public that the government is committed to reducing inflation.
Anything that convinces the public that the Federal Reserve System is committed to reducing inflation.
Decrease the costs of production.
Anything that reduces costs of production. Increasing the world supply of oil, for example, would reduce production costs for many industries.

Reduce aggregate demand.
Decrease government purchases or increase taxes. Since government purchases are a component of aggregate demand (and GDP), reduced government spending will reduce aggregate demand directly. Higher taxes leave workers and businesses with less disposable income. This leads to a reduction in consumption and investment spending, which are two of the components of aggregate demand.
Decrease the money supply to increase interest rates. Higher interest rates discourage borrowing. This causes a decrease in consumption and investment spending, which are two of the components of aggregate demand
Table 3. Using fiscal and monetary policies to achieve low inflation.

GAO Chief Warns Economic Disaster Looms

In the October 30, 2006 article "GAO Chief Warns Economic Disaster Looms," Associated Press national writer Matt Crenson reports that the chief accountant for the U.S. government believes current fiscal policy is unsustainable.

AUSTIN, Texas (AP) -- David M. Walker sure talks like he's running for office. "This is about the future of our country, our kids and grandkids," the comptroller general of the United States warns a packed hall at Austin's historic Driskill Hotel. "We the people have to rise up to make sure things get changed."

But Walker doesn't want, or need, your vote this November. He already has a job as head of the Government Accountability Office, an investigative arm of Congress that audits and evaluates the performance of the federal government.

Basically, that makes Walker the nation's accountant-in-chief. And the accountant-in-chief's professional opinion is that the American public needs to tell Washington it's time to steer the nation off the path to financial ruin.

From the hustings and the airwaves this campaign season, America's political class can be heard debating Capitol Hill sex scandals, the wisdom of the war in Iraq and which party is tougher on terror. Democrats and Republicans talk of cutting taxes to make life easier for the American people.

What they don't talk about is a dirty little secret everyone in Washington knows, or at least should. The vast majority of economists and budget analysts agree: The ship of state is on a disastrous course, and will founder on the reefs of economic disaster if nothing is done to correct it.

There's a good reason politicians don't like to talk about the nation's long-term fiscal prospects. The subject is short on political theatrics and long on complicated economics, scary graphs and very big numbers. It reveals serious problems and offers no easy solutions. Anybody who wanted to deal with it seriously would have to talk about raising taxes and cutting benefits, nasty nostrums that might doom any candidate who prescribed them.

"There's no sexiness to it," laments Leita Hart-Fanta, an accountant who has just heard Walker's pitch. She suggests recruiting a trusted celebrity - maybe Oprah - to sell fiscal responsibility to the American people.

Walker doesn't want to make balancing the federal government's books sexy - he just wants to make it politically palatable. He has committed to touring the nation through the 2008 elections, talking to anybody who will listen about the fiscal black hole Washington has dug itself, the "demographic tsunami" that will come when the baby boom generation begins retiring and the recklessness of borrowing money from foreign lenders to pay for the operation of the U.S. government.


"He can speak forthrightly and independently because his job is not in jeopardy if he tells the truth," said Isabel V. Sawhill, a senior fellow in economic studies at the Brookings Institution.

Walker can talk in public about the nation's impending fiscal crisis because he has one of the most secure jobs in Washington. As comptroller general of the United States - basically, the government's chief accountant - he is serving a 15-year term that runs through 2013.

This year Walker has spoken to the Union League Club of Chicago and the Rotary Club of Atlanta, the Sons of the American Revolution and the World Future Society. But the backbone of his campaign has been the Fiscal Wake-up Tour, a traveling roadshow of economists and budget analysts who share Walker's concern for the nation's budgetary future.

"You can't solve a problem until the majority of the people believe you have a problem that needs to be solved," Walker says.

Polls suggest that Americans have only a vague sense of their government's long-term fiscal prospects. When pollsters ask Americans to name the most important problem facing America today - as a CBS News/New York Times poll of 1,131 Americans did in September - issues such as the war in Iraq, terrorism, jobs and the economy are most frequently mentioned. The deficit doesn't even crack the top 10.

Yet on the rare occasions that pollsters ask directly about the deficit, at least some people appear to recognize it as a problem. In a survey of 807 Americans last year by the Pew Center for the People and the Press, 42 percent of respondents said reducing the deficit should be a top priority; another 38 percent said it was important but a lower priority.

So the majority of the public appears to agree with Walker that the deficit is a serious problem, but only when they're made to think about it. Walker's challenge is to get people not just to think about it, but to pressure politicians to make the hard choices that are needed to keep the situation from spiraling out of control.

To show that the looming fiscal crisis is not a partisan issue, he brings along economists and budget analysts from across the political spectrum. In Austin, he's accompanied by Diane Lim Rogers, a liberal economist from the Brookings Institution, and Alison Acosta Fraser, director of the Roe Institute for Economic Policy Studies at the Heritage Foundation, a conservative think tank.

"We all agree on what the choices are and what the numbers are," Fraser says.

Their basic message is this: If the United States government conducts business as usual over the next few decades, a national debt that is already $8.5 trillion could reach $46 trillion or more, adjusted for inflation. That's almost as much as the total net worth of every person in America - Bill Gates, Warren Buffett and those Google guys included.

A hole that big could paralyze the U.S. economy; according to some projections, just the interest payments on a debt that big would be as much as all the taxes the government collects today.

And every year that nothing is done about it, Walker says, the problem grows by $2 trillion to $3 trillion.

People who remember Ross Perot's rants in the 1992 presidential election may think of the federal debt as a problem of the past. But it never really went away after Perot made it an issue, it only took a breather. The federal government actually produced a surplus for a few years during the 1990s, thanks to a booming economy and fiscal restraint imposed by laws that were passed early in the decade. And though the federal debt has grown in dollar terms since 2001, it hasn't grown dramatically relative to the size of the economy.

But that's about to change, thanks to the country's three big entitlement programs - Social Security, Medicaid and especially Medicare. Medicaid and Medicare have grown progressively more expensive as the cost of health care has dramatically outpaced inflation over the past 30 years, a trend that is expected to continue for at least another decade or two.

And with the first baby boomers becoming eligible for Social Security in 2008 and for Medicare in 2011, the expenses of those two programs are about to increase dramatically due to demographic pressures. People are also living longer, which makes any program that provides benefits to retirees more expensive.

Medicare already costs four times as much as it did in 1970, measured as a percentage of the nation's gross domestic product. It currently comprises 13 percent of federal spending; by 2030, the Congressional Budget Office projects it will consume nearly a quarter of the budget.

Economists Jagadeesh Gokhale of the American Enterprise Institute and Kent Smetters of the University of Pennsylvania have an even scarier way of looking at Medicare. Their method calculates the program's long-term fiscal shortfall - the annual difference between its dedicated revenues and costs - over time.

By 2030 they calculate Medicare will be about $5 trillion in the hole, measured in 2004 dollars. By 2080, the fiscal imbalance will have risen to $25 trillion. And when you project the gap out to an infinite time horizon, it reaches $60 trillion.

Medicare so dominates the nation's fiscal future that some economists believe health care reform, rather than budget measures, is the best way to attack the problem.

"Obviously health care is a mess," says Dean Baker, a liberal economist at the Center for Economic and Policy Research, a Washington think tank. "No one's been willing to touch it, but that's what I see as front and center."

Social Security is a much less serious problem. The program currently pays for itself with a 12.4 percent payroll tax, and even produces a surplus that the government raids every year to pay other bills. But Social Security will begin to run deficits during the next century, and ultimately would need an infusion of $8 trillion if the government planned to keep its promises to every beneficiary.

Calculations by Boston University economist Lawrence Kotlikoff indicate that closing those gaps - $8 trillion for Social Security, many times that for Medicare - and paying off the existing deficit would require either an immediate doubling of personal and corporate income taxes, a two-thirds cut in Social Security and Medicare benefits, or some combination of the two.

Why is America so fiscally unprepared for the next century? Like many of its citizens, the United States has spent the last few years racking up debt instead of saving for the future. Foreign lenders - primarily the central banks of China, Japan and other big U.S. trading partners - have been eager to lend the government money at low interest rates, making the current $8.5-trillion deficit about as painful as a big balance on a zero-percent credit card.

In her part of the fiscal wake-up tour presentation, Rogers tries to explain why that's a bad thing. For one thing, even when rates are low a bigger deficit means a greater portion of each tax dollar goes to interest payments rather than useful programs. And because foreigners now hold so much of the federal government's debt, those interest payments increasingly go overseas rather than to U.S. investors.
More serious is the possibility that foreign lenders might lose their enthusiasm for lending money to the United States. Because treasury bills are sold at auction, that would mean paying higher interest rates in the future. And it wouldn't just be the government's problem. All interest rates would rise, making mortgages, car payments and student loans costlier, too.

A modest rise in interest rates wouldn't necessarily be a bad thing, Rogers said. America's consumers have as much of a borrowing problem as their government does, so higher rates could moderate overconsumption and encourage consumer saving. But a big jump in interest rates could cause economic catastrophe. Some economists even predict the government would resort to printing money to pay off its debt, a risky strategy that could lead to runaway inflation.

Macroeconomic meltdown is probably preventable, says Anjan Thakor, a professor of finance at Washington University in St. Louis. But to keep it at bay, he said, the government is essentially going to have to renegotiate some of the promises it has made to its citizens, probably by some combination of tax increases and benefit cuts.

But there's no way to avoid what Rogers considers the worst result of racking up a big deficit - the outrage of making our children and grandchildren repay the debts of their elders.

"It's an unfair burden for future generations," she says.

You'd think young people would be riled up over this issue, since they're the ones who will foot the bill when they're out in the working world. But students take more interest in issues like the Iraq war and gay marriage than the federal government's finances, says Emma Vernon, a member of the University of Texas Young Democrats.

"It's not something that can fire people up," she says.

The current political climate doesn't help. Washington tends to keep its fiscal house in better order when one party controls Congress and the other is in the White House, says Sawhill.

"It's kind of a paradoxical result. Your commonsense logic would tell you if one party is in control of everything they should be able to take action," Sawhill says.

But the last six years of Republican rule have produced tax cuts, record spending increases and a Medicare prescription drug plan that has been widely criticized as fiscally unsound. When President Clinton faced a Republican Congress during the 1990s, spending limits and other legislative tools helped produce a surplus.

So maybe a solution is at hand.

"We're likely to have at least partially divided government again," Sawhill said, referring to predictions that the Democrats will capture the House, and possibly the Senate, in next month's elections.

But Walker isn't optimistic that the government will be able to tackle its fiscal challenges so soon.

"Realistically what we hope to accomplish through the fiscal wake-up tour is ensure that any serious candidate for the presidency in 2008 will be forced to deal with the issue," he says. "The best we're going to get in the next couple of years is to slow the bleeding."

David M. Walker is a certified public accountant. He has a B.S. degree in accounting from Jacksonville University. His complete biography can be found on Wikipedia.