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Financing the State: Romney Must Get the Message
by Joseph Stiglitz and Simon Johnson
Tuesday Sep 18th, 2012 4:51 AM
The role of the state and the necessity of common action is a main theme in the political debate. Regulation ensures the same rules for everyone in competition. Conservative politicians in the US underrate the importance of publically provided education, technology and infrastructure. A system that taxes speculation less than hard labor distorts the economy. Without public goods, a modern national economy cannot survive.
FINANCING THE STATE

ROMNEY MUST GET THE MESSAGE

By Joseph Stiglitz

The rich of a society may not cheat in financing the state. Otherwise the market economy cannot survive as a system.

[This article published September 7, 2012 is translated from the German on the Internet, http://m.ftd.de/artikel/70086146.xml?v=2.0. Joseph Stiglitz is a professor of economics at Columbia University and a Nobel Prize winner for economics.]

The income taxes of Mitt Romney have developed into a great theme in the US election campaign. Is this only a political detail or is it actually important? It is not only important for Americans. The role of the state and the necessity of common action is a main theme of the present political debate in the US. The private sector is very important for a modern national economy but alone is not enough for its success. The necessity of regulation, for example, was clear through the financial crisis that began in 2008.

Regulation ensures the same rules for everyone in competition. In addition, modern national economies depend on technological innovations that presuppose basic research financed by governments. This is an example for a public good – something from which we all profit but which can only be made available insufficiently (if at all) by the private sector alone. Conservative politicians in the US underrate the importance of publically provided education, technology and infrastructure. National economies whose governments provide these public goods are much more successful than those that abstain.

But public goods cost money. Everyone should share in their financing. There can be different opinions about what this means. But those at the top of the income pyramid who pay 15 percent of their declared income (money in tax havens like the Cayman Islands and elsewhere does not need to be reported to US authorities) certainly do not pay a proper amount. An ancient proverb says a fish begins to stink from the head. When presidents and their relations do not pay fair taxes, how can we expect everyone else to do that? And if no one pays fair taxes, how can we then finance the public goods we need?

The presupposition for the tax system in democracies is a spirit of trust and cooperation. If everyone put as much time and resources into avoiding taxes as the rich, the tax system would either break down or much more monitoring and pressure would be necessary. Both alternatives are unacceptable. A market economy cannot function if every agreement has to be enforced legally. It can only survive if the system is generally seen to be fair. New research has shown that the view that the economic system is unfair undermines both cooperation and initiative. More and more Americans think their economic system is unfair. This perceived injustice is reflected in the tax system.

The billionaire Warren Buffet said he would only pay the taxes he had to pay. However something is fundamentally wrong in a system that taxes his earnings less than the earnings of his secretary. He is right about that. If Romney took a similar position, he could be pardoned. A rich politician at the peak of his power who champions higher taxation of the rich could change the course of history. But Romney has decided against that. Obviously he does not understand that a system that taxes speculation less than hard labor distorts the economy. A large part of the money heaped up by the richest consists of what economists call profit. This arises out of the need to secure a larger share in existing wealth, not out of the expansion of the total wealth.

At the top of the income pyramid, we find more and more monopolists who gain their income by restricting production and anti-competitive actions and corporate executives who exploit legal loopholes to get a larger share in business profits for themselves (leaving little for the workers). Today aggregate demand is weak in nearly all industrial countries which leads to higher unemployment, lower wages, greater inequality and ultimately less consumption. The vicious circle is closed. The connection between inequality and economic weakness is recognized ever more intensively.

There is another vicious circle: economic inequality leads to political inequality and vice versa. This is intensified by a tax system exempting people like Romney – who emphasizes he had to pay “at least 13 percent” taxes in the last ten years – from having to contribute a fair share.

Perhaps Romney is not a tax evader. Only the US tax authorities can make that judgment. But he certainly evades taxes to a great extent in light of the top US income tax rate of 35 percent. The problem is obviously not only Romney. On the larger plane, his kind of tax avoidance makes hard financing public goods. Without public goods, a modern national economy cannot survive. Without public goods, faith in the fundamental fairness of the system is undermined and the cohesion of society is weakened.

HOW THE US UNDERSTANDS “FISCAL-CONSERVATIVE”

By Simon Johnson

The amount of debts is politically unimportant. That is the Reagan principle of the “fiscal conservatives.” When the world is unstable, it takes shelter in the dollar – even though the US is the cause of the instability.

[This article published September 7, 2012 is translated from the German on the Internet, http://m.ftd.de/artikel/70085636.xmi?v=2.0. Simon Johnson is a former chief economist of the IMF, co-founder of the economic blog The Baseline Scenario and professor of economics at MIT.]

In most countries, being “fiscally conservative” means emphasizing the budget deficit and the debt level and setting these themes at the top of the political agenda. In many countries of the Eurozone, “fiscal conservatives” are a powerful group today. Their focus is on strengthening state revenues and bringing spending under control. Even in Great Britain, leading (fiscal-) conservatives seem willing to raise taxes and limit future spending.

The United States functions completely differently. To US “fiscal conservative” politicians, it is more important to lower taxes irrespective of the effects on the US budget deficit and the total sum of outstanding debts. One of these politicians is Paul Ryan, Republican candidate for the office of vice-president running in November alongside the presidential candidate Mitt Romney.

American politicians were not always caught in this mindset. In 1960, the advisors of President Dwight D. Eisenhower recommended lowering taxes to pave the way for his vice-president to become president. Eisenhower refused – in part because he did not especially like or trust Nixon but above all because he wanted to leave behind a more balanced budget to his successor.

Why are US- fiscal conservatives so little concerned about their state debts nowadays compared to their colleagues in other countries?

The political-economic course of the US changed dramatically when the international monetary system collapsed in 1971 and the US could not maintain a fixed rate of exchange between the dollar and gold any longer. That fixed rate was the cornerstone of the Bretton Woods system after the war. This system broke down because the US did not want a tightened monetary policy or a stricter budgetary policy. The contentment of US voters was more important to President Nixon than maintaining a global system of fixed exchange rates.

Strangely enough, the end of the Bretton Woods system promoted the use of the US dollar in the world instead of undermining its dominant international role. Much was written in the last four decades about a possible decline and fall of the dollar. Nevertheless foreign investors have substantially more US dollar reserves today than in 1971.

Investors always want to have more dollar-assets when the world appears unstable – even if the US caused the instability itself when mammoth US banks ran into trouble or Americans fought a political battle over their state finances. The trial of strength of the last years over the debt ceiling waged in Congress may cost the US its AAA-rating from Standard & Poors. However the credit costs for the US government are lower now than they were at that time.

What did America make out of the most favorable financing in the history of humanity?

America did little as to productive investments, strengthening education or maintaining the basic infrastructure. But it did much in introducing tax cuts that raise consumption and lower tax revenues. That is the inheritance of George W. Bush with his “temporary” tax cuts introduced in the first years after the turn of the millennium.

Americans have adopted political philosophies that regard state debts merely as a distraction. Former Vice-president Dick Cheney said: “Reagan taught us deficits are unimportant.” During his term in office, Reagan lowered taxes and increased the deficit and nevertheless did not have to suffer any negative political consequences.

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