Here’s How We Fix This Mess

09/15/2011 1:54 pm EST

Focus: MARKETS

Igor Greenwald

Chief Investment Strategist, MLP Profits

Payroll tax cuts financed by the Fed could buy us enough time to overhaul the unaffordable health-care system, writes MoneyShow.com senior editor Igor Greenwald.

The US economy is in trouble.

While multinational exporters and a few tech champions prosper, sales-starved Main Street scrimps and sweats and stagnates.

On Tuesday, we heard from the clinically depressed small-business owners, and learned of spreading poverty and the latest decline in household income.

So it should hardly have come as a surprise that the severe shortage of jobs is once again driving many Americans out of malls and into dollar stores, to judge from August’s slack retail sales.

A four-day relief rally by a market representing the economy’s global elite means little in the context of rising unemployment claims and a serious downturn in manufacturing.

A new Bloomberg poll finds 72% convinced the country is on the wrong track, and 44% convinced they’re worse off than at the start of 2009, when the economy was hemorrhaging 800,000 jobs a month, the banking system was on the verge of collapse, and the stock market was at 75% of current levels (and headed much lower).

No Time to Waste
The increasingly unpopular president is hardly alone in pushing for government action to turn the tide.

As the head of the nonpartisan Congressional Budget Office testified before the congressional supercommittee this week, “There is no inherent contradiction between using fiscal policy to support the economy today, while the unemployment rate is high and many factories and offices are underused, and imposing fiscal restraint several years from now, when output and employment will probably be close to their potential.”

Richard Fisher, the conservative president of the Dallas Fed who has opposed the Federal Reserve’s latest easy-money pledge and additional asset purchases by the central bank, argues that “Congress and the president must put together a program that will encourage growth in final demand as soon as possible.”

Fat chance. President Obama is using his new $447 billion stimulus plan as a campaign prop, proposing funding it with tax hikes on the rich and the not-quite-rich that have no chance with the Republicans.

The latter will be in even less of a compromising mood after victories in congressional races in New York and Nevada, including Anthony Weiner’s old seat in Brooklyn and Queens—last held by a Republican when Calvin Coolidge was in the White House.

At most, Republicans might extend the current 2% payroll-tax holiday, if only to avoid campaign commercials accusing them of raising taxes. Some of the business tax breaks proposed by the president might also prove tempting.

But as a coherent program for jump-starting growth, Obama’s American Jobs Act already looks spent. At best, it will bring some temporary relief for an economy in need of a fundamental fix.

This is the right time to think about long-term solutions to our troubles, however politically implausible they now seem. The Fed and the CBO are right to argue that the economy needs structural reforms as well as a near-term boost. The price of doing nothing or merely following the path of least resistance is liable to prove much too high in the long run.

Tripling Down on Payroll Tax Cut
I’ll start by agreeing with Harvard economist Edward Glaeser that lower payroll taxes are the most effective part of the president’s plan. That’s because that tax cut is most likely to translate into immediate increased spending of the sort the economy actually needs, as opposed to boondoggles like Solyndra that are the inevitable byproduct of an industrial policy crafted by bureaucrats and lobbyists.

Obama’s bill doubles the cost of the 2% payroll-tax holiday currently in place, allocating $240 billion to cut the payroll-tax rate in half to 3.1% for employees in 2012, and to provide a matching tax break for employers on their first $5 million in payroll.

But another one-year extension is not enough, because it would encourage businesses and workers to save the proceeds against the looming tax hike in 2013. Instead, let’s scrap the rest of the Obama stimulus and triple down on the proposed payroll tax cut to keep it in place through 2014. The total cost would be around $720 billion, spread over three years.

NEXT: Send the Bill to the Fed

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Send the Bill to the Fed
How to pay for that? Through higher inflation, which will have the added benefit of paring the economy’s debt relative to income. Over-leveraged economies need nominal growth to make debt service more manageable.

Eight years ago, in a Tokyo speech proposing solutions to Japan’s long deflationary morass, a Federal Reserve governor named Ben Bernanke suggested a tax cut, coupled with a commitment by the Bank of Japan to buy up—and effectively extinguish—the resulting debt.

Taxpayers, he reasoned, would be more likely to take the extra cash if they knew it wouldn’t need to be repaid with interest.

In effect, the tax cut should be financed by “money creation,” Bernanke suggested. Let’s admit, before anyone reaches for their concealed weapon, that many politicians and other Americans consider this course not merely ill-advised, but downright treasonous.

But while inflation is a different kind of tax, as Bernanke acknowledged in Tokyo, it is the sort the encourages people to spend. And that increased spending is very likely to translate into millions of new jobs, which would improve the US fiscal outlook much faster than any combination of spending cuts a supercommittee might recommend.

Monetizing some of the US debt is a solution with appeal even to some Republican presidential candidates from Texas. And if Rep. Ron Paul is willing to toss Treasuries into a bonfire in the name of eliminating the Fed, surely he would agree that restoring millions of American jobs is a cause at least as deserving.

Time for Some Radical Surgery
The three-year payroll tax cut would amount, of course, to little more than a very expensive Band-Aid. After three years, it would go away. And an unreformed economy would likely run into the same obstacles to growth that brought it low in the first place.

That’s why it’s so essential that any reprieve a near-term tax cut might provide not be wasted. A modest hike in the Social Security retirement age for younger workers, as recommended by the Simpson-Bowles commission, Harvard’s Glaeser, and many others, would greatly help the long-term fiscal outlook.

But the single biggest structural impediment the economy confronts—by far the biggest strain on public budgets in the coming years, and the main drag on the creation of new jobs—is the increasingly unaffordable price of health care, which has gotten completely out of whack with what other advanced countries pay to secure similar, and often better, levels of well-being and longevity.

The fact that most services are paid for by insurance dampens the economic incentive for consumers to conserve scarce medical resources. In most other countries, national health plans do the necessary rationing. We’ve opted to subcontract that task to private insurers—which, instead of rationing, have every incentive to pass on their rising costs to employers.

Employers have few good options in responding to the premium hikes, other than asking workers to shoulder more of the burden. Meanwhile, health-care consumers have little to no ability to shop for their medical care based on price, and very few incentives to economize.

The result is a jobs-killing cost spiral running far in excess of inflation for the last few decades.

The federal government deserves most of the blame here, for pinning the responsibility for health care on employers by making health-care benefits tax-deductible. It’s a policy that costs the feds some $600 billion in foregone tax revenue annually. Worse, it inflates health-care costs public and private, imposing a burden on public finances that will require increasingly drastic cuts elsewhere if nothing changes.

We need to put the responsibility for controlling health-care costs where it belongs, with consumers making economic choices daily who are best placed to determine what makes the most sense for their families.

That means eliminating the health-insurance deduction for all plans, not just the high-priced ones as President Obama is again suggesting. The hit to taxpayers could be offset by lowering income-tax rates. Consumers should also be empowered to opt out of employer-paid health care altogether, and pocket the benefit as extra pay.

The government might mandate bare-bones catastrophic health care insurance, so that no campaign manager for a libertarian presidential candidate need ever again die broke, saddling his family with a mountain of medical bills.

But most services would be paid either directly, by people taking home significantly higher pay, or by insurers that have convinced those same people—in competition with many other insurers—to buy their plan. The government would be there to make sure consumers had a range of competitive insurance options, and that providers posted clear prices for their services.

When was the last time you knew, or cared, how much your insurer will be billed for a test or a procedure? The absence of such information, and the fact that we couldn’t profit from it even if we had it, are the main reasons we pay so much more for health care than any other country.

So, to sum up, give most Americans a hefty tax break for three years that won’t add to the national debt, and use that time to truly free the market for health care in order to drastically cut costs.

The economy, freed from the burden of spiraling premiums, would respond. The federal budget would be in far better shape, with millions of extra taxpayers and a much lower trajectory of Medicare and Medicaid costs.

We might have to live with 3.5% inflation for a year or two. But that’s a far better fate than a decade with 9% unemployment.

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