How to NOT Defuse the Debt Bomb

by Eyck Freymann

Last Friday Fareed Zakaria had an interesting article on how America can tackle it's debt problem. His suggestions break into three categories:

1. A value-added tax (VAT or sales tax) of 25-30% to replace the income tax. 
2. Ending of distorting subsidies for agriculture and homeownership
3. Shift in entitlement system (tying Social Security benefits to inflation, rather than wages, adjusting the retirement age as life expectancy increases, etc.)

Zakaria is a keen geopolitical observer, but I don't think he's considering the consequences of the changes he advocates. His 25% VAT, for instance, sounds an awful lot like Mike Huckabee's "Fair Tax" of the 2008 campaign. You will recall that the plan was roundly discredited during the campaign, mostly for the reason that it isn't fair at all. The income tax raises a huge amount of government revenue, but it does so mostly from the middle and upper classes. The poor simply cannot afford to lose significant percentages of their income to taxes--they need every penny to pay for food and rent. Suddenly eliminating the income tax will do the poor little good, and will not come close to counteracting the enormous increase in food and energy prices. A family with a million-dollar annual income makes fifty times the amount as a family with a forty-thousand dollar income, but it does not spent fifty times as much on food and basic necessities. 

What Zakaria is proposing, effectively, is a tax on the poor. 

Moving on, let's consider the "distorting subsidies." It's true--every year Congress passes a multi-hundred-billion dollar farm bill consisting of subsidies, tax incentives, etc. for agricultural states and businesses. Some of this money is used more productively than the rest, but the overall effect is startling. 

The Omnivore's Dilemma by Michael Pollan explains this process in more detail: it actually costs farmers more to produce cash crops (such as corn and soybeans) than they can earn at market prices, so government subsidies make up the difference. The farm bill alters the equilibrium of the market by incentivizing farmers to produce a glut. This causes prices to plummet and makes the products more attractive to consumers and exporters. The technique is known as supply-side economics (no, not trickle-down economics). 

Say what you want about supply-side economics, the Farm Bill money doesn't go down the drain. It goes back to the consumers in the form of cheaper food and ethanol. If Congress didn't pass the Farm Bill next year, farmers would go bankrupt, prices would soar (hurting the poor here and around the world), production would fall, and we would face a destabilizing global food crisis. 

Zakaria makes an excellent point about Social Security and Medicare. As the boomers retire, there will not be enough money coming in to continue benefits as they are now. The best and most equitable way to solve the problem is exactly what Mr. Zakaria describes: tying benefits to inflation and raising the retirement age. 

Furthermore, Congress must pass comprehensive health care reform. Obamacare is a beginning, not an end. This bill will do a lot to bend down the cost curve, but ultimately the only ways to reduce costs are to emphasize preventive care (yearly general practitioner visits), improve Americans' eating and exercise habits, and front the money for more qualified students to get medical degrees. 

So before we start cutting willy-nilly, we need to examine the non-deficit-reduction aspects of our proposals. When we start doing that, like when Tim Pawlenty of golf-club fame couldn't name a government program he wanted to cut, we can lose sight of the real human beings who stand to gain and lose. That's why the GOP likes "Big Government" nice and vague: when services we rely on are on the cutting room floor, downsizing doesn't look quite so rosy.