Bankruptcy

Note to Policymakers: Be Aggressive, but Smart

By Christian E. Weller

With Wall Street in turmoil and the economy on a downward slope, policymakers' ingenuity to help financial markets and the economy is demanded. The response will have to be large, but also smart. Voters will likely not accept an approach that simply throws money at the problem, never mind that the government will eventually run into some hard times itself if policymakers think that more money will fix all that ails us. Undoubtedly, some tax cuts and some spending increases will have to be part of the solution, but given the recent financial rescue package and the need for a short-run money injection to avoid a major recession, policymakers will need to think smartly about other tools at their disposal to help the economy to recover.

We need something big. The financial crisis did not just happen overnight. It had been in the making for years. Family incomes and the labor market never really recovered from the last recession. With prices for large ticket items rising, families turned to all forms of debt to maintain their consumption. The debt build-up proceeded thus more than four times faster in the 2000s than in the 1990s. Running an economy on ever more debt was simply not sustainable. The crisis that started in the labor market in early 2006 and spread to Wall Street in early 2007 had been in the making for the prior six years. The solution thus has to match the problem. It needs to be large and it needs to be sustained for years and possibly decades to come to put the economy on a sustained recovery.

There are many ideas that could do the trick, and many that should be considered, because they are big, smart policy and address the underlying failings in the economy. Two such ideas may offer a flavor of what is needed. The first one goes to strengthening financial security and the second to improving retirement income security.

First, Elizabeth Warren has proposed a new agency to regulate and oversee consumer financial products for their impact on consumers' financial security. In one fell swoop, the creation of such a commission, akin to FDA and other consumer financial protection efforts, would replace the stepwise approach to financial security that has produced little tangible success.

Second, many tax experts, including Gene Sperling, President Clinton's chief economic advisor, and President Bush's tax commission, have proposed to replace the existing system of tax deductions into saving accounts with a flat tax credit. Right now, a person with a marginal tax rate of 35% will get 35 cents from the federal government for every dollar that they contribute to a 401(k), while a person with a top marginal tax rate of 10% will get only 10 cents. This may explain the ineffectiveness of these tax incentives to get more people to save more for retirement. Giving everybody the same incentive relative to their contributions makes a lot more sense, has bi-partisan support, and can be done in a revenue neutral way.

It is time to fix the economy by trying things that work, that are large, and that can create strong and durable growth, but that are also affordable in the long run.

Full post as published by Credit Slips on October 20, 2008 (boomark / email).