Chaining ourselves to (slightly) higher tax rates

I was going to suggest a couple of potentially good things about chained-CPI, a slower and allegedly more accurate measure of inflation than the one currently in use, as a means of boosting tax revenue. Josh Barro slowed me up. Having criticized chained-CPI as a means of reducing Social Security benefits, which Barro believes should be indexed to income growth rather than inflation, he moves on to taxes:

Inflation indexing of the income tax code also makes little sense. Every year, income tax brackets are adjusted upward in line with CPI. So, while the 25 percent federal income tax bracket started at $34,500 of taxable income in 2011, it doesn't start until $35,350 for 2012. But, except in recessions, incomes tend to rise faster than price inflation. That means that, absent changes in tax law, a taxpayer at any given place in the income distribution will face a higher effective tax rate over time.

This effect is called "real bracket creep," and it’s undesirable if we want a tax code that produces stable collections and a stable distribution of the tax burden over time. Indexing tax brackets to national income would cause the bracket thresholds to rise faster, eliminating real bracket creep.

Autocracy, inflation, revolt, crackdown

A few weeks ago, social scientists Michael J. Lamia and James Raymond Vreeland published the results of an exhaustive statistical study of the factors that lead countries to transition to democracy. One ostensibly surprising conclusion was that rapid GDP growth does not correlate with such transitions:

Regarding transitions to democracy, we find that economic growth has a robust negative effect. This finding, standing in stark contrast to modernization theory, suggests that autocracies with strong economic performance are unlikely to see democracy emerge. Instead, economic contraction causes dictatorships to break down. Also in contrast to modernization theory...the level of GDP per capita does not have a robust relationship with the emergence of democracy (p.2).

We have an interesting finding for economic growth: it makes dictatorships more likely to survive and lowers the chances for democracy to emerge (p. 27).

Is this really so surprising? No one wants to change a winning game. As long as an autocracy delivers the goods, people are likely to tolerate it. However, these researchers also found that

autocracies with strong economic performance are unlikely to see democracy emerge. Instead, economic contraction causes dictatorships to break down.

What happens when rapid economic progress gives way to economic stress? Perhaps that is the danger point for many autocracies.

Such was the case in the runup to the Tiananmen Square crackdown in China in 1989. From 1984-1988, China's average yearly growth rate (not compounded) was 12.1%, according to Chinability. In 1989, growth slowed to 4.1%, shrinking to 3.8% the next year before soaring again to 9.2% in 1991 and never dipping below 7% thereafter. The major economic stress point in the months prior to the student protests, however, was runaway inflation, which led to widespread calls for increased centralized control of the economy after a period of liberalization.

The Chinese people ultimately accepted continued authoritarianism after the Tiananmen crackdown. Prior to the 1989 dip, they had experienced a dozen years of extraordinary growth, and after a two-year slowdown in 1989-90 the country resumed its torrid wealth creation. Some may lament the wealth-freedom tradeoff. But the government has credibility to the extent that it's fostered the commonwealth for a generation.

Iran's current crisis is also occurring at a moment of economic pressure following a period of growth. Since 2000, according to the Congressional Research Service, GDP growth has averaged about 6.4% per year; this year, in the midst of the world financial crisis, it's projected at 3.5%. But again, the chief stressor is inflation: the official CPI was 17.1% in 2007 and 28.0 in '08, the real rate is higher, and the costs runups hit people where they live, in housing and food prices. Unemployment is also high - 12.1% in 2007 -- and Iran suffers the world's biggest brain drain, according to the IMF, as its young population goes abroad in search of opportunity.

Unlike the Chinese in 1989, Iranians today widely consider their country to be mismanaged economically. Ahmadinejad has held interests rates artificially low, fueling inflation. The international sanctions bite, and foreign investment is low.

A Tiananmen-style crackdown could happen at any time in Iran. But the Iranians have less cause to accept their government's heavy hand than the Chinese did. There is no upside to acquiescence -- no promise of prudent economic stewardship, or of stability and increasing foreign engagment.

Deflation nation?

Most Americans lucky enough to own any assets have lost - and are still in process of losing - a significant portion of their wealth in the current crisis. Home values will probably have dropped at least 30-40% before bottoming out. People with half their savings in stock funds have lost in the neighborhood of 20% since the fall 2007 peak-- often more, since most bond funds lost too, and most managed funds have outpaced the broad indexes in the downward dive. Those lucky enough not to have lost jobs or gotten seriously ill probably have lost/will lose about quarter of their nominal net worth.

At the same time, wealth is a fluid and relative thing. What we've lost -- if it doesn't reach the level of something that massively impacts current life, like a home or health -- won't be clear for a long time, and may even turn to gain, if we build on more sustainable foundations. That is, if our collective wealth is more equitably and efficiently shared, if we succeed in reforming education and rebuilding effective public safety nets and fostering innovation in sustainable industries. . Life is long, as Salman Rushdie characters bent on revenge like to say -- and so are our economic biographies.

One large set of variables in assessing economic losses is the potential upside of deflation, broadly understood. Deflation, as officially defined by economists, is both a very bad thing -- perhaps the main precondition of a true Depression -- and relatively modest in percentage terms. Like headline inflation over the last two decades, any official deflation we undergo is likely to register in low single digits.

But headline inflation has not captured a far more rapid inflation in the "Three H's" of economic well-being -- homes, higher education, and healthcare. Add to those high costs the increase of major risk in middle class American life -- job loss, loss of health insurance (or loss of adequate health insurance), loss of defined benefit pensions -- and we've clearly suffered a major "inflation" in the sense that solvency and security are more difficult to obtain than they were a generation ago. The convergence and bursting of our several debt bubbles has made it clear that much of our national wealth was illusory.

If real inflation has outstripped officially measured inflation, perhaps a more broadly understood deflation, enabled in part by good policy, will not only far outstrip any official cost-of-living deflation (or co-exist with official inflation), but actually make prosperity and security more attainable. The linchpins of economic well-being should become relatively easier to obtain:

• Housing: In my New Jersey suburb, 20 miles from New York City, small starter homes scraped $600,000 in 2005. How could even affluent young couples afford, say, a $550,000 mortgage? Probably by taking on some exotic interest-only loan, with the rate escalating in 2-3 years - taken on the assumption that the couple could then either refinance or trade up, financing a more expensive home with profits from the first one. In a year or two or five, that same starter home may cost $400,000 or less, with a mortgage -- if the couple can obtain one -- at a fixed rate under 5%.
• Higher education: I've never really understood the massive runup in college costs, topping out today at over $50,000 per year at prestigious private colleges. Today it's hard to imagine schools, themselves slammed by the fiscal crisis, lowering costs. What should improve fast, though, is the disgustingly exploitive privatization of the student loan business, whereby schools have steered students into loans with opaque terms and usurious rates, sometimes scraping 20% for students in trade schools training for relatively low-wage professions. Expanded opportunities to trade tuition aid for service commitments should also help to bring college within reach for many. At the same time, a swift, massive cultural shift away from all kinds of spending, stemming from economic hardship, should at least slow tuition inflation.
• Healthcare: Effective health insurance reform that provides affordable coverage for the uninsured and mandates adequate coverage of catastrophic costs will halt an enormous source of wealth destruction for Americans. If we can't get this done, and at least bring our healthcare costs and outcomes to the levels enjoyed by most advanced democracies, there's simply no hope for continued American prosperity. Can we afford it in the midst of the economic meltdown? As Obama asked in a Dec. 11 press conference: How can we afford not to?
  
• Debt and consumption: Harsher bankruptcy laws were supposed to discipline borrowers. Now, a massive wave of bankruptcies is disciplining lenders. In hard times, people will take on less discretionary debt and save more. That's bad for the economy short-term, but it will mean less money spent on debt service for many Americans. Debt servicing aside, spending less money on what you don't need makes you wealthier. And while vast numbers of Americans have been driven deep into debt and bankruptcy by circumstances beyond their control, such as uninsured or underinsured illness, there's no doubt that we've all been culturally inclined to spend more than we need to on nonessentials.
  

I've always daydreamed occasionally about being offered fairy tale choices, such as Achilles' choice between a long and happy or short and glorious life. One such imagined supernatural game show question that I posed to myself at various points in the election cycle: would you give up, say, a quarter of your worldly wealth to see Obama elected? That is, to have a shot at this country rolling back the shredding of our civil liberties, belligerent adventurism abroad, growing economic inequality at home, accelerated global warming, etc. etc.? Framed as a purely economic choice: would you stand for a drastic downward revaluation of your assets this year, as part of a national and indeed worldwide revaluing and rebalancing, forcing national and international efforts to restructure on a more sustainable footing? To get even deeper into the realm of nonsensical cosmic planning, this time from a future vantage: was it worth eight years of Bush to get us to Obama?

What's the point of framing up supernatural pseudo-choices? Only to get somehow at this: democracy's saving grace is the capacity to self-correct. In the past, the country has recovered from horrendous mistakes to move on toward renewed prosperity, and, as Obama likes to say, progress toward a more perfect union. The election suggests that American democracy has retained that capacity for self-correction. Will we be able to dig ourselves out the hole we've dug. Obama says "yes we can." For this long lovely moment, the country seems disposed to agree.