Arnold Kling  

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Nobel Laureate Gary Becker comments on the possibility of a debt crisis.

Morgan Stanley's report argues debt/GDP is not a good measure of default risk, and suggests instead the ratio of debt to government revenues. On this measure, the US looks terrible, with a ratio of 3.58. This ratio is much higher than that of the eight European nations because they tax a much larger fraction of GDP than the federal government of the US does. Yet it is not obvious to me that using tax revenue rather than GDP in the denominator is a better measure of solvency risk. Countries that already collect a sizeable fraction of GDP as tax revenue have less room to raise taxes than do countries like the US that tax a much smaller fraction.

I wonder how the state and local sector plays into this. If we add in state and local taxes, then the ratio of taxes to GDP in the U.S. is not so much lower than that in European countries (although it is still somewhat lower). In addition, state and local governments have also accumulated unfunded liabilities (although not nearly as much as the Federal government's future obligations in Social Security and Medicare).

In any case, I think it would be brave to assume that raising the ratio of tax revenues to GDP is a feasible solution to our fiscal problems, even if it were politically palatable.

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CATEGORIES: Fiscal Policy

COMMENTS (3 to date)
mark writes:

I am not sure GDP is the relevant denominator because it has a significant government spending component and it doesn't seem like that should be used to support further government debt incurrence; isn't that sort of Ponzi-ish? Further, why is not the export / import balance relevant to the amount of debt a population can upport? Further, you would want to account for the amount of private sector indebtedness and you would want to think about what the asset side of the government balance sheet looked like. It seems like there is also a dynamic aspect to the relation between changes in debt repayment and any measure of economic output that the simple ratio does not capture.

Various writes:

I think one of the reasons that many policy makers believe higher tax rates produce significantly higher tax revenues is one of bias. In other words, they have specific assumptions about the J curve that I think are wrong. Don't take this the wrong way, but I think most folks in academia have a somewhat distorted view of taxpayer incentives, and especially high income tax payers. Specifically I think most adademics assume that the incentives and stress levels of very high income earners are similar to their own incentives and stress levels. In reality, I think high income tax payers propensity to work (and thus earn taxable income) is much more sensitive than those in adademia. This is because their jobs are more stressful and their career paths much more risky. High income earners are more likely to "take a vacation" if the risks and stresses associated with making lots of taxable income don't appear worth the reward.

Case in point....I worked on Wall Street during the 1990s. Gave up my life in sunny California to move to New York and work 80 hours per week. There is no way I would have made that trade in a significantly higher marginal tax rate world.

Doc Merlin writes:

'Countries that already collect a sizeable fraction of GDP as tax revenue have less room to raise taxes than do countries like the US that tax a much smaller fraction.'

This assumes that countries don't usually tax the maximum politically acceptable amount.

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