We Must Start Planning for the Next Financial Crisis

We face numerous potential triggers for a financial crisis. Here are just a few:

1. Too many corporations have borrowed too much money because interest rates are so low. They have used it for stock buy backs and dividends in an attempt to bolster their stock prices and executive compensation. That is coming to an end regardless of whether the Federal Reserve raises interest rates because the corporations are over-leveraged and did not use the money to invest in productivity or new products. As a result, stocks could decline by 20 percent or more.

2. Federal, state, and private pension funds; Medicare; and Social Security are all running out of money because they've assumed a rate of return far in excess of their actual rate of return and have made promises that they cannot fulfill. Their day of judgment is fast approaching. We are either going to have to raise more revenue, cut benefits, or both.

3. We have a tax code that is far too complex and encourages the export of jobs and profits, which increases the trade deficit and the value of the dollar, thereby handicapping our ability to compete in the worldwide economy.

4. Our complex tax code increases economic inequality by benefiting the very wealthy at the expense of the middle class. Unfortunately, because of the failure of our educational system and the media, most Americans have not identified the real cause of their economic plight. They know that part of their economic problem is caused by the lack of a rational tax code because it was designed by lobbyists for the wealthy. But just as important is the theology, fostered by right-leaning think tanks, that the solution to our economic problems is to cut taxes and the budget, particularly of the IRS. They ignore the results of the real world experiment of cutting taxes and spending in Europe and, closer to home, in Kansas. Republican Gov. Sam Brownback cut his state's tax rate significantly, promising that it would pay for itself in business growth. Unfortunately, the result was that his tax cut left the state with a huge deficit, poor infrastructure, poor schools, higher local taxes, and a flight of businesses that wanted better education and infrastructure.

There are other potential crisis triggers, but there is no doubt that in the next four years we will face a new financial crisis. The question is whether the next president can get Congress to act before it happens. The answer, unfortunately, is probably not until we have a full blown crisis, but we must begin thinking now about what can be done. We cannot afford the ad hoc response to the last crisis when taxpayers were forced to bail out the financial institutions that caused the crisis. Currently, the House can't pass a bill because of differences with the president and extremists in both parties. Moreover, House Republicans have not been able to eliminate clearly wasteful and duplicative programs because no subcommittee has been willing to give up its jurisdiction.

There is widespread agreement among economists that monetary policy led by the Fed has run out of steam and that we should employ fiscal stimulus by, for example, spending on infrastructure. The danger will be the temptation to use tax reform to continue favoring the rich rather than the middle class, which would only increase inequality and deprive the middle class of the money needed to increase demand. Lobbyists are already scrambling for clients to take advantage of additional subsidies that can be hidden in the tax code. Aside from Tax Notes and a few other dedicated journalists, there is little chance the average taxpayer will ever learn about what will be buried in a massive tax reform bill. Remember the old adage: The more complex a tax provision is, the greater the likelihood it is hiding an unjustifiable subsidy.

The key to tax reform is simplicity or as Milton Friedman put it, elimination of all tax subsidies, which could both raise revenue and lower rates. That would also make the code more equitable by eliminating, what I believe, are inequitable subsidies. We could accomplish that by taxing income from investments the same as income from labor; treating all businesses, corporations, and noncorporations the same to level the playing field; eliminating deferral of taxes on overseas profits so that the multinational corporations cannot continue to hide income from taxes and gain an unfair competitive advantage over domestic corporations; and eliminating transfer pricing and going to a unitary system of accounting that allocates worldwide profits based on where the corporations can prove they earned their profits either by sales or a combination of sales, personnel, and property.

Although many economists think that adopting a VAT is the way to simplify the code, they apparently have not looked at the European experience and discovered how complex a VAT becomes in "special situations" faced by even the most fervent capitalists who demand either protection from competition or a government subsidy. Besides, in my opinion, once the Republicans figure out how much money a VAT could raise and the Democrats realize most of the burden would be shifted to the middle class and working poor, it doesn't stand a chance of passage.

While we cannot say with certainty when the economic crisis will occur, we can say that it will occur. Therefore we must start thinking now about how we can use the crisis to cut through the political and economic deadlock that has injured our economy. Whatever choice we make should not exacerbate our economic inequality but should help our country grow by investing in education and particularly preschool education, research, and infrastructure, and making the U.S. economy more competitive in the world economy.