Complete the Revolution

Wednesday, January 16, 2008

Milton Friedman devoted a major part of his life to the pursuit of institutional frameworks that would facilitate free international trade, stable (low inflation) monetary outcomes, and a fiscal regime that would eliminate both wasteful government expenditures and the inefficiencies and disincentives associated with taxation.

Here is the outline of a method for implementing Friedman’s 1948 suggestion that government expenditure should be determined “entirely on the basis of the community’s desire, need and willingness to pay for public services.” The traumas of the economic nationalism of the 1930s led to an institutional revolution (the World Trade Organization, plus bilateral agreements) that continues to lower tariff barriers and increase trade. The inflationary traumas of the 1960s and 1970s also led to an institutional revolution: more or less independent central banks, equipped with a mandate to use monetary policy to target modest inflationary outcomes.

Despite Friedman’s advocacy, ongoing fiscal traumas have failed to produce a similar revolutionary constituency. The fiscal principle of “No Taxation without Representation” emboldened the Founding Fathers “to die, and leave their children free” (in Ralph Waldo Emerson’s words). But “representation” by itself merely replaced a British monarch with an elite of American incumbents; its limitations enable the Fathers to spend and leave their children in fiscal bondage. America’s tax revolution is incomplete. Representation needs to be supplemented by accountability, transparency, and evaluation (RATE).

It is institutionally superior to have the Federal Open Market Committee overseeing monetary policy rather than having interest rates adjusted according to the requirements of the political business cycle; even incumbents have accepted the post-traumatic lessons of inflation and disinflation. Yet fiscal reformers have focused on pet projects (flat taxes, consumption taxes, balanced budget amendments, etc.) rather than pursuing an institutional revolution that can embody sound and balanced principles.

Taxpayers should get shareholder-style information, as well as an invitation to say where they want their money to be spent.

America’s ongoing tax revolution requires an independent body of professional economists and accountants (independent of both the Office of Management and Budget and the Congressional Budget Office) who can evaluate spending proposals before and after they are debated and signed into law. This “Fiscal Fed” could be located either within the “Monetary Fed” or separately.

The 2006 Federal Funding Accountability and Transparency Act indirectly attempts to unravel the tangled web with an Office of Management and Budget (OMB) website of fiscal recipients. The 2008 presidental aspirants (including the two initial co-sponsors of this bill, Barack Obama and John McCain) could seize the fiscal high ground by declaring that if elected they would institutionalize this initiative by establishing a Fiscal Accountability Transparency and Evaluation (FATE) board. The checks and balances (and hence the legitimacy) of our system would be enhanced by doing more than outing those whose checks jeopardize the fiscal balances. What principles should underpin this Fiscal Fed?

First, evaluation. The Fiscal Fed should rank all spending proposals according to a social cost-benefit analysis (plus midpoint and postmortem evaluations) and evaluate their macroeconomic implications. In this way, red ink–inducing, low-priority projects can be delayed, if not shelved. As Friedman noted, tax cuts unaccompanied by spending cuts are merely taxes deferred.

The second principle is transparency. When the Fed sets interest rates, the process is relatively open and decisions and disagreements are accompanied by reasons and evidence. Fiscal policy disagreements should be equally open, transparent, and informed by evidence. We the people will never achieve fiscal nirvana; we also know from current arrangements that silk purses can’t be made from sow’s earmarks or pork barrels.

America’s ongoing tax revolution requires an independent body of economists and accountants who can evaluate spending proposals before and after they are debated and signed into law.

The third principle is accountability. The economic marketplace is a reasonably efficient vehicle for eliciting consumers’ preferences, and the political marketplace is the best vehicle for eliciting general (personnel) political preferences. But elections are inefficient ways of determining magnitudes (of national income that governments should take) or priorities (the uses to which those funds should be put). Fiscal democracy would be enhanced if community objectives trumped the self-interest and corruption of incumbents.

Taxpayer preferences could be elicited directly by providing shareholderstyle information (a detailed breakdown of how their funds were spent in the past tax year) accompanied by an invitation to express a preference about magnitudes (taxes as a proportion of national income in the following year) and priorities (the categories to which their taxes should be allocated, revealed by allocating descending numbers to broad, or precise, spending categories). Congress need not slavishly follow taxpayer preferences, but such information should be publicly available to inform taxing and spending decisions.

Congress is empowered to collect taxes (the input side), and a Fiscal Fed would assist Congress in meeting its unfulfilled constitutional commitments on the output side: “to pay the debts and to provide for the common defense and the general welfare of the United States.” In contrast, under current institutional arrangements, the national debt is not being paid, and much Washington expenditure feeds unelected representatives (lobbyists) and their clients rather than contributing to the general welfare.

Politicians would override this FATE process at their electoral peril. The Fiscal Fed would constitute a permanent institutional assault on smug spenders and tax deferrers in chief, those with snouts in the fiscal trough and heads in the fiscal sand. Washington may become less of a black fiscal hole if embattled taxpayers rallied behind a presidential candidate prepared to build a bridge to a place where taxing and spending serve the common interest.

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