- By Robert H. FrankRobert H. Frank is economics professor at Cornell University's Johnson Graduate School of Management and author of The Darwin Economy: Liberty, Competition, and the Common Good.
Recessions that follow severe financial crises are stubborn. Consumers won’t lead a recovery because they’re still paying down debt and worried about losing their jobs. Nor will businesses invest, because they already have more than enough capacity to produce what people want to buy. Government is the only actor with both the motive and the ability to boost spending enough to restore full employment in the short run — but as long as entrenched political leaders insist on austerity, they won’t.
Fortunately, there is another tool available. It isn’t the best tool, but it is one that can work in spite of U.S. and European governments’ newfound commitment to austerity. We could enact a steeply progressive surtax on the annual consumption of the wealthiest households, while making sure it’s scheduled for gradual phase-in only after the economy has returned to full employment. A household would report its income to tax authorities as before, and would also report its annual savings, as many already do with tax-exempt retirement accounts. The difference — income minus savings — is the household’s annual consumption. The surtax would begin once annual consumption exceeded a high threshold — say, $500,000 — and rates would rise with consumption beyond that threshold.
Taking this step would create an ensured future revenue stream to balance government budgets. More importantly, it would spur a massive burst of private spending as wealthy families rushed to buy bigger yachts and completed planned additions to their mansions before the surtax took effect. It would, in effect, be a second stimulus — one bankrolled not by Uncle Sam but by Uncle Pennybags.
It’s an idea with a long history — even the sainted free marketeer Milton Friedman once proposed something similar. A progressive consumption surtax would have other benefits in the long run too. Its gradual phase-in would shift resources over time from consumption toward investment. Total spending, and hence total employment, would remain the same, but productivity and income would grow more rapidly.
The tax would also give us a much more potent tool to help address future economic downturns. The most widely used current remedy is a temporary income tax cut; this tends to be ineffective because in times of economic uncertainty most people are likely to put the extra money into savings. By contrast, the only way consumers could take advantage of a temporary consumption surtax cut would be by spending more right away.
Let’s not forget that a far better approach would be large-scale spending on productive public investments, such as infrastructure and education. In this austerity-crazed age, though, that isn’t going to happen anytime soon. In the meantime, any port in a storm!