Automatic Stabilization Tax Adjustments

By John Atlee, September, 1981
(see also the full-length version of this document)

FASTA is the key to reducing interest rates, inflation, federal deficits and unemployment, and ensuring stable money growth and stable full-employment economic growth within the framework of a "free enterprise" economy.

Our economy is now caught in a complex mess of interlocking vicious circles and policy dilemmas which none of the traditional policy approaches offers credible means of solving. It is now widely recognized that the most strategic key to breaking into many of these vicious circles and policy dilemmas is to achieve effective control of the federal deficit. But with our present policy tools there is no way to control the deficit precisely or even to know how much deficit would be economically appropriate at any given time.

Fiscal 1982 federal borrowing to finance the deficit is now expected to require almost one-fourth of the economy's total supply of credit. This is being piled on top of an already high rate of consumer, business and state/local borrowing. When the demand for credit exceeds the supply, interest rates rise -interest is merely the "rental-price" of credit.

High and rapidly rising interest rates put political pressure on the Federal Reserve to increase the supply of credit by faster money growth. If the Fed refuses, interest rates go up because credit demand continues to exceed supply. This increases the federal deficit through higher interest costs on the existing federal debt. (Each 1% rise in interest rates is estimated to cost the Treasury about $2 billion more in interest payments.) Moreover, if the present rate of money growth is in fact so slow as to cause slow economic growth, this further increases the federal deficit through smaller tax receipts and higher unemployment benefits. (Each 1% increase in unemployment increases the deficit by about $25 billion.)

If the Fed permits faster money growth, interest rates may still go up because of the traditional belief that faster money growth is inflationary -even when the faster growth is actually needed to maintain adequate real economic growth.

Thus, both the actually realized federal deficit and interest rates are determined largely by general economic conditions over which Congress now has little effective control.

The key to solving these vicious circles and policy dilemmas is actually so simple that it should have been obvious long ago. We need to adopt policy machinery, completely separate from the regular budget process, which can adjust the federal deficit as often as necessary (even every month) by small but precise changes in withholding tax receipts. For instance, a $10 change in each person's tax withheld in one month -- which would hardly be noticed by the taxpayer -- would cause a $10 billion change in the annual rate of federal deficit. Even smaller planned changes in the federal deficit, if precisely timed, could have a major effect on the trend of interest rates, money growth and real economic growth before the economy gets so badly out of balance that it gets locked into another roller-coaster trip. (This is where "a stitch in time" could save more than nine!)

But for such precision, the amount and timing of the changes need to be determined "automatically" by a formula based on market interest rates. This formula would increase tax receipts (and thus reduce the deficit) whenever the total borrowing by all sectors (households, businesses, federal and local government) becomes excessive and causes interest rates to rise. It would reduce these tax receipts (and thus increase the deficit) whenever total borrowing falls low enough to push interest rates below those in other industrial countries (which risks causing a decline in the dollar's foreign exchange rate.

Stabilizing interest rates in this way, entirely through "fiscal" policy (rather than "monetary" policy) would take responsibility for interest rates off the shoulders of the Federal Reserve. Then the Fed could allow the money supply to grow at whatever rate is needed to maintain a stable, non-inflationary rate of real economic growth, without regard to its effect on interest rates.

Credible assurance that both money growth and the federal deficit would be controlled "automatically" by formulas tied precisely to the actual needs of the economy (regardless of any mistakes made by the Administration or Congress in legislated budget policy) would reduce Wall Street's inflation worries. This would reduce interest rates and interest costs, which would reduce the inflation rate and the actually realized federal deficit. It would also facilitate faster and more balanced real economic growth, which would increase productivity, thus further reducing inflation.

Thus, the self-perpetuating "spiral" of inflation would be broken, and the key tools of economic management would be in place for assuring continued fullemployment economic growth. With the demise of the traditional "business cycle" business could confidently plan further ahead for the capacity- and productivity-increasing investment which is so badly needed to reinvigorate the American economy.

When we put our national economic policy "on automatic pilot" with FASTA and stable money growth we can end our disgraceful and dangerous roller-coaster economic performance, debilitating uncertainty about future economic conditions and unnecessary federal deficits.

Written: September 1981
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