As House Republicans noisily demonstrate their utter lack of interest in governing, other parts of the federal system continue to operate. The Fed, for example, continues to battle inflation.
In a lengthy October essay in the New York Times, Ezra Klein provided an overview of the causes of inflation and the choices policymakers face when trying to control it.
Inflation often begins as a mismatch of supply and demand. But if people get accustomed to prices rising, then inflation becomes about expectations. And so the task of ending it grows fuzzier: You need to use policy not just to manage the economy but also to alter psychology. The arid language of economics obscures the brutality this demands. You need to hit the economy hard enough to cow everyone who makes decisions within it.
Because that’s what prices are: decisions. Those decisions, even when mediated by algorithms, are made by people trying to predict the decisions other people will make. When people start to believe that other people are raising prices, they will raise prices. If they think other people are raising prices even faster, they will raise prices even faster than that. “How can you persuade people to expect differently?
One way is by increasing supply., but that usually can’t be done quickly. Another is by cutting demand by raising interest rates–but that makes it harder to borrow money or afford homes, and inevitably throws people out of work.
Klein reminded readers of Paul Volker’s approach to “stagflation” in the 1970s.
Volcker forced a recession so deep that the entire psychology of the American economy changed. Today he is celebrated for his steel. Powell invokes him as inspiration. In a speech at a Fed conference in Jackson Hole this summer, he mentioned Volcker twice and said, of the intended rate hikes, “we must keep at it until the job is done,” presumably a reference to Volcker’s memoir, “Keeping At It.”
Using interest rate hikes to manage inflation operates like a sledgehammer: it reduces demand, but also cuts supply.
When people lose their jobs, they stop producing the goods and services the economy needs. When mortgage rates spike, developers build fewer houses, despite the fact that high housing costs are often caused by too few houses. When borrowing money becomes expensive, people stop borrowing it and cease to make the investments that create future productivity.
Klein documents the various ways in which interest rate hikes disproportionately harm the poor and the jobless, and says that it would be “nice to have a policy that targeted the rich rather than the poor and did so in a way that didn’t hurt long-term investment.”
He asserts that “such a policy exists.” It’s a progressive consumption tax.
Here’s how it works. Instead of reporting your income to the I.R.S. and being taxed on that, you report your income minus your savings, and you’re taxed on that. That’s a consumption tax: Your taxable income is what you spend, not what you save. Congress can make it progressive by adding a hefty standard deduction and applying a much higher tax rate to people making much more money, just as we do now.
The economist who proposed this approach wasn’t concerned about inflation. He thought rich people’s spending wasn’t just wasteful, but harmful. Whether one accepts his definition of “harmful” or not–I’m dubious–Klein points to a truly useful aspect of a progressive consumption tax: it can be dialed up and down to respond to different economic conditions.
In a time of recession, we could drop taxes on new spending, giving the rich and poor alike more reason to spend. In times of inflation, we could raise taxes on new spending, particularly among the wealthy, giving them a concrete reason to cut back immediately and to save and invest more at the same time.
Ideally, adjustments could also be made automatic.
Perhaps for every percentage point increase in unemployment above 5 percent, the tax rate would fall by three points, and for every percentage point increase in inflation above 3 percent, it would rise by four points. Other rules could apply for periods when unemployment and inflation moved together. The tax code would become responsive to the economy by default, rather than only through new acts of Congress.
Given the GOP’s semi-religious objection to taxes, and the current domination of the House by people who can barely spell “economic policy,” let alone leave their preoccupations with culture war issues long enough to consider the operation of the economy, I don’t hold out much hope for passage of a progressive consumption tax in the near future, but it’s an intriguing idea.
We should file it away with other good ideas that await a (hoped-for) return of political sanity and lawmaker interest in actually governing.