We Need a Fiscal Authority to Complement the Fed

Two current events earlier this year highlight the poor state of fiscal policy in the U.S. The President proposed a budget and the effect was similar to the dropping of the puck at the start of a hockey game. Is this really the way to conduct fiscal policy in a manner conducive to the health of the U.S. economy? Why do we have so much trouble with fiscal policy and so little trouble with monetary policy?

With Ben Bernanke having taken over the post of Fed Chairman, attention is directed to asking, "Can he do the job?" That is a fair-enough question but in light of the Fed's generally superb monetary policy performance over the last twenty years it misses the real source of current macroeconomic problems in the U.S.: the federal government's not-so-stellar fiscal policy performance. By contrast, the effectiveness of the Fed in monetary policy is barely a question.

Monetary policy involves the tweaking of interest rates to achieve macroeconomic objectives. The Fed does this with near complete independence from the rest of government. Monetary policy - here and abroad - has been well-served by keeping politicians out of the loop. In contrast, fiscal policy is an intensely political process, involving federal taxing and spending, incessant haggling between the Administration and Congress, and the now fairly distant possibility of an occasional electoral correction.

The present fiscal policy process does not serve the public well. Used as a tool for short-run macroeconomic management, fiscal policy has become a plaything of politicians to curry favor with special interest groups. Poor fiscal policy has been offset only by the ability of the monetary authority - the Federal Reserve - to adeptly conjure monetary policy solutions to fiscal policy mistakes. It is time to give the monetary authority a fiscal authority counterpart. The current Council of Economic Advisers, an advisory body for the President, should be disbanded and a new entity - the Council of Fiscal Authority (CFA) - should be constituted.

As is the case for the Fed now, CFA governors would be appointed to nonrenewable 14-year terms, report twice a year to Congress on the state of the economy, and possess certain decision-making powers with real bite. In particular, the CFA would have the authority to influence fiscal policy by specifying economy-wide average personal and corporate tax rates. The CFA would not specify marginal rates, would not dole out tax exemptions, and would not speak to tax reform, would not - in a word - be caught up in administrative and tax-burden distribution issues that are properly the domain of elected representatives. Congress would still need to fulfill its constitutional duty to "lay and collect" taxes, only that the average rate would be set by a disinterested outside party, the CFA. Congress must spell out in the enabling legislation that it is granting this agency the right and power to set only average tax rates commensurate with Congressional spending and the interests of the nation's economy. Just as IRS collects the taxes with agency from Congress the CFA will "lay taxes" by setting the rates with the agency granted to it by Congress. Congress shall not forego its ability to take back that right at some time in the future. The CFA would have no right to create new taxes only the right and power to set the rates on income taxes created by Congress. The rates would be set in accordance with the spending dictated by Congress.

This average rate would be set so as to compel Congress to attend to its spending habit with more care than it has in recent years. If Congress "overspends," driving federal budget deficits and national debt beyond economically acceptable limits, the CFA could raise the average tax rate, obliging Congress to accept the consequences of its profligacy. Politicians fond of pork would be encouraging taxation, sure to result in considerable political discomfort. The ideal is that the existence of the CFA would induce fiscal responsibility in those who are elected.

Our scheme is not a one-way street. If the CFA felt that the average tax rate were too high or that the economy would do better in the long-run with a year or two of deficits then it could dictate a lower average tax rate. The key is to take an important portion of fiscal policy management out of the hands of politicians. For example, for fiscal year 2004, federal government receipts were 16.03 percent of GDP, whereas federal outlays amounted to 19.54 percent of GDP. Under our scheme, the CFA could mandate Congress to raise the average tax rate to result in tax collections equal to 17, 19, 20, or an even higher percentage of GDP. Presumably, Congress would rather cut spending than to be compelled to "lay and collect" more taxes. In turn, boundaries should be set to prevent the CFA from setting an average tax rate that deviates by more than, say, two percentage points from spending levels. The only exception to the CFA's tax-regulation powers would be a declaration of war by Congress when dealing with an emergency involving a foreign power. (The CFA would also have the authority to forbid Congress to impose unfunded mandates on state or local governments or to impose taxes under any euphemistic name such as "user fees.")

Our proposal will strike some readers as fancy. Why would Congress give up certain fiscal powers? One answer is that Congress already has delegated numerous important powers - including monetary policy - to certain federal agencies, jobs they are better suited to take on. Thus, Congress created the ICC, FCC, FDA and, regarding its constitutional charter to "lay and collect" taxes, created the IRS to collect the taxes. Creating an agency to set the tax rates is no more an abrogation of its authority and responsibility than is the existence of the IRS.

In creating a CFA, we need to mirror what works with the Fed: real power, terms spanning several administrations, and a "non-dismissal of governors" rule. In time, the CFA might be given other useful powers such as setting budgeting and accounting rules for the federal government that mirror more stringent private-industry practice, especially those that track obligations coming due in future. But the foremost need today is simply to get fiscal policy out of politicians' hands back into the realm of macroeconomic policymaking proper. The CFA would help do that. In short: let politicians do the spending but let another entity provide fiscal "checks and balances" by having final authority over taxation.

Also make a visit to Jurgen's site

-- Dick Lepre & Jurgen Brauer

Comments

[William Cubley]

Dick,

The creation of a CFA would probably help make the issue of taxes very clear to the average man.

We might. FOR EXAMPLE, decide that the housing industry does not need a the mortgage interest deduction. Canada has about the same percentage of home buyers/owners as does the USA. Canada has NO tax deduction for mortgage interest. Homes still get built in Canada for a profit by builders.

We might decide to tax oil [GASOLINE] at the same uountries do in Europe and elsewhere.

Yes, the annual pork bill might have a lot fewer items in it as the taxes must be collected to pay for this. Money spent should benefit the public and not reward campaign contributors.

Someone once said that war is too important to be left to generals. Maybe tax rates are too important to be left to elcted officials.

However, we must remember this - at least our economy is GREAT. We have NOT dispossed our creators of wealth as has Zimbabwe. We still are a land of opportunity.

[D Shangraw]

This sounds way too simple to have our government accept. It's quite possible this could be a great tool to get some politicians publicly flogged!!(not a bad idea)As with abolishing the antiquated Electoral Vote system, this would put some of the control back in the laps of the (alleged) educated public. It would help the American people to better understand tax issues and tie taxes to a more logical platform. At worst it would keep the public more informed without using a political bias -- just facts.

[C Martin]

An interesting idea. Although you've gone out of your way to suggest that this would not require amending the constitution, a simple analysis suggests that this would never hold up in court. The IRS and other agencies, for example, cannot currently "forbid" congress from enacting legislation, as you propose that this group would have the "authority to forbid Congress to impose unfunded mandates on state or local governments or to impose taxes under any euphemistic name such as "user fees." I do recognize that such power would be essential for this system to be useful, but it would (and should) never stand up to a court challenge.
A second sticking point is that you underestimate the influence of political power. Giving this group the power to accept deficits if it felt that the country would benefit is opening a political playground. Just as there is pressure to stack the courts with those of your ideology, there would be even more pressure to stack this body. Imagine if this body could raise or lower rates just before an election, in order help or harm the party in power. The temptation (or driving force) would be too great.

[Dick Lepre]

In reply to C Martin's comment:

I have to agree with you that we need to tone down the "Congress cannot do this part." Let's give CFA the power to set rates on personal and corporate taxes and have Congress reserve the right to screw things up. Clearly the Constitution gives the right to tax to Congress. Our suggestion will be that having created income taxes Congress can pass along the details regarding the rates to this new entity. CFA will be chartered to set those rates in accordance with the spending of Congress and the best interests of the nation's economy.

[Michael Lee]

Similar to Shangraw's comment, it makes too much sense for politicians to accept, especially since they seem to refuse to agree on anything. Have you taken these thoughts any further? I'd like to discuss it in more detail.