The voices of Tax Policy Center's researchers and staff
A News Years Eve, 1965, Time magazine article quoted iconic free-market economist Milton Friedman as saying, "We are all Keynesians now." Friedman later explained that the quote was taken out of context. He meant that even though the language of John Maynard Keynes—famous for recommending fiscal policy as a tool to manage the economy—had pervaded popular consciousness, most people had no idea what this meant.
I thought of Keynesian misunderstandings a few days ago when explaining to a reporter the many, many flaws of the FairTax. It's a terrible idea, but the reporter volunteered a critique not on my list: The tax would discourage spending. "The economy runs on consumption," he opined, no doubt thinking that I'd applaud his economic acumen.
I'd heard reporters and others make this claim before, and I recalled President Bush entreating the nation to visit Disney World as our first response to terrorism. Clearly, the public, our political leaders, and at least some members of the press have decided that spending is a civic virtue.
That is a dangerously misguided view of macroeconomics. Sure, a sudden drop in spending could bring on a recession, and more spending (and investment) is the tried and true Keynesian cure for a downturn. But during ordinary times, inadequate consumption is not a problem we have to worry about. Instead, too little saving is the real threat.
Experts debate how to measure personal saving, but by any reckoning it has been trending south for a long time. By some measures, it is now close to zero. Lower interest rates and the rapid rise in stock market prices in the 1990s followed by soaring house prices this decade likely contributed to the decline in savings. But part of the problem may be that we have gone from believing that thrift is a virtue—a lesson learned hard during the depression—to thinking that it is a vice. It reminds me a bit of parents entreating their kids to clean their plates "because children are starving in Africa," as if somehow malnutrition half a world away could be alleviated by American children's obesity.
Spending beyond our means—both privately and publicly (through deficits)—is a big problem. To start, when we spend more than we produce the difference has to be made up by imports. There's a direct connection between our spendthrift ways and our massive trade deficits and the shrinking dollar.
Second, at the household level, people need to save to buffer themselves against financial shocks—an unexpected layoff or medical expense, for instance—and to finance retirement. The baby boomers should have been saving like crazy during their peak earning years instead of spending like there's no tomorrow.
Third, baby boomers' retirement and the continuing rise in medical costs will impose unprecedented demands on the government. Our best option would be to put entitlement programs—Social Security, Medicare, and Medicaid—on a secure financial footing. But there's no sign of that happening any time soon. Next best would be to leave our children and grandchildren enough financial resources to cover the hefty taxes needed to pay for the promises we've made to ourselves.
Bottom line: that reporter misread Keynes. Saving is still a virtue.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.