Monday, April 6, 2009

Coming soon: Higher taxes, bigger government

We've all hunkered down for a pretty lousy year. Maybe 2010 will bring some good economic news, though I don't know anybody who is actually willing to bet on that.

Still, sooner or later - please, please let it be sooner - things are going to get back to something we can call "normal." But what will the next normal look like?

It's hard to picture because we haven't had anything like a normal economy for a very long time. It's spooky: I'm in my late thirties, and I've just realized that almost my entire working life has been spent inside one asset bubble or another (first stocks, then homes).

A generation of Americans grew into middle age thinking that they had more wealth than they really did and that their future was a lot more secure than it really was. This age of fantasy economics changed not just the way we thought about spending and borrowing (leading us to do too much of both) but also the way we thought about politics.

Social safety nets didn't seem so important when even families with modest incomes could get 10% to 20% annual gains on their houses.

Colin Crouch, a professor of governance at the University of Warwick in Britain, has coined a useful name for this situation: privatized Keynesianism.

The economist John Maynard Keynes has been in the news a lot lately. During the Depression his great insight was that government could take on budget deficits to pull the economy back up. The U.S. and parts of Europe embraced Keynesianism for a time as a way of ensuring popular support for a mostly market economy. But under an accidental system of privatized Keynesianism, says Crouch, many rich countries leaned heavily on the deficit spending - that is, the chronic debt - of ordinary families.

Coming into this financial crisis, about 70% of U.S. gross domestic product came from consumer spending, boosted by easy mortgages and unsecured credit card borrowing. The nation wouldn't have recovered from the 2001 recession so quickly without all those loans.

Some optimistic pundits even saw this borrowing spree as a workable solution to the new stresses that were showing up in the economic statistics, such as rising inequality and increasingly unstable middle-class incomes. If you lost your job or didn't get a raise, you could borrow to smooth things over until better times.

It seems unlikely we'll revert to that behavior anytime soon. So one prediction I'll make about the next normal is that voters will look to government to help them manage risk.

That means President Obama might actually push through the national health-care system he campaigned on (although a change that big is still a tough political battle). A safer bet: Social Security will be one of your most solid assets. Whatever the system's internal financing problems, keeping it going is mostly a matter of political will. And with 401(k) balances deep in the tank, the political demand for Social Security is only going to go up. Talk of big benefit cuts will fade. In fact, I suspect benefits may actually increase for those seniors living closest to the bone.

It follows that life in the next normal will carry a higher tax bill - maybe not in the next couple of years, but soon enough. Whether you look at top marginal rates or the effective burden on families, taxes have been at a historically low ebb in recent years. Given the deficits we faced even before the crisis, they were already bound to go up. It's just more obvious now.

You can prepare a bit for higher taxes (for example, by saving in a Roth IRA, which allows tax-free withdrawals in retirement). But should you be upset about it? If we could also get a more reality-based economy in the bargain, it seems to me a fair price to pay.

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