A Modest Proposal

By ANDREW TOBIAS Financial writer Andrew Tobias is the author of nine books, including The Only Investment Guide You''ll Ever Need, and a best-selling personal-computer program, Managing Your Money.

O.K., he's President. Read my lips: he ought to raise taxes. But not much! What's called for is not something so dramatic as to throw the economy into recession. That's the last way to lower the deficit. What's called for is a tax hike that would raise some money (I'll get specific in a minute) and that would lower interest rates by showing the financial markets we have the will to attack the deficit (but the wisdom not to shoot ourselves in the head by attacking it too hard). Lower interest rates would cut the deficit still further.

These two bites -- $40 billion or so from a tax hike and perhaps an additional $10 billion or $20 billion from lower interest rates -- would not wipe out the deficit. But we don't need to wipe out the deficit. At least not by raising taxes. And certainly not by legislating a balanced-budget amendment. And especially not by cutting investment in our future.

The way to wipe out the deficit is to grow our way out of it. Hold the line on Government spending while the economy grows and gradually throws off more tax revenue. Money for new programs should come from trimming waste from old ones.

While cutting the deficit to zero is something to shoot for, it's not critical. Growing families or businesses or nations have a legitimate need to borrow if they're investing in the future. It makes sense to borrow for education, research, equipment and infrastructure that will make us more productive. We would be insane to stint in these areas. Is NASA a place to cut back? Hardly. NASA and high-tech programs like it are engines of our economic future. If we lose our technological edge, we've lost our economic future.

THE 7% SOLUTION

Say we had real growth of 3.5% a year and inflation of a further 3.5% (just suppose). That would mean an economy growing at 7% a year -- half real, half inflation. What would that mean for the $2.5 trillion national debt?

It would mean the debt could also grow 7% a year without getting any bigger relative to the economy as a whole. Both would be growing at 7%, just as with a family whose income goes up a bit each year and therefore feels it can afford to take on a little more debt. Except that in the case of the U.S. economy, still the largest in the world, taking on an extra 7% in debt amounts to taking on an additional $175 billion.

In short, we could theoretically run $175 billion deficits forever without the national debt, relative to the economy as a whole, getting any bigger.

Should we settle for that? No. As everyone now seems to recognize, we're dangerously deep in hock. The $2.5 trillion national debt amounts to 50% of our $5 trillion gross national product. There have been times in our history when that percentage was much higher and we did just fine growing our way out of the problem -- World War II sent the ratio of debt up to 127% of GNP -- so don't believe the people who tell you we're doomed. But we're nonetheless well into the discomfort zone. We've got to whittle away gradually at the ratio.

How?

By seeing the debt grow less fast than the economy. Imagine an average annual deficit of $90 billion a year for the next ten years. Sounds horrendous, no? Yet under the scenario above, after ten years of 7% growth in both the economy and the debt, GNP would double from $5 trillion to $10 trillion; the national debt would grow from $2.5 trillion to $3.4 trillion. It would then represent not 50% of our GNP, as it does now, but 34%. After another ten years, under 25%. Of course, the world doesn't work so neatly. For one thing, it runs in cycles, not straight lines. (For another, we'd like inflation to be even less than 3.5% a year. Zero is the goal.) But on average, 7% expansion of the economy, between real growth and inflation, may not be unrealistic at all. With the dollar low, real growth could remain strong, as we're kept busy producing things for the foreigners who increasingly find our wares a bargain. And inflation, regrettably, might even exceed 3.5% (as it has in every year but one of the past 14).

This is not for a moment to say we should shoot for a $90 billion deficit each year. If we do, we'll end up getting $120 billion deficits in good years and $350 billion deficits in recessions. (Yes, someday there will be another recession -- and real soon, if we raise taxes too much or slash Government spending in a misguided attempt to balance the budget abruptly.)

Still, by steadily leaning against the wind, we can gradually shrink the national debt as a proportion of the overall economy.

Leaning against the wind is not dramatic or flashy. It's just sensible, slow-but-steady improvement.

It means restraining spending, on the one hand, and raising taxes a bit, on the other. Restraining spending is the more important of the two, because we are an imaginative people. No matter how much tax we collect, we will always be able to think of ways to spend more. It's the job of our leaders (if you can call members of Congress leaders) to impose the kind of discipline and make the kind of tough choices that any responsible businessperson or head of household would. This is not to say no debt: a medical student can sensibly take on debt for his or her education, a family to buy a home, a business to build a new plant. But it's to say no stupid, self-indulgent debt: debt to buy a $25,000 car or construct posh new offices. Expensive cars are terrific when they're within your means, but not when you have to forgo the IRA contribution or saving for your kids' education. Plush offices are O.K. when they're in scale with a business's size and success, but are not nearly so effective as funds spent on research and development and on the capital equipment needed to make the company more competitive in world markets.

Congress leans against the wind about as firmly as a kite, but at least it recognizes its problem and has passed the Gramm-Rudman-Hollings bill, which prescribes annual cuts in the deficit. It would be unwise to follow those prescribed cuts blindly. But it would be equally unwise and impolitic to stray too far from them. The people want lower deficits.

Which brings us to the other half of the equation.

THE SMART WAY TO RAISE TAXES

This is tricky not just because it's politically unpalatable. Even for a dictator it would be tricky, because raising tax rates does not necessarily raise more revenue. Raise capital-gains rates to 100%, say, and far from raising more tax revenue you would raise virtually no tax revenue: no one would sell anything in which he or she had a profit; he'd just hold on until some sensible politicians came along and lowered the rates.* Impose a tax on securities transactions, and you simply drive the securities business to London and Tokyo. Ultimately, you'd only enrich the British and Japanese. Raise corporate tax rates past a certain point (not to say anyone knows exactly where that point is), and what you gain in revenue now you'd lose later -- by draining from corporations the money they could spend to expand and grow, and by making America a less attractive place for anyone, Americans or foreigners, to invest.

So it's not easy. And the popular thing ("Let's stick it to IBM, they can afford it!") is not always the smart thing (taking money from IBM for Congress to spend presumes Congress can spend it more effectively than IBM). What's needed is tax hikes that, first, would actually raise more revenue, and, second, are so fair and just and sensible they virtually scream to be introduced.

Here are four. They should be enacted as a package. Together they'd raise $40 billion in taxes, cutting the deficit by nearly a third. The lower interest rates that would probably result would cut the deficit still further -- and keep the economy rolling to take some of the sting out of the tax hikes.

First, raise my taxes. Under the current tax law, the top federal income- tax bracket is 28%, but above $43,150 (or $71,900 for joint returns) it effectively rises to 33% for a while and then drops back to 28%. Don't misunderstand. I love paying just 28%. (And at 28%, I pay a heck of a lot more than I ever did when the top rate was higher, because, far from trying anything stupid to shelter my income from taxes, I'm quite happy to send the Government its share.) But keeping the top rate at 33% instead of dropping it back to 28%, it seems to me, would not be perceived by most high earners as terribly unfair or unbearable. It would raise upwards of $5 billion a year.

Second, raise my mother's taxes. My dad paid into Social Security for decades while he was alive, but nowhere near enough, even assuming it had been invested wisely, to throw off the kind of Social Security benefits my mother will receive over her lifetime. (We forget that as recently as 1977 the maximum contribution was only about $1,000 a year. Throughout the 1950s and '60s, it ranged from $45 to $374.) If Social Security were all she had to live on, it would be unthinkable to ask her to take less. But because she has income above $25,000 a year, half her Social Security benefits will be subject to tax. Would it be cruel or unfair, when so many are homeless and when the Government is spending $150 billion more each year than it has, to subject her full benefit to tax? Exposing both halves of the Social Security benefit to taxation for retirees with income over $25,000 (just as we tax 100% of unemployment-insurance benefits and 100% of almost any other kind of income) is rough. But under the circumstances, it's sensible and fair. To a retiree earning $25,000 or $50,000 or $100,000 from investments, the extra tax would sting, but it wouldn't bite. And it too would raise about $5 billion in new revenue. Congressman Claude Pepper and the mighty American Association of Retired Persons should resist the urge to fight this if they really want to do right by their constituents -- and their constituents' grandchildren.

Third, add an extra penny to the cost of each cigarette by way of an increased federal excise tax (currently eight-tenths of a penny). While it's hard not to sympathize with the addicted smoker, the cost of smoking to society, in medical care and lost productivity, far exceeds the current tax on the product. That is, nonsmokers subsidize smokers. With a tax hike -- this one would raise $5 billion -- they'd merely subsidize them less.

Finally, raise the excise tax on gasoline. A 25 cents-per-gal. hike would raise about $25 billion a year -- but would still price our gasoline at well under half what it costs throughout Europe and Japan. When the U.S. was a net oil exporter and the world's dominant economic force, we could afford to be cavalier about cheap gasoline. But we're now in debt up to our eyeballs, and we're back to severe dependence on imported oil.

Where possible, you don't tax the things you want to encourage, like investment and work, which is why we should never let the top tax bracket creep back up past 33% (it was 70% as recently as 1981). But you do tax the things you'd like to discourage, like inefficient energy consumption (and its attendant pollution), reliance on imported oil (which threatens national security and worsens the trade deficit) and tobacco (widely recognized as the nation's leading cause of preventable death).

The $40 billion a year we'd raise from these four tax hikes would not be so large as to stifle economic growth, but it might encourage the world financial markets to lower our interest rates. Between the added tax revenue and lower interest on the national debt, the deficit would be cut more than a third. More to the point, there would be the reasonable prospect that the national debt would grow only about half as fast as GNP. So, gradually, over the next decade we'd find ourselves on ever firmer ground.

For a retired chain smoker driving 1,000 miles a month and earning $100,000 a year from investments plus another $6,000 from Social Security, all four of these tax hikes would hit. Total: an extra $1,800 ($1,300 filing jointly). But look how much better he'd sleep knowing the economy was headed for solid ground, his investments were likely to gain, and his grandkids likely to inherit a prosperous economy rather than decay, debt and decline.

Read my lips, Mr. President: sold right (and that's your job), this would not be an unpopular program.

FOOTNOTE: *This is why lowering the capital-gains rate back to 20%, at least on non-real estate assets, really might raise more revenue and encourage productive investment.