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Facing Up to the Economy's Problems

How everyday citizens still hold the key to the country's economic future.

Peng Chen, 05/04/2010

Charles Wheelan, Ph.D., is a senior public policy lecturer at the University of Chicago and the author of Naked Economics: Undressing the Dismal Science (W.W. Norton & Co., 2002). He gave the keynote address March 4 at the Morningstar Ibbotson Conference. Peng Chen, the president of Ibbotson, sat down with Wheelan after his speech to discuss whether the government (and we citizens) is up to the challenge of solving the problems that confront the U.S. economy.

Peng Chen: With the large deficits on our government's balance sheet, it seems inevitable that taxes will have to be raised at some point. In fact, there are tax proposals already on the table to help pay down the deficit. What is your view on these proposals? What's the most likely outcome?

Charles Wheelan: The scariest outcome is doing nothing. It's a simple equation. You've got spending, and you've got taxing, and they need to balance. We are locked in this ideological battle over whether we want a smaller government or a bigger government, and we've compromised by having small revenues and big spending, which is not a compromise that works. At the same time, as much as we talk about spending, we seem unwilling to cut much there. If you look at where we spend money, which is entitlement programs, defense, and interest, there are not a whole lot of options. We can't cut our interest payments. We've got two wars going on. And people seem unwilling to reduce health-care spending and to raise the retirement age.

So I suspect we're going to have to do something on the tax side. If I were a betting man, I'd say that five or 10 years from now, tax rates are going to be higher than they are now. As an economist, my admonition is that we need to pay a lot more attention to the kinds of taxes that we're imposing, and a lot less attention to what's the total amount that's coming out of your pocketbook. The most important thing to think about is that taxes raise revenue, and they change behavior. If we have to raise revenue, or even change the composition of our current revenue, I would strongly favor moving toward taxes that discourage activities that we don't think are socially beneficial. We do it with smoking. I would like to see it at the global scale; tax things like carbon that have an adverse environmental impact. Therefore, we would not have to raise taxes on capital investment, on labor, on other kinds of things that actually have positive spillovers.

PC: Things to encourage economic growth.

CW: Absolutely. I'd like to see this discussion focus more on specific spending cuts, which I think we're going to have to do, and more on the kinds of taxes that would not only have the least negative impact on the economy, but would also be positive in the long run.

PC: From an investing perspective, then, financial advisors and individual investors should look at ways to position their portfolios to be even more tax-efficient, on both the equity side and the bond side.

CW: Yes, you probably should expect that you're going to have higher taxes down the road. And I'm not sure you should count on policymakers doing what I think is a good idea, which is taxing things like carbon and so on, which would not have a terribly pernicious effect on your portfolio. They will go back to the standard taxes that we use, which are income, sales, property, and so on, none of which are particularly good taxes in terms of behavioral outcomes. Grading the Bailout

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