One interesting part of the discussion was about the long-term fiscal outlook in America. He lays out the possible solutions to the huge problem of the impending explosion in federal entitlement obligations brought on by retiring baby-boomers (Social Security, Medicare, etc.). Here is his prediction of which option will prevail:
Mankiw: Our children will pay vastly higher taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. rates than we currently face. The alternative is to reduce spending, but the spending cuts that are necessary to maintain our current levels of taxation are politically untenable. If I had my druthers, I would raise the eligibility age for Social Security and Medicare, but that is a political non-starter.
It comes down to the classic economic question: what is the right trade-off between equality and efficiency? The more robust the social safety net that you have, the higher the taxes to pay for it. We are moving in the direction of a more robust safety net — that is what the health care bill is about. We are going to look more like Western Europe. Higher taxes blunt economic incentive and adversely affect economic growth, however. As a result, our kids will face less incentive to work than we have.
Interviewer: What does that mean for US competitiveness?
Mankiw: It will slow GDP growth. That’s not necessarily the end of the world. Facing higher tax rates, Europeans have developed a culture that is more leisure-based than ours; work doesn’t pay as well at the margin as it does here. But that is hardly a catastrophe. You don’t look around Paris and think, “Oh, these poor people,” but they are less well off than Bostonians.
For more on the effects of high marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. s on the labor supply in Europe, see Edward Prescott’s 2003 paper “Why Do Americans Work So Much More Than Europeans?“Share