Greg Mankiw’s Prediction for America

February 25, 2010

Harvard economist Greg Mankiw has an interesting interview on the economic outlook for the U.S. He covers a variety of topics and the whole piece is worth a read.

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 tax 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 rates on the labor supply in Europe, see Edward Prescott’s 2003 paper “Why Do Americans Work So Much More Than Europeans?


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