The Legacy of Milton and Rose Friedman’s Free to Choose
Economic Liberalism at the Turn of the 21st Century
October 23–24, 2003
A Conference Hosted by the Federal Reserve Bank of Dallas

Session 3 Q&A

Q: Let’s start with a question for Bill Niskanen, and I have them arranged in a particular order here. Let me ask Bill a couple questions, and then I’ll go to Tom, and then we can go back and forth. For Bill Niskanen, what do you estimate was the economic burden of taxation prior to the Regan revolution?

A: [William Niskanen] I haven’t made the estimate, but it must have been huge because the top marginal federal rate was 70 percent. Now, the average rate was not that much different from what it is now. In other words, the relative size of the federal government in the United States has been remarkably constant now for 40 years. So the average rate was about the same, but the top marginal rate was much higher. I have not made the calculation. The burden must have been much higher.

Q: The second question I have is two different ones, but they look like variations on the same theme, so let me read them both and let you put them together as you see fit. Is the burden of deficit financing more or less than the burden of taxation? And a variation on that, is the marginal burden of selling bonds to the public, or creating base money, as high or higher than the marginal burden of taxation?

A: [Niskanen] The issue with respect to borrowing is mostly a matter of intergenerational equity. I think most economists have paid far too much attention to the presumed short-term economic effects of government borrowing. We should have learned a long time ago that at least in the developed countries there’s no significant relationship between government deficits and inflation, or between government deficits and interest rates. The only short-term effect that seems to be at all noticeable is the relationship between government borrowing and the current account deficit, with the world financing a good bit of our government deficit these days. So the issue is basically whether we should bear the economic burden of taxation or our children should. And that is an issue that has to be decided on other criteria. I would have no hesitation in borrowing almost any amount of money to, say, win World War II. And I think borrowing to win the Cold War was also very important. It’s the use of the money that is critical because if you are doing something that is going to be of terribly great value to your children and to their children, then I see no particular intergenerational equity issue from borrowing. I do not think that is now the case. I can’t think of very many federal programs that have substantial downstream benefits to my children, but we’re putting about a sixth of federal spending on a credit card and giving them the bill. So I think we need to back away from, I think, generally mistaken views about the short-term economic costs of borrowing. The issue is whether we should pay for those programs or our children should pay for them. Sooner or later somebody is going to bear the economic burden of the total size of government. If the progressivity of the tax system goes up in the meantime, it would be more expensive for our children to pay that debt than it would be for us to pay it. So again this is mostly a question, I think, of intergenerational equity and not one of straightforward economics.

Q: For Tom Saving, let me ask the short question first. Can we sustain Samuelson’s Ponzi scheme through increased immigration?

A: [Tom Saving] Well, I would say there are two things. It’s interesting that you should ask that because every time we have a trustees meeting, one of the things embodied in our estimates are assumptions about immigration. Now, the one thing we know about the world is that the developed world has fertility rates that are well below population sustaining rates on the whole. That means that every one of those countries is going to need immigrants, and the competition for immigrants is going to result in the increased price of immigrants. The price of immigrants is going to rise. I keep telling our guys we can’t have this sanguine approach that we are going to have this constant flow of immigrants, when every other country in the world is trying to get them from us. And we are all competing for the same group of immigrants. And the other thing that is happening is that of course because these countries are going to have capital in excess of the amount of labor they have, they’re going to be exporting capital, and they are doing that. The Japanese are exporting huge amounts of capital to China. What that’s doing is, again, reducing the supply of immigrants. So it’s just not going to happen. There aren’t going to be enough immigrants. The world’s population may be at constant levels by 2050 or so; it’s not going to happen.

Q: Okay, next question for Tom. It appears that productivity growth may be on a higher long-term trend path and is built into current Social Security forecasts. How does this affect the problem?

A: [Saving] Well, it affects it in a minimal way because the program is a replacement rate program, and that’s what you have to keep remembering. You can’t grow your way out of the problem because the benefits grow with growth. So, the only benefit you might get would come from one thing, if once you become a recipient, we only let your benefits grow with the price index and not with the wage index. Even well-known economists might say, let’s grow our way out of it, but they don’t recognize it as a replacement rate program. If it were a fixed benefit program, we could grow our way out of it.

Q: Okay, another productivity related question, but this one for Bill. Over the last eight years the U.S. economy has enjoyed rapidly growing private sector productivity. Does this tell us anything about the changing size and role of government?

A: [Niskanen] Well, I think that it was in some sense an accident because about 1974 we had the first microprocessor and most of the increase in productivity has been directly or derivative of the information technology revolution. Now the surprising and pleasing thing about that is that it apparently was not a spike. It spread throughout the economy and it looks like it’s going to last for awhile. Until a few years ago, there was a big debate in the economics profession, between Bob Gordon on one side and Dale Jorgenson on the other, about whether this productivity spurt starting in 1996 was a spike or a long-term phenomenon. And I think that Dale has won that argument. The most interesting thing about that is that productivity growth stayed high during the recent recession. Typically productivity growth falls during a recession because employers are slower to lay off labor than the fall of demand, but productivity growth stayed quite high during this last recession. I don’t think it was in any meaningful way a consequence of what the government did, other than the fact that it had always been involved in encouraging high tech through both the spending and tax side.

Q: Okay, next question for Tom. I am debating on whether I ought to paraphrase it or leave the provocative wording in it. I think I will leave the provocative wording in it. What are the limits or restrictions that should be put on private accounts? Can worker X put all their money in the next Enron? Do you think Joe and Jane Average will invest wisely since many clever, educated workers did not? In other words, if we give them the freedom of private accounts, do we want to limit the freedom of how it’s invested. Should government play a role in that?

A: [Saving] Well, I would want to say a couple of things. One of them is, if we were to have a system in which we gave you control and you promised us you would never ask us for anything no matter how bad things went for you, then I’d say you’re on your own. You can buy the lottery tickets if you want to. But that’s not the world we’re in. If we let you buy lottery tickets with all the money you were going to put in, you’re either going to retire really rich or the rest of us are going to support you when you retire. So I think that you’d want to take care of this risk issue. You would have to be well invested in broadly based, probably world-type portfolios, because you wouldn’t want to have a lot of country risk and that’s especially true. It’s not so true for us but if you notice the way a lot of the Eastern European countries have done their kind of reforms, they require these investments to be in their own country. If you’re a small country like the Czech Republic, that’s insane. There isn’t enough there for you to invest in. Chile had exactly the same kind of thing when they first started. They were very lucky in that they had a terrible economic system, but they freed everything up, and they had this huge growth and that rescued them. They were issuing these recognition bonds and other things they could never have paid off. They were able to pay them all off as it turned out because of the huge growth they had. But otherwise you would not want the country to limit the investments to the country, and that’s another reason why you can’t let the government do it. You have to let the individuals, but you have to be broadly based.

A2: [Niskanen] I would modify that only in one respect. I think anybody who has purchased an annuity that is equal to the safety net should be able to put any additional amount in anything he or she wants. The question is, as Tom said, if we are going to provide the safety net anyway, then I think there’s a rationale for limiting the risk of the portfolios they’re allowed to buy. But once individuals can, in effect, beat the safety net themselves, then I think they ought to be able to put their money anywhere they want.

A3: [Saving] That’s consistent with what I said. If you could write a contract that was enforceable, that you wouldn’t ask us for anything, then you can do anything you want to. The enforceable contract is the one that’s the minimum that we’re going to make sure that you would have. Say poverty or something. That’s enforceable, and then we do have an enforceable contract, and then I don’t care what you invest in.

Q: Okay, we are just about out of time. I want to use the last couple of minutes if I can to ask Professor and Mrs. Freidman if they have anything they would like to add on this subject.

A: [Milton Friedman] Well, I find two things here very interesting. One is, Bill comes up with an estimate that 11 percent is the right level of government spending, the optimal level of government spending by a rather mysterious definition of optimal. I’ve been asked over and over in my life, “What do you think is the right level of government spending?” And I’ve said, “I don’t believe that there is any theoretical way of determining that.” But I believe in history. And I know that when Britain was at the height of its power, when Queen Victoria was celebrating her jubilee at the end of the 19th century, government spending in Britain was 10-12 percent of national income. I noticed in the United States when the United State was doing pretty well (before the Great Depression) in the 1920s, government spending in the United States at all levels of government, federal, state and local, was around 10-12 percent of national income. I notice that over the millennia the church has always recommended tithing. So somehow I come up with the idea that 10 percent is about right. And now here is Bill coming along with a very sophisticated mathematical analysis coming up with 11 percent. So you have to believe some things. So far as Social Security is concerned, that’s a subject I have long been interested in, and I think Tom has been doing some remarkable work in that area. I can’t follow it at all. But there’s one point having to do with it that bothers me. This goes beyond Social Security to the security market as a whole. I’ve always been in favor of, on a personal level, indexing. But if you think of indexing and spreading it out it’s bad from the point of view of the market as a whole because every extension of indexing reduces the fraction of the market which is setting the prices on the various securities. If everybody indexed, there would be no market setting of prices at all, there would be nothing. And now, if you have private accounts which are governmentally controlled, the kind that everyone talks about, one of the conditions that everybody says has to be there is that you have to invest in a broad range of assets. And essentially what’s going to be required is that private owners of Social Security should have to essentially index their assets. And so you’re increasing the total fraction of the market which is indexed. The question and issue is, how large can indexing be before it really seriously interferes with the efficiency of relative pricing of equity. I don’t have any answer to it, don’t misunderstand me, but that’s another question for you to contemplate.

A: [Saving] Well, it’s a question that we have attempted to contemplate because the social security systems around the world, if we’re really going to privatize them. In effect, in countries that don’t have social security systems, there are private systems and individuals are on their own, in effect. But you’re right. We discussed this a lot because this is a huge number, even compared to the size of markets, and they get much, much bigger. And I think you’re absolutely right that if you attempted to index everything, you might get to the point of having the same proportion of shares of every company. There are no relative prices going on there, and I think that’s a serious issue.

A: [Milton] It is an enormous number. I once wrote that the socialists were very stupid not to press the United States for full funding of Social Security, with government handling the funding, because within not too long of time government would own the whole of the industry.

[Saving] What my estimates say in the beginning of this paper were that if you had Medicare and Social Security, if we let things go on the way they are, the share of money that would pass through government in the United States is going to get to 37 percent. It’s going to double from 18 to 37 percent to the federal government. And that’s in just something like 35 years. And that’s like a war-time change, and we’re a small player because Europe is a much bigger problem. They have a bigger problem than we do, and they already have a huge share of government to start with.

[Niskanen] Let me make a prediction about social security. The problem will be resolved primarily by the government breaking its promises. The government will not increase taxes sufficiently to meet these promises. And I think that we shouldn’t be indifferent to the way the government breaks the promises. One way is to increase the age before retirement, which I think is wholly appropriate. Another is to change the indexing formula for future benefits from wages to prices basically. That will maintain the same real benefits but reduce the replacement ratio. I proposed just those things in 1981 to try to counter David Stockman’s proposal, but David wanted big budget savings right away, and so David won out on that issue. What we had proposed at the time was to increase the age for full retirement by one month a year or one year every 12 years and to start indexing future benefits to prices. That does break the existing promise, but it does so in a very gradual way. It does not reduce benefits in real terms to anybody and I think ultimately that’s going to be the way the government handles most of this.

Okay, we are out of time. Please join me in thanking our speakers and Milton and Rose.