Ludicrous Proposal by Harvard Economics Professor to Force Taxpayers to Buy Spanish Bonds; Mish's Five-Point Alternative Proposal

As the economic crisis lingers on, the number of ludicrous proposals to deal with the crisis rises every month.

I have lost count by now of preposterous ideas and who made them (does anyone have the complete list?), but a proposal by Harvard Economics professor Martin Feldstein to force taxpayers to buy Spanish bonds surely makes the list of top-five ludicrous proposals.

Martin Feldstein, writing for the Financial Times says Taxpayers must backstop Spain�s budget

Spain is rapidly approaching a liquidity impasse. Markets are nervous because it�s not clear how the government will finance its budget deficit and the rollover of its maturing bonds. To meet its financing needs, the Spanish government needs the confidence of foreign and domestic investors.

Building investor confidence during this process requires a plan to avoid a Greek-style default.

One part of such a plan is to negotiate access to the European Stability Mechanism, the �700bn fund created to protect member governments from default. But if the refinancing shortfall from private sources is very large, Spain will need to supplement the funds from the ESM.

Raising those additional funds by increasing taxes would push the Spanish economy into a deeper recession and would weaken the supply-side incentives needed to stimulate long-term growth.

An alternative emergency approach would be to mandate, on a temporary basis, bond purchases by Spanish households and businesses. Here�s how such a plan might be implemented.

The Spanish government could use the income tax system to levy a temporary �lending surcharge� on individual incomes. In exchange for those surcharge payments, the households would receive an interest-bearing government bond with a maturity of five to 10 years. A similar surcharge could be levied on businesses based on corporate profits or the businesses� value added.

The Spanish government should therefore move quickly to enact such a plan before it is overcome by its current liquidity problems.

Earth to Feldstein

For starters, Martin Feldstein correctly points out that "increasing taxes would push the Spanish economy into a deeper recession".

Unfortunately, Feldstein then left planet Earth with his proposal for "Spain use the income tax system to levy a temporary lending surcharge on individual incomes", as if that would not have precisely the same effect as a tax.

Highway Robbery

Feldstein's proposal would take money out of taxpayers' pockets to feed government programs just as a tax would, yet amusingly he warns against weakening "supply-side incentives needed to stimulate long-term growth".

Feldstein proposes giving taxpayers interest on their forced loans to the government. Let's assume 4%. Under Feldstein's proposal (highway robbery is a more apt description than a tax), taxpayers would have access to at most 4% of their money deposited into the scheme.

Somehow "using the income tax system" to take money away from consumers (with a promise to pay it back later) will not cause a drop in consumption, but a tax would. With that idea, Feldstein left planet Earth for some unknown, academic wonderland, alternate universe.

Unfit to Teach

Precisely why should taxpayers bail out banks that made stupid loans? Feldstein never bothers to say.

Are bondholders never, ever to take a loss?

Feldstein's proposal is so preposterous and so devoid of rudimentary thinking about taxes (by whatever name) that it should be clear that he is unfit to teach.


Mish's Five-Point Alternative Proposal

1. Spain should plead for emergency funds from the ECB, IMF, EMU, wherever it can get them.
2. Spain should declare a bank holiday and announce a return to the Spanish Peseta
3. Spain should issue a statement to the ECB, IMF, EMU to the effect "anyone stupid enough to lend us money deserves to lose it at least two-thirds of it. All debts in Euros will be repaid 1-1 in Pesetas."
4. Spain should then devalue the Peseta by 65%. Should Europe, the IMF, and EMU threaten sanctions, Spain would counter with a threat of 100% default on all external debt rather than 65% of it.
5. Spain should lower the VAT, lower corporate income taxes, and make it easier to hire and fire workers.

Point number one is a bit tongue-in-cheek as it is tantamount to purposeful fraud. However, the rest of the points can easily stand on their own merits.

In regards to point number three, Spain can be much more diplomatic in its statement to the ECB, IMF, and EMU, but the bottom line would be the same regardless of how Spain phrases the statement.

Results

• Spain would immediately be relieved of 65% of its foreign debt obligations. 
• The threat to not pay back any of its external debt if Europe of the IMF retaliates (perhaps coupled with a promise to pay back another 15% if everyone plays exceptionally nice) would prevent retaliation.
• A lower VAT and lower corporate income taxes would encourage growth
• At a huge discount to the Euro, Spain would become a tourist mecca
• Spain's products would be far more competitive on the global economy

Effectively, I propose Spain do what Iceland did. The Icelandic economy is in recovery now, while Greece, Spain, Portugal, and Italy flounder.

In contrast, Feldstein proposes more bailouts of banks by taxpayers, while playing preposterous word games with the definition of  "tax".

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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