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OPINION
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April 19, 2012, 7:16 p.m. ET
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How the Fed Favors The 1%
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The Fed doesn't expand the money supply by dropping cash from helicopters. It does so through capital transfers to the largest banks.
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By MARK SPITZNAGEL






A major issue in this year's presidential campaign is the growing disparity between rich and poor, the 1% versus the 99%. While the president's solutions differ from those of his likely Republican opponent, they both ignore a principal source of this growing disparity.



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The source is not runaway entrepreneurial capitalism, which rewards those who best serve the consumer in product and price. (Would we really want it any other way?) There is another force that has turned a natural divide into a chasm: the Federal Reserve. The relentless expansion of credit by the Fed creates artificial disparities based on political privilege and economic power.



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David Hume, the 18th-century Scottish philosopher, pointed out that when money is inserted into the economy (from a government printing press or, as in Hume's time, the importation of gold and silver), it is not distributed evenly but "confined to the coffers of a few persons, who immediately seek to employ it to advantage."



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In the 20th century, the economists of the Austrian school built upon this fact as their central monetary tenet. Ludwig von Mises and his students demonstrated how an increase in money supply is beneficial to those who get it first and is detrimental to those who get it last. Monetary inflation is a process, not a static effect. To think of it only in terms of aggregate price levels (which is all Fed Chairman Ben Bernanke seems capable of) is to ignore this pernicious process and the imbalance and economic dislocation that it creates.


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spitznagel
Bloomberg
Fed Chairman Ben Bernanke



As Mises protégé Murray Rothbard explained, monetary inflation is akin to counterfeiting, which necessitates that some benefit and others don't. After all, if everyone counterfeited in proportion to their wealth, there would be no real economic benefit to anyone. Similarly, the expansion of credit is uneven in the economy, which results in wealth redistribution. To borrow a visual from another Mises student, Friedrich von Hayek, the Fed's money creation does not flow evenly like water into a tank, but rather oozes like honey into a saucer, dolloping one area first and only then very slowly dribbling to the rest.



The Fed doesn't expand the money supply by uniformly dropping cash from helicopters over the hapless masses. Rather, it directs capital transfers to the largest banks (whether by overpaying them for their financial assets or by lending to them on the cheap), minimizes their borrowing costs, and lowers their reserve requirements. All of these actions result in immediate handouts to the financial elite first, with the hope that they will subsequently unleash this fresh capital onto the unsuspecting markets, raising demand and prices wherever they do.



The Fed, having gone on an unprecedented credit expansion spree, has benefited the recipients who were first in line at the trough: banks (imagine borrowing for free and then buying up assets that you know the Fed is aggressively buying with you) and those favored entities and individuals deemed most creditworthy. Flush with capital, these recipients have proceeded to bid up the prices of assets and resources, while everyone else has watched their purchasing power decline.




At some point, of course, the honey flow stops—but not before much malinvestment. Such malinvestment is precisely what we saw in the historic 1990s equity and subsequent real-estate bubbles (and what we're likely seeing again today in overheated credit and equity markets), culminating in painful liquidation.



The Fed is transferring immense wealth from the middle class to the most affluent, from the least privileged to the most privileged. This coercive redistribution has been a far more egregious source of disparity than the president's presumption of tax unfairness (if there is anything unfair about approximately half of a population paying zero income taxes) or deregulation.



Pitting economic classes against each other is a divisive tactic that benefits no one. Yet if there is any upside, it is perhaps a closer examination of the true causes of the problem. Before we start down the path of arguing about the merits of redistributing wealth to benefit the many, why not first stop redistributing it to the most privileged?



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Mr. Spitznagel is the founder and chief investment officer of the hedge fund Universa Investments L.P., based in Santa Monica, Calif.


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Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

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The world economy

Weather report

The euro crisis casts a chill over a sunnier economic picture

Apr 21st 2012
WASHINGTON, DC

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UNTIL recently, the spring meetings of the International Monetary Fund (IMF) and World Bank, due to be held this weekend in Washington, DC, looked set to coincide with blossoming optimism about the world economy. But the euro crisis is again casting an unseasonal chill.


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Things look brighter than they did even a few months ago. America’s fragile recovery continues. After a disastrous 2011, Japan is on track for 2% growth in 2012, thanks in part to a boost from reconstruction spending. And the European Central Bank’s interventions in the banking system in December and February have pulled the euro area back from the brink. The IMF’s newest World Economic Outlook nudges up expected global growth in 2012 to 3.5%, from 3.3% in January. In September last year, the IMF reckoned there was a 10% chance of global growth dipping below 2% in 2012. Now the chance is just 1%, it says.
Inflationary pressures that buffeted emerging economies have been dampened by the global slowdown from 2011, allowing more room for monetary easing. The Reserve Bank of India surprised markets on April 17th by cutting its benchmark interest rate by 50 basis points, despite an IMF inflation forecast of 8.2% in 2012. And a well-managed slowdown appears to be in progress in China. The fund has raised its forecast of Chinese output growth to 8.2% in 2012.



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How China does is of critical importance to emerging markets. A recent paper by the Inter-American Development Bank, for instance, estimated that the impact of Chinese output variations on Latin American economies has tripled since the mid-1990s, while the effect of American economic wobbles has halved. America nonetheless remains crucial: it is still Latin America’s largest trading partner, and the fund reckons a strengthening US recovery will help growth in Mexico, Central America and the Caribbean to outstrip that in Brazil this year.



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But the sky is anything but clear. Although the IMF reckons the prospects for a broad and destabilising commodity-price spike are falling because a decade of rising food and metals prices has bolstered production, oil remains a dangerous exception (see left-hand chart). Although oil prices eased this week after talks about Iran’s nuclear ambitions, a supply shock which caused oil prices to spike to 50% above the baseline forecast (of about $115 a barrel) could reduce global output over the next two years by 1.25%.
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Inevitably, Europe is the biggest cloud on the horizon. The hopes generated when the ECB provided over €1 trillion ($1.3 trillion) in three-year liquidity to banks have faded. The yield on ten-year Spanish debt is flirting with unsustainable levels once again. Just as the IMF’s wintry January forecasts came too late to take the ECB’s actions into account, the fund’s new numbers may reflect the optimism of March and be too sunny as a result.


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Much depends, of course, on how bad things get. That, in turn, depends on how well Europe uses the time bought by the ECB. The IMF sketches out three possibilities. On current policy, euro-area credit is expected to fall by 1.7% by the end of 2013, producing a shallow recession this year and a return to growth in 2013. Given better-than-anticipated progress on strengthening the euro zone’s rescue fund and governance, credit would shrink by just 0.6% in 2012 and the euro area could grow this year.


Alternatively, if recent fiscal agreements unravel, credit could tumble by 4% or more, touching off a deeper euro-zone recession. Recent Spanish difficulties, including slower growth and disappointing progress on fiscal goals, suggest that this ugly scenario is becoming more likely.



The fund reckons that growth in America, Japan and emerging Asia could be reduced by more than a percentage point in 2012 and 2013 if the ugly scenario did indeed occur. If the euro zone implodes, the fallout will settle most heavily on its own backyard.

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Central and eastern Europe are most exposed to euro-zone bank deleveraging, and the huge importance of the euro area in the region’s trade will deal it a further blow (see right-hand chart). Some of the additional money that the IMF is seeking to raise could well end up being directed here. Financial linkages are less important in CIS countries and in the Middle East and north Africa, but a deeper euro-area recession will batter export industries there, too.



The conventional wisdom, nonetheless, is that the world economy could just about cope with stagnation or a shallow recession in Europe. But there is another, stormier possibility: that of renewed market turmoil caused by the risk of sovereign default or a euro-zone break-up. The ECB’s efforts have greatly reduced the possibility of a Lehman-like shock, but policymakers elsewhere still fret about the ability of the Europeans to fend off the direst outcomes, not least because they seem unable to come up with any remedies besides fiscal austerity. The global economy is in bud, but it is far too soon to plan for summer.

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Up and Down Wall Street
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FRIDAY, APRIL 20, 2012
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A New Round of Monetary Easing Ahead?
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By RANDALL W. FORSYTH
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The bulls assume central bankers have their back. But the impact of stimulus may be waning.





Is the world on the cusp of a new round of monetary easing? Not yet, but if the global economies, debt crises or risk markets deteriorate, investors are expecting central banks to pump up their liquidity provisions, again.


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Two of the BRIC nations -- India and Brazil -- cut official interest rates more than expected while China is expected to lower required reserve ratios for banks, which frees up liquidity. Meanwhile, the last member of the quartet, Russia, also could ease policy down the road if its economy cools.



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Elsewhere, Australia could resume lowering rates next month. And Japan has pledged to keep the monetary pedal to the metal in order to weaken the yen and bolster trade. All of which reflect signs of slowing in global trade, which affects these largely export-dependent economies.



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The real focus will be on the two most important central banks, the European Central Bank and the Federal Reserve. While the official line at the ECB and the Fed is that no further stimulus is in prospect beyond what's already been provided, markets are looking for clues for that to change.



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But the salutary effects of the ECB's Long-Term Refinancing Operations appear to be wearing off. While the €1 trillion ($1.31 trillion) of cheap (1% for three years) funding provided to European banks in the first tranches of the operation helped quell the euro zone sovereign-debt crisis -- which was an important element in boosting global risk assets, including U.S. stocks -- the impact of the LTRO has been short-lived.



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The focus has moved to Spain, where 10-year bond yields this week hit 6%, a psychologically important level that led to bailouts for Greece, Ireland and Portugal, according to the just-published May issue of the Bank Credit Analyst. Meantime, losses at Spanish banks have mounted and the stock market has fallen back to financial crisis lows of March 2009.



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Indeed, the LTRO may have worsened the financial situation by inducing peripheral banks to use the cheap loans from the ECB in a carry trade in Spanish securities, a losing position since the rise in yields and consequent fall in bond prices, BCA adds.



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"Spanish Prime Minister Mariano Rajoy has, of course, dismissed the idea that Spain needs a bailout, confirming Otto von Bismarck's observation that one should never believe anything in politics until it is officially denied," according to the highly regarded research publication.



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An ECB official briefly calmed the markets last week by suggesting the ECB could resume buying sovereign bonds, but BCA sees a problem. After the precedent of the Greek bailout -- in which the ECB's holdings were senior to those of the private sector, which was forced to take a hefty haircut in the bond swap -- private holders of securities that the ECB buys to support the markets would find themselves similarly subordinated. The unintended consequence could be higher financing costs for European governments, BCA concludes.



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In the event of a new crisis, however, the ECB can be expected to throw money at it, along with the other members of the "troika," the European Union and the International Monetary Fund. Ahead of the weekend meeting of the latter, IMF head Christine Lagarde said Europe has sufficient resources to deal with the problem. Left unsaid is that these monetary moves don't address the basic fiscal problem, that the austerity forced on deficit nations exacerbates the debt problem by crushing economic growth.



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As for the U.S. central bank, no action is expected at next week's two-day meeting of the Federal Open Market Committee that concludes Wednesday. But there is apt to be plenty of talk with the release of updated economic projections and a follow-up press conference by Ben Bernanke, the Fed head. Key will be comments about what to do when its maturity-extension program -- the swapping of shorter paper for longer issues -- ends in June.



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Poor employment numbers will revive talk of a third round of outright purchases, or quantitative easing, according to Owen Fitzpatrick, chief equities strategist and head of the U.S. large-cap equity team at DWS Investments unit of Deutsche Bank.



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The potential for QE3 puts "a floor under the U.S. equity market," Fitzpatrick says. It's "an escape clause" for equity investors, who last year got hit by a summer swoon as the economic numbers turned weak and the debt-ceiling fiasco roiled sentiment.



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For better or worse, the bulls assume the central bankers have their back. Perhaps, but the half-life of any effects of any treatment seems to be getting progressively shorter.

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CROSS COUNTRY

Updated April 20, 2012, 7:53 p.m. ET .

A 50-State Tax Lesson for the President
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Over the past decade, states without an income levy have seen much higher growth than the national average. Which state will be next to abolish theirs?
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By ARTHUR LAFFER AND STEPHEN MOORE




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Barack Obama is asking Americans to gamble that the U.S. economy can be taxed into prosperity. That's the message of his campaign for the Buffett Rule, which raises income-tax rates on millionaires to a minimum of 30%, and for the expiration of the Bush tax cuts. He wants to raise the highest income tax rate by 20%, double the rate on capital gains, add a new 3.8% tax on all capital earnings, and nearly triple the dividend tax rate.


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All this will enhance "economic efficiency," insists a White House economic report. As for those who disagree, says President Obama, they're just pushing "the same version of trickle-down economics tried for much of the last century. . . . But prosperity sure didn't trickle down."




.Mr. Obama needs a refresher course on the 1920s, 1960s, 1980s and even the 1990s, when government spending and taxes fell and employment and incomes grew rapidly.



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But if the president wants to see fresher evidence of how taxes matter, he can look to what's happening in the 50 states. In our new report "Rich States, Poor States," prepared for the American Legislative Exchange Council, we compare the economic performance of states with no income tax to that of states with high rates. It's like comparing Hong Kong with Greece or King Kong with fleas.



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Every year for the past 40, the states without income taxes had faster output growth (measured on a decadal basis) than the states with the highest income taxes. In 1980, for example, there were 10 zero-income-tax states. Over the decade leading up to 1980, those states grew 32.3 percentage points faster than the 10 states with the highest tax rates. Job growth was also much higher in the zero-tax states. The states with the nine highest income tax rates had no net job growth at all, and seven of those nine managed to lose jobs.



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Then there's the question of in-migration from state to state—or how people vote with their feet. As common sense would dictate, people try to move from anti-growth states and cities to more welcoming climates. There are relevant factors other than tax policy, of course (as in North Dakota today, where the oil boom has brought about the lowest unemployment rate in the nation), but in general the most popular destination states don't have income taxes. That's as true recently as it was 40 years ago.
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cclaffer
Associated Press
A worker hangs from an oil derrick outside of Williston, N.D., in July.

.Over the past decade, states without an income tax have seen 58% higher population growth than the national average, and more than double the growth of states with the highest income tax rates. Such interstate migration left Texas with four new congressional seats this year and spanked New York and Ohio with a loss of two seats each.






The transfer of economic power and political influence from high-tax states toward low-tax, right-to-work ones is one of America's most momentous demographic changes in decades. Liberal utopias are losing the race for capital. The rich, the middle-class, the ambitious and others are leaving workers' paradises such as Hartford, Buffalo and Providence for Jacksonville, San Antonio and Knoxville.



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Illinois, Oregon and California are state practitioners of Obamanomics. All have passed soak-the-rich laws like the Buffett Rule (plus economically harmful regulations, like California's cap-and-trade scheme), and all face big deficits because their economies continue to sink. Illinois has lost one resident every 10 minutes since hiking tax rates in January. California has 10.9% unemployment, having lost 4.8% of its jobs over the past decade.



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Now these blue states may raise tax rates again. In California, a union-backed ballot initiative would raise the state's highest tax rate to 13.3%. Union-funded groups in Illinois aren't satisfied with last year's income tax rate hike to 5% from 3%, so they now want to go as high as 11%. That would put them in the big leagues with California and New York. And in Oregon, lawmakers are considering raising the highest rate to 13% from 9.9%. In all of these states, proponents parrot Mr. Obama, insisting that the rich can afford it.


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They can, but they can also afford to save hundreds of thousands or more each year by getting out of Dodge. Every time California, Illinois or New York raises taxes on millionaires, Florida, Texas and Tennessee see an influx of rich people who buy homes, start businesses and shop in the local economy.



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Republican governors in Florida, Georgia, Idaho, North Dakota, South Carolina, Ohio, Tennessee, Wisconsin and even Michigan and New Jersey are cutting taxes to lure new businesses and jobs.



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Asked why he wants to reduce the cost of doing business in Wisconsin, Gov. Scott Walker replies: "I've never seen a store get more customers by raising its prices, but I've seen customers knock down the doors when they cut prices."




Georgia, Kansas, Missouri and Oklahoma are now racing to become America's 10th state without an income tax. All of them want what Texas has (almost half of all net new jobs in America over the last decade, for one thing).




Taxes aren't all that matters, to be sure, and low-tax states don't always outperform high-tax ones. Often people who smoke don't get cancer, and sometimes people who don't smoke do get cancer, but that doesn't mean it's smart to smoke. It's a dangerous gamble to raise taxes on capital and businesses to nearly the highest rates in the world and hope that nothing bad will happen.




Mr. Laffer is president of Laffer Associates. Mr. Moore is a member of the Journal's editorial board.



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Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

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That Old Tax Magic

Simon Johnson


20 April 2012

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WASHINGTON, DCTax time in the United States – the dreaded mid-April deadline for filing annual income-tax forms – has come and gone. The system, Americans have been reminded, has become painfully complex, with many a loophole through which one might try to squeeze. The fear of an audit by the Internal Revenue Service lurks in homes across the country.


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At such a sensitive time, it is no surprise to hear politicians pitching the idea of “tax reform” – suggesting that they can simplify the system, close loopholes, and use the proceeds to reduce tax rates. The allure of such appeals is that a crackdown on others’ tax avoidance will mean that you personally will pay less in taxes.


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In the policy jargon increasingly heard in today’s political discourse, tax reform will be “revenue neutral” – meaning that it will not worsen the budget deficit or drive up the national debt. The broader subliminal message is that you can have whatever you currently expect in terms of government services for less than it costs you now.

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The problem with this vision of tax reform is that it is magical – an attractive illusion with no basis in reality. Consider the recent pronouncements of Mitt Romneynow the presumptive Republican candidate to challenge President Barack Obama in November. Romney wants to cut tax rates, mainly benefiting those at the upper end of the income distribution. He also wants to close loopholes, but none of the details that he has offered add up to much. His boldest proposaleliminating deductions for interest paid on mortgages on second homes – is trivial in terms of generating revenue.


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Obama is only slightly better. While he talks less about “tax reform,” he is currently communicating the message that merely raising taxes on rich people – the infamous 1% – will bring the budget and national debt under control. That, too, is a pipedream.


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Americans – and taxpayers in many other countriesneed a more transparent approach to assessing candidates’ budget proposals. In the US, there are groups that offer their own assessments. For example, the Committee for a Responsible Federal Budget performed an admirable service in “scoring” the fiscal plans of rival candidates for the Republican nomination.


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The problem is that in an election with high stakes and deep polarization, who, exactly, can voters trust? Everyone has an agenda, perceived or real. The veracity of any organization that is funded by particular individuals, or through less transparent corporate channels, will be called into question.


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What the US and many other countries need is an independent, competent, and experienced body that leans neither right nor left. Fortunately, the US has the Congressional Budget Office, which scores legislation in terms of its budgetary impact, assesses official budget proposals, and formulates its own economic projections. (I serve on the CBO’s Panel of Economic Advisers, which comments on the draft forecast twice a year, but does not assess budget proposals or anything else.)


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Because the CBO reports to the relevant congressional committees – those dealing with tax and budgets – both Republicans and Democrats watch its every move. But the CBO, created in the 1970’s precisely to bring greater transparency and accountability to the rather byzantine congressional budget process, really is independent and run by professionals.


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The CBO does not, however, score proposals by political candidates, and that is part of the problem. In the run-up to the pre-election debates between Obama and Romney, both sides should agree to submit detailed budget proposals in the correct format for CBO assessment. The relevant congressional committees also should agree to this exercise.


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If one presidential candidate refuses to cooperate in this manner, that should confer an advantage on the candidate who is willing to disclose more fully the specifics of his plan. And, to make this pressure to disclose meaningful, part of one debate should focus on budget proposals, with the questions being structured around how the CBO has reacted to specifics. If either candidate does not want to bring the national debt under control, he should be pressed to explain why.


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This is not a matter only for the world’s largest economies. Candidates to lead their countries should not be allowed to get away with speaking in generalities or engaging in vague rhetorical flourishes. Democracy can and should be better than that.

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Simon Johnson, a former chief economist of the IMF, is co-founder of a leading economics blog, http://BaselineScenario.com, a professor at MIT Sloan, a senior fellow at the Peterson Institute for International Economics, and co-author, with James Kwak, of White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.


. Copyright Project Syndicate - www.project-syndicate.org