The American economy: Soak the boomers to save capitalism

"The reason we're having this argument over socialism and capitalism," Pete Buttigieg explained recently, "is that capitalism has let a lot of people down." Buttigieg, one of the Democrats' many candidates for president, is not wrong — but this isn't class warfare so much as intergenerational warfare. As such, there may be a way to resolve it without the economic destructiveness that often accompanies class conflict.

Some history can help explain where the tension is coming from. Well-educated, affluent baby boomers have done exceptionally well over the last 60 years. Yes, that's due partly to prudence and hard work, but it's also the result of luck. Over the last half century, the U.S. and global economies have undergone profound changes that have redounded to their benefit.

The first boomers were the most fortunate. They graduated from high school and college into the strongest labor market on record and an economy whose productivity was soaring due in part to a massive public investment in technology. In 1966, the federal government spent 0.7% of U.S. GDP on NASA — a level of spending that Medicare wouldn't reach for another decade, and Medicaid wouldn't see until the 1990s.

That cohort began taking out its mortgages a few years later. The principal on those loans was subsequently devoured by the inflation of the late 1970s and early 1980s, resulting in enormous gains for boomer homeowners. By the mid-1980s, just as the first boomers were entering their peak earning years and beginning to save for retirement, the Fed was embarked on a project of ratcheting inflation ever lower. This process would weaken the job market for new workers but set the stage for a series of asset price explosions, first in stocks and bonds and later in housing.

The rise of the global economy accelerated the trend. The fall of the communist bloc in the 1990s and the opening of China in the 2000s added hundreds of millions of workers to world markets, bringing cheaper consumer goods for those with money and more difficulty finding well-paying jobs for those just entering the labor market.

It's no accident, then, that many younger Americans take a dim view of capitalism. They were surrounded by great wealth, but they had limited access to well-paying jobs and faced ever-higher housing prices. Many middle-aged Americans probably aren't so sure about capitalism, either: They may have had a brief taste of prosperity in the 1990s — yet not nearly enough to set themselves up for retirement or prepare them for the choppy labor market and wage stagnation of the last 20 years.

The question, then, is not the existence of these different perceptions, or of the intergenerational imbalance, but what to do about it. If the baby boomers continue to ignore it, the most socialist visions of the far left will continue to grow in popularity. The result won't just be an expansion in government spending, but an intense effort to redistribute (or even destroy) accumulated wealth.

Rhetorically, that effort will be focused on the 1%. But it will soon become apparent that soaking the 1% is not enough.

Instead, the U.S. government should cut taxes on workers and replace them with taxes that target the lifestyles of the more fortunate. A straightforward way of doing this would be to cut or even eliminate payroll taxes and slowly replace them with a value-added tax, or VAT. Payroll taxes are the most significant taxes that young and lower-income people pay. Reducing or eliminating them would significantly raise the incomes of working people and encourage businesses to hire workers with less experience.

A VAT is a tax on the consumption of goods and services, and thus falls more heavily on those who spend a lot. The tax does raise the cost of living for those on Social Security, and that would have to be addressed. But it is also more progressive than a state and local sales tax.

There are other ways the government might change the tax code to help tamp down generational resentment. Eliminating the mortgage interest deduction, for example, would help deflate the artificial rise in home prices. The caps on mortgage interest and state and local tax deductions, which went into effect as part of the 2017 tax cut bill, already seem to be bringing down home prices in some expensive parts of the country.

Many of these changes would be unpleasant, to put it mildly, for affluent boomers living off their gains from their investments in the market and real estate. They might want to ask themselves, however, which is more painful: giving up some of their wealth — or ignoring the plight of the millennial generation and fomenting revolutionary change?

Karl W. Smith is a former assistant professor of economics at the University of North Carolina's school of government and founder of the blog Modeled Behavior. He wrote this article for Bloomberg News.