European banks, including those in Germany and other wealthy jurisdictions, hold sizeable amounts of threatened countries’ debt, and U.S. banks hold a lot of European debt too. A banking crisis could easily spread across Europe and then to the United States, much as the recent U.S. mortgage and broader financial crisis spread to Europe.
As the crisis in Greece and other countries worsened, ECB could step up purchases of sovereign debt but that would simply replace Greek and other sovereign debt with billions of new euro in circulation and inflation.
At the end of the day—the combination of existing debt and public expectation for a generous social safety net may compel Germany and other richer countries to choose between Greece and other poorer countries quitting the euro—returning to their own currencies—or a combination of high inflation and greater fiscal union in the EU. Regarding the latter, either the North subsidies the South through ECB printing euro and inflation, or the EU transfers tax revenues from richer to poorer countries.
The Germans rightly fear hyper-inflation, but granting the EU broad taxing authority to finance a pan-EU social safety net is unlikely. Instead, countries like Greece may be forced to leave the euro zone or the euro will disappear all together.
This could take several years to play out, but monetary union is simply not possible without fiscal union.
Lessons for the United States
The U.S. government and many states face similar difficulties but for the fact that the United States prints dollars—the global currency—but that could change.
The budget published by the Obama Administration assumes GDP growth of about 4 percent for 2011 through 2015, even though most private economists believe less is likely.
It contains the politically less difficult fiscal levers—repeal of the Bush tax cuts for families earning over $250,000 and cuts in defense spending—and projected revenues and cost savings from the 2010 health care law, including the new interest and dividend tax.
More realistic assumptions about growth and the cost of health care put U.S. projected deficits on the path to unsustainability—more than $1 trillion a year for many years.
Congressional Republicans are throwing around grand numbers—demanding $2 trillion in spending cuts to approve an increase in the debt ceiling. But how those cuts are to be accomplished remains vague, and those come to only about $200 billion a year. Simply, the GOP plan would just boot the problem past the 2012 elections.
At that point, the United States would almost certainly face a downgrade in its bond rating, higher borrowing costs, forced reductions in spending, and significant new taxes.
The Democrats have the value added tax waiting in the wings. However, in the current environment of fiscal indiscipline, a VAT would be a disaster.
The polemic is appealing. Other industrialized countries have one, now that U.S. social benefits are more like theirs with the passage of national health care, the United States should have one too?
Not so fast.
Europeans pay a VAT and have income and corporate taxes too but they pay little for health care and higher education—the government uses those taxes to pick up the tab.
With a VAT, U.S. businesses and individual taxpayers would have tax burdens comparable to Europeans but would still face hefty bills for private health insurance and college tuition that Europeans do not bear.
The reason is simple. Americans pay 50 percent higher prices for health care services than the Germans and most other Europeans, and U.S. universities are chronically wasteful institutions. And U.S. regulatory costs are higher—witness how Initial Public Offerings are fleeing the United States for Europe and other venues, because of higher costs imposed by the Sarbanes-Oxley accounting law.
Obama Care contains firm commitments about scope of coverage and benefits guaranteed each citizen, but offers only vague commitments to reduce higher U.S. drug, medical professional fees, administrative costs, and malpractice expenses.
U.S. governments, federal and state, pay for about half of U.S. health care expenses, and a VAT would take away the pressure to chisel down higher U.S. costs.
U.S. higher education is another big hole in household and state finances. Americans pay too much for what they get, except perhaps from their most modest institutions—community colleges. Too many young Americans are simply unprepared to compete in the global economy.
A VAT, without offsetting reductions in personal and corporate taxes, will only make Americans poorer and with even fewer incentives to work and innovate than the Europeans, cause businesses to offshore even more jobs and tax economic growth to anemic levels.
Without a VAT and absent real and substantial cost cutting for health care and provision of other public services, budget deficits will drive up U.S. borrowing costs to unmanageable levels.
With a VAT and no real cost cutting, the absence of growth will strangle American prosperity, cause the collapse of the dollar standard and throw the United States on the mercy of its principal creditors—read China.
Greece is a warning to governments that promise too much and pay too much for what they promise.
The United States is hardly free of such folly, and Americans should be prepared to someday accept from China the medicine Germany is now administering Greece.
Peter Morici is a professor at the Smith School of Business, University of Maryland, and former Chief Economist at the U.S. International Trade Commission.