Nobel Laureate Edward Prescott offers his views on tax policy in an interview published in today’s Wall Street Journal:

• WSJ: Your research suggests that a Keynesian response to economic slowdowns is not good policy. So, was recent government stimulus — in the form of income-tax cuts and business-investment incentives — the right response to the U.S. economic slowdown?

• Prescott: We should get away from thinking about stimulus policies and worry about long-run growth policies, and when it comes to taxes we should worry about policies from the perspective of their efficiency and distributional consequences. We should use economic theory to design a good tax system, and this means that we should avoid using taxes for social engineering. The purpose of the tax system is to collect needed revenue at the least cost to the people.

• WSJ: What course should income-tax policy take in the next four years, and how should the mounting federal budget deficit be factored into decisions about tax policy?

• Prescott: We should reduce the Social Security tax from 12.4% to 2.4% for those who agree to have 10% of their salary and wage income put into a 401-type retirement account. Individuals would turn these savings into annuity payments at some time subsequent to reaching age 62. With this policy, labor supply would increase, promises to the elderly would be honored, and the young would be made better off. Associated with this change, there would be a period when government debt, relative to gross national income, would increase before decreasing. Currently, privately owned federal government debt, which is the relevant debt, has been flat over the last three years at 28% of gross national income — the same as in 1940. While it is true that there have been fluctuations in the interim, since 1960 this rate has been essentially level, with modest fluctuations.