Morningstar Advisor - April/May 2010 - 45

So I suspect we’re going to have to do something on the tax side. If I were a betting man, I’d say that five or 10 years from now, tax rates are going to be higher than they are now. As an economist, my admonition is that we need to pay a lot more attention to the kinds of taxes that we’re imposing, and a lot less attention to what’s the total amount that’s coming out of your pocketbook. The most important thing to think about is that taxes raise revenue, and they change behavior. If we have to raise revenue, or even change the composition of our current revenue, I would strongly favor moving toward taxes that discourage activities that we don’t think are socially beneficial. We do it with smoking. I would like to see it at the global scale; tax things like carbon that have an adverse environmental impact. Therefore, we would not have to raise taxes on capital investment, on labor, on other kinds of things that actually have positive spillovers.
PC: Things to encourage economic growth. CW: Absolutely. I’d like to see this discussion

Grading the Bailout
PC: Let’s take a step back, and look at how we got here. The past couple of years have been very dramatic, with the financial crisis, the government’s reaction to it, and now the policymaking around it. I gather from listening to your speech today that you believe that we tend to do the right thing when the garage is on fire—which seems to indicate that you think that the bailout package and TARP were the right things to do.

But why do that, when you can pay people to do high-speed rail in the Midwest, or research in California on solar energy, or go back to get a GED, or go to graduate school. Those are all things that also create demand, but at the end of 20 years, you don’t have holes that were dug and filled in; you have a more productive, better-educated population.

Investing in Education
PC: You mentioned human capital, and you

CW: Yes. Broadly speaking, I think they both

also talked a lot about human capital in your book. Can you elaborate on that a little bit? I think a lot of what you mean is about real education and increasing the size of human capital in society. CW: Exactly. Education is at the core of

had to be done. If you go back 15 months, there was the potential for this to spiral in a really nasty direction. What I fear most, as somebody who watches human behavior and finance, is a series of negative feedback loops, where you stop making mortgage payments, your bank fails, you stop making loans to healthy firms, you lay off people, you go into default, and it just all feeds on itself. Nobody knew exactly what we had to do, and at that point, you err on the side of action. I actually felt very comfortable with Ben Bernanke at the Fed, which is not to say that everything he did was perfect. But he certainly is one of the most informed people in financial crises that you could have at the helm. Government had to step in. The problem is how should they step in. My great disappointment with the stimulus was that the investments weren’t better targeted. We shouldn’t have spent money on anything that didn’t make sense in the long run. I was disappointed that we didn’t do more in transportation infrastructure and basic research in alternative energy, in human capital— I mean, all this stuff that will not only deal with the short run but also position us to get to a better place. Worst case, pay people to dig holes and fill them in. That actually has some positive effect, if the economy is bad enough. We did that in the Great Depression.

focus more on specific spending cuts, which I think we’re going to have to do, and more on the kinds of taxes that would not only have the least negative impact on the economy, but would also be positive in the long run.
PC: From an investing perspective, then, financial advisors and individual investors should look at ways to position their portfolios to be even more tax-efficient, on both the equity side and the bond side. CW: Yes, you probably should expect that you’re going to have higher taxes down the road. And I’m not sure you should count on policymakers doing what I think is a good idea, which is taxing things like carbon and so on, which would not have a terribly pernicious effect on your portfolio. They will go back to the standard taxes that we use, which are income, sales, property, and so on, none of which are particularly good taxes in terms of behavioral outcomes.

anyone’s human capital, but there are related skills: job experience, your willingness to work hard, gumption, entrepreneurial spirit. It’s the package of what you bring to a job or to life. We’re talking about it in an income and investment climate, but, actually, it makes you a better parent, it makes you a better citizen. There are a whole bunch of reasons that you want more-informed citizens. What’s striking now is that here we are with unemployment lingering near 10%. For college graduates, it’s still only around 4% or 5%, which is terrific by global standards and by historical standards. Highly educated people do well in any climate, even this climate. In a better climate, it’s going to be 1.8%–2%. The other thing that’s really interesting is there’s now pretty good research that there are very important spillovers among highly educated people. That’s why everybody is here in Orlando. If you’re smart and I’m smart, and we have lunch together, it actually could collectively increase our productivity. Silicon Valley is a perfect example of this. Not only are you more productive as an individual when you’re highly skilled, you make other highly productive people around you also more

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Morningstar Advisor - April/May 2010

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