||Felix G. Rohatyn, a well-known financier, published a letter on the editorial page of the New York Times on July 1, 1990. He wrote: I was startled and dismayed by [an earlier Times editorial] supporting Government borrowing as the appropriate way to deal with the bailout of bankrupt savings and loan institutions. Borrowing may be politically expedient; it is, however, wrong, from both an economic and moral point of view. The straightforward, and least damaging, way to deal with this fiasco is to pay off the $130 billion loss with a temporary three- to four-year surcharge on income taxes. The economics are simple: (1) Borrowing will turn a $130 billion loss into a $500 billion drain over 20 to 30 years. It will maintain pressure on the credit markets and lead to higher interest rates. It will add $10 billion to $15 billion annually in interest costs to the Federal budget deficit, when interest costs constitute, after defense, the largest Federal expenditure. It will require continued high inflows of foreign capital. It will squeeze out badly needed domestic programs. (2) A three- to four-year temporary tax surcharge will eliminate $300 billion to $400 billion in interest costs and contribute to lower interest rates and capital costs. This will foster economic growth. The tax will not have negative economic impact because the bailout is basically a transfer program from taxpayers to depositors. (3) A basic economic principle justifies borrowing only for assets with a useful life. Nothing is more remote from that definition than borrowing to finance losses that have already been incurred. The moral issue is even simpler. Borrowing burdens the next generation with repayment of our foolishness and burdens lower-income Americans with the interest costs. The income tax puts the burden where it belongs: on the present generation and on higher-income Americans. a. Find at least one elementary economic error per each paragraph. b. Focus on the “basic economic principle” articulated under point 3. In an indifference curve diagram, show what happens if, after you have optimized, a tragedy destroys a substantial chunk of your current consumption. Is it better to reduce your consumption by that full amount in the current period? Or is it better to spread out the loss over the present and future by “borrowing to finance losses that have already been incurred”? c. Suppose that the government does follow Mr. Rohatyn’s advice and raises current taxes to meet the costs of the bailout in what is essentially the immediate present. How might individual taxpayers adjust their private borrowing and lending? Will the costs really be paid in the present, or will they be spread out over time despite the government policy? Explain why the Rohatyn plan might have no effect on any important economic variable. d. Suppose that contrary to your argument in part (c), the Rohatyn plan does have a real effect, either because people are unable to borrow as much as they would like at the market interest rate or because they are insufficiently sophisticated to borrow their way through the higher tax years. In that case, does the Rohatyn plan make people better off or worse off?