05/08/2011 03:40 pm ET Updated Jul 08, 2011

Roadmap for U.S. Recovery: How to Keep the Bush-era Tax Cuts, Invest in Clean Energy and Still Get Ahead

He's a rock star at the Billionaire Boys Club, having keynoted the luncheon at the Milken Global Conference every year since it began. His lyrics -- namely human capital -- are pop vernacular. He's rich -- after winning the Nobel Prize for economics in 1992 -- well-dressed and respected. Bestselling Freakonomics economist Dr. Steven Levitt is the director at his think tank (the Becker Center) at the University of Chicago.

Yet, as we enter the restaurant at the Beverly Hilton on April 4, 2011 for this interview, it is me who the waiter rushes to appease. Dr. Gary S. Becker, an icon in the world of economics, recipient of the Presidential Medal of Freedom and one of the most important thinkers of our day, despite all of his achievements, is still a humble, likable guy with an easy-going smile. The kind you might walk right by without knowing it.

More importantly for this article, he has been right on the money for decades. Each year he packs the ballroom at the Milken Global Conference, with thousands of the world's most rich and powerful people (mostly men) leaning on his every word, as he directs them on how to promote public policy and business practices that will stimulate GDP growth, curtail deficit spending, reduce debt and reform the tax code. He was right, where most were still burned and wrong, on when the tipping point of recovery had taken hold in the Great Recession, and the Dot Com Recession before that.

Most people don't think of University of Chicago professors as having much regard for government spending, however, as the author of human capital, Dr. Becker believes that investing in education and health care are critical to a healthy economy. Though he says entitlement spending is "too generous," his approach would be to reduce Medicare subsidies for "those who can afford it," and provide incentives for staying healthy, such as Health Savings Accounts. In Dr. Becker's view, the Stimulus Spending was a mistake, however, he supports investments in alternative energy. He "often agrees with the Republicans," but describes himself as an Independent.

So how can we keep the Bush-era Tax cuts, invest in clean energy and still get ahead? Is it even possible? Dr. Becker sat down with me to outline the details to his Roadmap for the U.S. Recovery.

Natalie Pace: With the recent S&P downgrade of the U.S. debt outlook, how close are we to a downgrade?

Dr. Gary Becker: I don't think we're very close, in sense of the next few months. In terms of the next few years, it's very possible that we'll be downgraded, if we don't do anything about the deficit. Then there is a very high probability that we'll be downgraded.

What happens then?

The interest rates that we have to pay on the debt goes up. It becomes more expensive. That makes it harder to finance the deficit. So, that's why it's self-enforcing. That's how countries like Greece get into trouble. I don't think that's going to happen in the United States, but the consequences will be higher interest rates.

Will the states have to face this before the national government does?

Some of the states and local governments, like California, the city of Chicago and other cities are in serious financial trouble. They can't issue substantial debt, the way the government can do.

What can they do to start pulling back the reins on debt and escalating interest rates?

States really can't go bankrupt; local governments can. They have to get their delayed payments under control, particularly their pensions and medical care. They are much too generous. They have to extend the age at which people retire. And they have to make retirement income based, not on the earnings of the last year or two, but on your lifetime contributions to some kind of fund. All of those things almost every state in the union does wrong.

What is the best cost-cutting strategy for the federal government that is on the table?

The big programs are three - Social Security, Medicare and Medicaid. And the fourth one would be defense. We have to make some adjustments. We could delay the age of eligibility for Social Security to age 70, which is not an unreasonable age with modern health. Medicare should be means-tested. When higher-income people can afford it, they should get much smaller subsidies from the government. With Medicaid, we need block grants to the states, and if they want to spend more money, they have to spend their own money, not the federal taxpayer's money.

Editor's Note: Dr. Becker walks the walk on delaying retirement. He's 80 and still carrying a full teaching load at the University of Chicago, writing a weekly blog and keynoting conferences.

Natalie Pace: What about defense?

Dr. Becker: I can see some cuts in defense. Hopefully we will wind down our involvement in Afghanistan and Iraq and that will have a big impact on our defense spending.

What happens if the Bush-era tax cuts are not renewed this year?

I think it would be a mistake. The tax cuts are good, although other tax reforms should occur. If you want to increase the revenue back to before the Bush tax cuts, you want to make the tax base flatter and the income base wider. That's the real tax reform that should occur.

Do you think the economy needs to be stronger before that occurs?

I think that should occur now. That would be lower taxes for most people, higher taxes for some people and generous no taxes for lower-income people. It would be much more rational. Lower corporate tax would be folded into the income tax.

What about capital gains?

I would fold that into a flat income tax and it would be taxed at the same rate as income. Dividend income would not be taxed separately; it would be taxed as income to the individuals. Undistributed corporate profits would be taxed as regular income tax.

The U.S. Feds have been slow, compared to China, the European Union and Canada, in raising interest rates. How do you feel about that?

There's no rush in raising rates. But I was opposed to QE2, the $600 billion dollars that the Federal Reserve spent. I thought that was not wise spending. Rates would have gone up a little if we hadn't done that. I am worried down the road -- not this year and not 2012 -- about inflation. Nominal rates will rise if you get inflation. We have to be moving from an aggressive anti-Recession crisis mode into a mode more similar to the European Union.

Do you think interest rates have to rise in the near term?

No, not rapidly in the near term, but before too long the Feds have to stop easing. And if that means a rise in interest rates, we have to accept that.

What is the best strategy for increasing income and stimulating GDP growth?

We have to invest in education. Human capital is the capital in the modern global capital. That is our number one priority. Our number two priority is flattening the tax rate and widening the tax base and number three is getting spending under control. If we do all of that and improve our immigration policy, we can increase the growth rate.

What do you think of the Stimulus Spending?

I think it was a mistake. I don't think it accomplished its goal. It's still controversial, and we won't know that answer - maybe we never will - and certainly not for a while. There was a lot of money spent too quickly and too unwisely.

President Obama always emphasizes that he is investing in clean energy and emerging economies, like bringing Federal agencies online and automating health care...

I would separate that from Stimulus. If you want to invest in alternative energy, that's fine. I support some of that, up to a point. I think it's important to support alternative energy, but don't call it a stimulus. Call it an investment in trying to get us less dependent on oil, on global warming and all of these issues.

Clean energy is a part of the spending that the Republicans are keen on cutting...

I don't agree with everything that the Republicans put forward. I'm an Independent, though I often agree with the Republicans. Medical research should be supported generously and other basic research should be supported. That's one thing the government can do that the private sector can't do well because they don't have the right incentives. We should increase our investment in alternative energy. I think that's desirable. I think we have to become less dependent and we have to worry about the global warming issue.

Dr. Gary Becker is a University Professor, Department of Economics, and Sociology Professor, Graduate School of Business, The University of Chicago. He won the Nobel Prize in Economics in 1992 for his groundbreaking work in "human capital." President George W. Bush awarded him the Presidential Medal of Freedom in 2007.

To keep track of Dr. Becker's continuing research and commentary, visit his website and blog.