The Beat Goes On

What beat?  The beat of political drums is pounding across America.  Cut spending!  Raise taxes!  Create jobs!  Help the sick and the poor!  Defend our country and our way of life!

As political debate rages around us, spending, taxes and the federal budget deficit remain high on the list of topics.  If people thought the deficit issue or the problem would go away with the recent passage of an increase in the federal debt ceiling, they were sadly mistaken.  Our government faced the enemy and it was staring back at them in the mirror.  They had a chance to do the correct thing for the good of our nation but, instead, they blinked.

At the eleventh hour and fifty-ninth minute they agreed on a not-at-all-sufficient deficit reduction program offset by a too-small debt ceiling increase.  They kicked the can down the road until another day in the not-too-distant future:  2012.

What was the hang-up?  The answer is easy but sad.  They—both sides—worried more about getting re-elected than doing the correct thing for America.

What should they have done?  Although complicated and not at all popular, this answer is easy, too.  They should have raised the debt ceiling in conjunction with significant spending cuts and an increase in taxes on the very rich.  Now that I've said it, I may not be very popular, either.

Warren Buffett, a very smart and really rich guy whom many of us respect, wrote recently, "My friends and I have been coddled long enough by a billionaire-friendly Congress.  It's time for our government to get serious about shared sacrifice."  [Excerpted from an opinion article in The New York Times.]

I agree with Buffett.  The “very rich” should pay higher taxes.  The problem is where one draws the line.  President Obama says he wants millionaires and billionaires to stop getting a free ride and pay their fair share.  He talks about taxing the super-rich, flying around in their personal jets but his proposals call for tax rate increases on incomes of $200,000 or more.  Does anyone recognize the term, “disingenuous?”  

Who, exactly, are the very rich?  According to Warren Buffett, he made $40 million dollars last year.  That’s very rich.  It’s also a long way from the $200,000 annual income figure that the Democrats use in their tax proposals.

So, what’s the correct income number on which to pay higher taxes?  If it were up to me, the magic number would be two additional tax rate brackets at $500,000 and $1,000,000, respectively.  The top tax rate, now, is 35% on income above $380,000.  I’d keep that rate and the lower brackets where they are but add a 37.5% rate at $500,000 and a 40% rate on income above $1,000,000.

So, what’s that going to cost?  A couple filing a joint return with taxable income of $500,000 would pay taxes in the future equal exactly to what they pay, now.   No increase.  Let me repeat that—No increase for 99% of tax filers.

However, a family who earned $1,000,000 would pay $12,500 more in federal income tax than before.  They can afford it.

Someone who had a very big income of $2,000,000 would pay $37,500 more under this new tax plan than they would under the current structure.  Again, they can afford it.

Incidentally, if Warren Buffett's income was ordinary earned income, he would have to pay a little over $1.5 million more in federal income taxes but, in case you’d forgotten, he’s not complaining and, you guessed it, he can afford it.  In reality, he wouldn't have to pay it because most of his reported income is from long-term capital gains, which I have not suggested changing.

Further, these proposed new income brackets and tax-rate increases would not destroy jobs, deter investment or prevent jobs from being created.  On the contrary, the financial stability that a realistic deficit reduction program would bring to the economy would encourage new investment and encourage corporations to begin spending some of the cash they’ve been hoarding.

To quote Warren Buffett, again, "I have worked with investors for 60 years and I have yet to see anyone--not even when capital gains rates were 39.9 percent in 1976-77--shy away from a sensible investment because of the tax rate on the potential gain.  People invest to make money, and potential taxes have never scared them off."  I can buy that.  The statement isn't true because Buffett said it, rather he recognized the truth of it in our economy.

How much new tax revenue are we talking about?  According to the most recent complete IRS information I could find (2008), returns with $500,000 or more of taxable income represented 19.2% of total taxable income from all returns.  These proposed tax rate increases would generate a little over $50 billion in additional tax revenue annually.  That’s $500 billion over a decade but it alone won’t fix the problem—and it shouldn’t. 

Actually, $50 billion of new tax revenue is only a drop in the bucket.  The deficit in 2010 was $1.3 trillion, which was more than 37% of total outlays of $3.5 trillion.  I’ll come back to these numbers later, so please remember them:  $1.3 trillion deficit; 37% of total outlays.

Is there a lot of waste in government spending?  Yes but it alone can’t save enough money to fix our problem.  Real cuts need to be made.

Where should we cut?  Isn’t everything on which the federal government spends money critically important?  No, it isn’t.  That should be the easiest to cut but some of the really important stuff will need to be reduced, also.

First, we, the people—represented by our federal government—spend approximately 20% of our annual budget on Social Security payments.  Current spending and current beneficiaries should not be touched.  Social Security is a future problem that must be fixed in the long term but not today.  We should adjust the start-point for future benefits of people who are under 55, today, so that the program will be sustainable in the future but current recipients should not be negatively impacted by any changes.

We also spend approximately 20% of our budget on defense, in one way or another.  That includes the costs of two wars that have cost many precious American lives and burned trillions of American dollars, many of which will never be accounted for.  We cannot afford to weaken our defense but we cannot afford these two wars of dubious value and accomplishment.  We surely cannot afford the waste and outright fraud that has accompanied them.  We should pull out of Afghanistan and Iraq and focus on the real defense of our nation.

We spend a whopping 21% of our budget on Medicare and Medicaid.  Are they sustainable?  Not in any calculation you can make.  Recent legislation has done nothing to reduce the runaway increase in healthcare costs.  Rather, it is an insurance program designed to decide who receives medical treatment and who pays for it.  Further, the cost of what is most often called Obamacare is enormous, does nothing to reduce the cost of healthcare and will most likely be judged unconstitutional.  We must find a way to cut these two huge programs—Medicare and Medicaid—now. 

We spend about 6% of our budget on interest payments on Treasury debt.  The bad news is, because of runaway deficit spending over the last decade, we’re borrowing way too much.  The good news is rates are cheap.  The yields on all bonds, including US Treasury bonds, are at historic lows.  The ten-year T-note is currently at a yield slightly below 2%.  If interest rates double over time, our debt service cost could double.  We cannot reduce this cost immediately because our sovereign debt must be honored but we must reduce the rate at which we’re adding to our national debt.  Then we have to find a way to reduce the debt itself.  Nothing less should be tolerated.

The remaining 33% of our expenditures should not be safe from reduction or elimination but there are no really big single programs to attack.  Instead, there are a bunch of little ones.  With these programs, the job of finding reductions will be different but we must reduce or eliminate many of them.

So, here we are at another critical crossroads.  If our government could reduce the cost of Medicare and Medicaid by one-third (7% of budget), defense by one-third (6.67% of budget), and the cost of other catch-all of programs by one-half (16.5% of budget), we’d still have a deficit of around 7% of expenditures.  The tax increases proposed above on incomes greater than $500,000 would further reduce the deficit to about 5.5% of total expenditures.  That sounds pretty good compared to the 37% of outlays in 2010 but it’s still too high.

The solution to a balanced budget in the future lies beyond this correction phase in a little thing called growth.  With renewed confidence in the stability of our government and our finances, people and businesses will invest.  They’ll put people to work and pay them salaries and those workers will pay taxes.

With our newfound responsible approach to expenditures, we also will need to hold the growth of spending to around 4% annually, compared with a historic average since 1950 of about 7.5%.  By itself, that won’t be enough.  We’ll need a steady increase of revenue, not from more tax increases but from economic growth.  Between 1990 and 2000, government receipts doubled, reflecting a 7% compound annual growth rate.  Between 2000 and 2010, gross receipts increased only 7%, reflecting the effects that two serious recessions had on economic activity.  The solution to this problem is clear:  Actively pursue government policies that promote economic growth with a targeted GDP growth rate of 4-5%.

This is what Congress and the White House should have been brave enough and strong enough to do for the good of the country, irrespective of political affiliation or the outcome of the next election.  Unfortunately, their priorities lie elsewhere.