Tax day

Another year, another tax day – and another time for people to complain that we aren’t spending enough but we are taxed too much [1]. I am not going to rehash old topics this year. Instead, I am going to risk being run out of town on a rail by stating a few bald truths:

1) We (i.e., the US government [2]) have been spending more than we take in.
2) We can fix this by spending less, by taxing more, or by some combination of the two.
3) Taxing less will not help.
4) Spending more will not help.
5) It took decades to get into this mess; it will take decades to get out of it.

And now to compound my offense by expanding on those points:

We have been spending more than we take in. With the exception of 1998-2001, the US has spent more than it brought in every year since 1969. In constant dollars [3], Carter increased the national debt by 17%, Reagan by 58%, Bush41 by 21%, Clinton by 6%, Bush43 by 24%, and Obama by 12% [4]. Since 1969, we have more than tripled the national debt in constant dollars, increasing our servitude to China and other foreign countries [5] by an average of 4%/year.  To put this into more prosaic terms, it is the equivalent of a typical family making $66,000 but spending $68,500. If the family does that for too many years, soon enough they won’t own anything except regrets. But if the family starts to spend less and earn more, they can become very happy indeed

We can fix this by spending less, by taxing more, or by some combination of the two. There are lots of people who have made considerable political hay by promising that we will be able to pay off the debt without having to make any sacrifices. They are the moral equivalent of those folks on TV who sell diet pill, promising that you will lose weight without diet or exercise. In short, they are liars and poltroons. Just as you cannot drop the pounds without a little effort on your part, we cannot get rid of this deficit without sacrifice from all levels of society. The most common quack nostrum proposed is the flat tax. Ignoring the socioeconomic aspects of the tax [6], if we were to impose a flat tax with the goal of paying down the debt over ten years without reducing spending, then you would have to pay a flat tax of 71% [7]. The second most common quack nostrum is lower tax rates on the wealthy. Again, ignoring the socioeconomic aspects [8], this approach has proven to be a total and complete failure. The third most common quack nostrum is “cutting out the pork”. Based on the FY2010 budget, about 2.5% of our total spending is “pork”– but the FY2010 deficit is nearly 40% of total spending. So saying that we can fix the deficit simply by cutting out the pork is the equivalent of saying that you can lose weight by skipping dessert after eating filet mignon. The only solutions that will work must include lower spending, higher taxes, or some combination of the two; there simply isn’t any other way.

Taxing less will not help. We have already seen that supply-side economics does not work. It does stimulate the economy, but there is no concomitant increase in tax receipts. Instead, tax receipts have gone down every time that supply-side economics has been put to the test. In practical terms, taxing less is the equivalent of a household saying “You know, we aren’t making enough to cover our bills. Why don’t you quit your job? That should fix the problem!”

Spending more will not help. Government spending is often necessary and is frequently a good idea. Without government spending, there would be no interstate highway system. Without government spending, we would never have landed on the Moon. Without government spending, we would not have a stable banking system. Without government spending, we would never have won World War II. However, spending just to spend (or, equivalently, to keep jobs in a specific district) is rarely a good idea. That sort of spending has brought us such disasters as the V-22 [9], the B-1 [10], the CVN-21 [11], and the Constellation program [12]. Such spending does not increase the nation’s wealth, nor does it make us stronger or smarter; it merely benefits one small area by short-changing the rest of the nation.

It took decades to get into this mess; it will take decades to get out of it. As we’ve seen, the current debt problem has been more than four decades in the making. For each of those four decades, there have been politicians on both sides of the aisle who have claimed that they wanted to reduce the deficit [13]; most of them have done this even as they worked to increase government spending in their districts. Neither party is innocent. Though, on average, the Republicans have been marginally worse at spending more than we take in, over the past forty years both parties have indulged in deficit spending [14]. Right now, the debt is four times our annual spending. In other words, if we were to spend our taxes only on paying down the debt, it would still take more than four years to do so! Thus, we will have to take at least a decade to pay off the debt [15]; two decades is more likely. And that will happen only if we, as a nation, muster up the courage to endure some sacrifice in order to ensure a better life for our children.

What will be required? First, we will have to reduce spending significantly. An across the board 15% reduction is the minimum that will work. How can we be sure? Because, over the past 30 years, the average deficit has been 15% of the budget. Thus, by reducing the budget by 15%, we as a nation will be able to live within our means; if we wanted to pay down the debt without raising taxes, we would have to cut spending by more than 15%. A 20% reduction in spending would allow us to pay off the debt in 70 years. A 25% reduction in spending reduces that to 35 years.

Next, we will have to raise taxes significantly. Merely allowing the Bush43 tax cuts to expire will not be enough; that will raise only about an extra $100 billion per year. Using that money to pay off the debt will do the job in a mere 141 years. Instead, we must raise taxes across all levels of income, even though that is politically unpopular. Because every citizen benefits from government programs, and so every citizen should pay a fair share of the government’s costs. Unfortunately, today more than 47% of filers will pay no federal income tax at all, thanks to a series of ill-conceived tax breaks and loopholes. For example, John McCain and Hillary Clinton were able to use tax breaks to reduce their tax burden by nearly a third (Obama and GW Bush paid at nearly the full rate). Worse, most companies will also pay no income taxes.

The only way to end this is to remove the majority of tax breaks; as a side benefit, this will also simplify the tax code. If we simplified the tax code by removing all deductions and exempting the first $10,000 of income [16] plus any money that was immediately re-invested in new equipment or R&D [17], then our revenue would increase by about 35% [18] even while keeping the current tax structure. This would allow us to pay off the debt in about 25 years, assuming that no new deficits are added. If we also returned the capital gains rate to 50% [19], then our revenue would increase by more than 40%, allowing us to be debt-free in 20 years (again, assuming that no new deficits are added).

Thus, though we can pay off the debt through tax increases or spending cuts alone, doing so would entail a multi-decade effort and a consistent political focus on maintaining the fiscal health of America [20].  So we must speed up the process by combining the two options. If we reduce spending by 15% and simplify the tax code, the debt will be gone in 25 years. If we reduce spending by 20% and simplify the tax code, we can pay off the debt in 15 years. If we reduce spending by 25%, simplify the tax code and restore capital gains, we can pay of the debt in under a decade.

However, as always, the devil is in the details. For example, most people agree that the tax code is too complex and that there are too many special deductions. However, very few are willing to get rid of those deductions that benefit them. To name one example, removing the mortgage interest deduction on houses would cause a great outcry among homeowners and businesses [21] but would not bother apartment dwellers. Similarly, people agree that the budget must be trimmed – until you start to trim government spending in their home town. Take the recent cancellation of the Constellation program as an example. Even though the project was behind schedule, over-cost, and under-performing, the Houston locals have gotten upset that it was cancelled. However, when the microgravity experiments were cancelled in order to fund Constellation, the people in Houston couldn’t have been happier.


But, the quacks cry, “We can do this by cutting FITB”. Unfortunately, that is not true. Looking at the US Budget for FY2011, 84% of our spending is on national defense, Social Security, unemployment, Medicare, Health, and interest on the national debt. In other words, if we were to close NASA, shut down the EPA, get rid of the Departments of Energy and Education, get rid of FEMA, shutter every national park, stop all farm subsidies, and stop prosecuting criminals, we would still not have reduced the budget enough to avoid deficits. Thus, any solution must involve all parts of the government. Social Security and Medicare must been limited, not expanded [22]. National defense must stop spending money on airplanes that we don’t need and vehicles that we don’t want. NASA must give up its goal of returning to the moon in two decades. The NSF must stop ORION. And so on, down the list. Every budget must shrink by 25%, no matter how painful that is because the alternative would be much, much worse [23].

And that, my dear reader, is the moral of this story: We must act now and we must do things that we don’t want to do. Because our alternatives are much, much worse.

John

[1] The logical inconsistency doesn’t seem to be evident to these folks for some reason.
[2] “We the people” isn’t a rhetorical device; it is a simple statement of fact. The US government is one of the few in the world designed from the start to be secular and representative. Thus, the only people that we have to blame for the current budget mess is ourselves.
[3] Constant dollars take out the effect of inflation and so are preferred for this sort of analysis. Using current dollars makes the situation much, much worse.
[4] On an annual basis, that works out to be Carter 4%/year, Reagan 6%/year, Bush41 by 5%/year, Clinton 1%/year, Bush43 3%/year, and Obama 12%/year [a].
[5] Debt is servitude; Shakespeare hit the nail squarely on the head with that one. And that is the primary reason that China has been buying US currency – so that they can defeat us with our own weapon.
[6] I.e., the fact that it is a tax increase on all but the wealthiest and that it encourages concentration of wealth instead of creation of prosperity.
[7] Here’s the math: 116,011,000 households making an average of $66,570 gives a net income of $7,743 billion. The 2010 budget was $3,721 billion. The national debt is $12,826 billion; to pay it off in ten years, we’d need to pay about $1,832 billion a year (including interest). That gives a total of $5,553 billion in spending each year. $5,553 billion/7,743 billion = 71%
[8] I.e., the fact that most prosperity comes not from investments by a few wealthy people but by the spending of the throngs of poor and middle class people. It is that spending that creates the profits that companies use to build new factories, employ new people, and develop better products. The investments are necessary, but they are not sufficient.
[9] Only the government would spend $55 billion over 25 years to build a military airplane that can’t fly and has no mission.
[10] Also known as “the little bomber that couldn’t”, the B-2 Spirit was designed exclusively for a first strike nuclear role – a direct violation of our agreements under MAD and a destabilizing weapon. At $1.2 billion dollars for each aircraft, it was the first plane that was literally worth its weight in gold (actually, gold would have been cheaper); all told, we’ve spent $45 billion on this boondoggle.
[11] It is a truism that the military is always equipping itself for the previous war, not the next one. The Navy’s approach to ships is a classic example. They canceled the littoral ship program in order to shift funds to this behemoth – a $14 billion set of aircraft carriers built solely to ensure that we have the capability to build more aircraft carriers.
[12] A $230 billion dollar program to go boldly where we’ve gone before, plagued with cost over-runs and stupid management decisions that resulted in a design that accomplished less and cost more than the program it was replacing.
[13] That they confuse the deficit (the amount we add to the debt in any given year) with the debt (the total amount that we owe) is telling.
[14] It is interesting that the shift from occasional deficits balanced with surpluses to deficits as far as the eye can see happened about the same time that the Baby Boomers became a political force. However, this is not a new pattern; it plagued Rome and England, and it will probably burden our greatn-grandchildren on Beta Pictoris.
[15] Remember those surpluses from the end of the Clinton years? Had they continued, it would have taken 73 years to pay off the debt.
[16] This would mostly affect those with part-time jobs, such as students and retirees, by making their income tax free.
[17] This would reverse the decades-long trend of shipping R&D and manufacturing to other countries where those costs can be deducted. Here, depreciation is a far larger tax break, which is why companies wait for something to break before they replace it.
[18] It would probably be closer to 50%, as this would also get rid of most of the loopholes (e.g., excess depreciation) used by companies to shelter income. Currently, companies shoulder less than 15% of the tax burden.
[19] Thereby reducing the perverse incentive that stockbrokers and money managers have to churn stocks in order to reap short-term gains. Right now, a stockbroker who makes $500,000 on a sale of stock held less than a year only pays $140,000 in capital gains, whereas a stockbroker who earns $500,000 in salary pays $152,000 in taxes; thus, by churning the stock, he gets to take home an extra $12,000.
[20] And when was the last time that a politician was able to maintain a consistent position on anything for more than one election?
[21] Heck, it would bug me, as I use that and the depreciation deduction as tax shelters. But that is exactly what has gotten us into this mess in the first place – we want the meal but don’t want to pay the tab.
[22] And, no, privatizing Social Security is not the answer. Look at what happened to the market over the past two years. On the other hand, allowing the government to invest in a broad fund would be a good idea [b]; had the government invested the Social Security fund in the market over the years, then there would be no looming Social Security crisis.

DOW

[23] Actually, there are two “alternatives”. Alternative 1: We can go broke. Alternative 2: We can let Congress fight over cutting programs in that state while increasing the funding for programs in this one. I’m not sure which one would be worse…

[a] While Obama has not had enough years to create a true picture of his spending habits, the results of his first year do not look promising.
[b ] Why the difference? Because the government has deep enough pockets to be able to weather any short-term slide in the Dow, where you and I may not.

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18 thoughts on “Tax day

  1. On an annual basis, that works out to be Carter 4%/year, Reagan
    6%/year, Bush41 by 5%/year, Clinton 1%/year, Bush43 3%/year, and Obama
    12%/yearI would be curious to see an annual breakdown of their percentages to see how those numbers compare to their overall averages. If they hold pretty steady across the course of their terms then Obama looks very bad, but if they tend to be weighted more heavily toward the early parts of their terms then he might not look so scary.

  2. re [2] or the system itself (representative democracy) has faults. (Heck, all systems have faults.)re [19] see also the Tobin tax to put a back-pressure on trades designed to drive speculation in the market.So, in summary, your analysis is simple and clear. At the level conducted.But how confident are you that Congress can change course as prescribed? That the American people will (think similarly to you and) partially relinquish entitlements?You say that defense expenditure could eliminate d.o.a. projects such as the V22 (Osprey), B2…. Well and good. How about a cost analysis on Iraq, Afghanistan, Pakistan, Iran… Africa? Empire: affordable?[1]OK. What about bankruptcy and concomitant freedom? (Bankruptcy has a uniformly bad connotation but, in a humane setting, it is intended as a "new start".(I say none of this in a combative mood but entirely in the spirit of extending a scintillating train of thought.)[1] Now you run into Eisenhower's warning and Kennedy's murder…[a][a] geek points for the reference. :)

  3. John, you obviously put so much effort into your posts. I don't know why you do it, but I for one, really appreciate it. I learn so much from the posts that you do. Thank you very much for your time and effort.

  4. I would posit that we, as a country, are not capable of cutting our spending because we, as individuals, are not good at doing the same. Our society has been trained for consumption because we deserve it! Were you not told in school that America is the richest nation? When household budgets should be cut, most folks turn to credit and so does the government.If you cannot pay your mortgage, the bank takes your home. If you cannot pay your national debt – does that mean we all become Chinese? It appears the Firefly 'verse is not that ludicrous after all. 稅人吃了我的靈魂

  5. But how confident are you that Congress can change course as prescribed? That the American people will (think similarly to you and) partially relinquish entitlements? As noted, it ain't gonna happen – we, as a people, are too willing to believe the snake oil salesmen and too unwilling to listen to the voices of reason. Even if both Pat Buchanan and Dave Stockman both agree with me. (It must be the end of the world.)John

  6. I would be curious to see an annual breakdown of their percentages to see how those numbers compare to their overall averages. Using constant 2005 dollars (Table 1.3 — Summary of Receipts, Outlays, and Surpluses or Deficits (-) in Current Dollars, Constant (FY 2005) Dollars, and as Percentages of GDP: 1940–2015), we get the following after adding in the debt in 2005::Carter: 7%, 7%, 4%, 6%Reagan: 6%, 8%, 12%, 9%, 9%, 8%, 5%, 5%Bush41: 4%, 6%, 6%, 6%Clinton: 5%, 4%, 3%, 2%, 0%, -1%, -2%, -4%Bush43: -2%, 3%, 6%, 6%, 3%, 2%, 5%, 15%Obama: 14%, 10%, 6%, 5%So it is clear that there are three factors at work here. First, presidents seem to become thriftier in their second term, perhaps because they no longer need to buy votes for the next election with government spending.Second, recession plays a strong part in government spending. The most notable is the most recent, which caused Bush43 to increase the deficit spending by 1/3 and which has caused Obama to start off with a high deficit. Similarly, the 1984-1985 recession shows as the spike in Reagan's spending.Third, Republican administrations have larger deficits than Democratic ones do. Twelve of the top eighteen debt increases took place under Republican leadership [1], whereas only eight of the eighteen smallest debt increases (or debt reductions) took place under a Republican president.John[1] This of course ignores the role that the Congress plays in budgets. But if we wish to blame Obama exclusively for the current high spending, then we should similarly blame Reagan exclusively for the high spending under his watch.

  7. This is very interesting. Of course, the last three numbers for Obama are speculative. Even though you show him still continuing to increase the debt his numbers are dropping faster than Clinton's did. If the trend were to continue he'd be looking pretty darn good by the end of his second term. I guess we'll have to wait and see what really happens.

  8. What irks me is that while I can't figure it all out ("Okay, so what would YOU do?"), when I read something like your piece, it's sensible and supported by facts. There's oh, I dunno…logic?What I hear pundits crying is emotion-based bs. Okay, let's say a pundit/ congressman/ who cares has ONE good point that's fact-based and not simply meant to provoke an emotional response in the listener who'll vote based on stoopidity. They repeat it over and over, like one thing is going to do it? Sadly, I get that they probably have to do that because the average American can only possibly grasp one thing, fact-based or emotion.One of my AVERAGE coworkers was bemused this AM because she couldn't get a hex job to work. "Yellow and green make orange, so why isn't it working?"I hate people.

  9. OK. What about bankruptcy and concomitant freedom? (Bankruptcy has a uniformly bad connotation but, in a humane setting, it is intended as a "new start"

    Sorry – forgot to answer this last go'round. By international law, countries are not allowed to declare bankruptcy. The last time that anything close to that happened was Russia in the 90's and Argentina in the 80's. What happens is that the countries currency becomes devalued to the extent that hyperinflation kicks in [1]. Barter becomes the norm of the day in the country and Gresham's Law kicks in with a vengeance outside of it. The debts are paid with devalued currency, so the country's credit rating becomes equivalent to junk bond status [2]. In the end, the country is wrecked and all of its fungible assets are taken over by other countries while the populace must begin again from ground zero.

    The IMF was created to help avert such problems, but it typically just makes them worse. It frequently requires such drastic cost-cutting in the country that infrastructure collapses and goods production halts, thereby eliminating the ability of the country to service its debt [3].In short, the last economic downturn would look like a freakin'' paradise compared to what would happen were the USA to declare bankruptcy.
    John
    [1] The legends of barrels of currency in Weimar Republic are true; they even had a two trillion mark note![2] Some economists would have it the other way around with the poor credit rating driving the hyperinflation.
    [3] Sounds dirty, doesn't it?

  10. Thank you indeed for following up on this point, John.As background, this post by Kimmers excerpting the Federalist Papers may be relevant. In it, Hamilton makes the claim that Congress can change the law on the people of the land at any time[1], but international treaties, once made, are inviolable. Hardly seems fair does it?The IMF are hated not just for the austerity measures they impose, but without going in to that, it works because it is backed up by the economic (and military) might of the West, the US and UK in particular. Default and you risk invasion.Therefore, a double standard is in operation. We are seeing Iceland getting the shit kicked out of it (e.g. Britain invoking its anti-terrorist act to confiscate Icelandic funds in Europe) for participating in a very small way in the gigantic financial fraud just perpetrated by the Anglo-Saxon banking elite. The US and UK are fundamentally insolvent (i.e. bankrupt and a large-scale cover-up and assist of fraudulent valuation of the assets of the largest financial institutions has been ongoing since 2007), but nobody is threatening them to pay up. You don't see China going to an international court and asking for repayment of its 1 or 2T$; apart from the fact that the double standard precludes any coercion for enforcement, China knows that the dollar will collapse unless it sells off very quietly (now in progress). Even so, China has made a bad bet and will lose heavily.International law. Take a look at the voting record in the UN. Another double standard. The US applies international law to other countries but flouts it at will. Reason: unenforceable. The US is the world cop and it does what it likes.OK, so where does this leave us? Three choices.#1 is as you say and would be a very civilized way to proceed. Hunker down, reverse disastrous policies, repay obligations, live happily. Even if the voters were persuaded by your eloquent common-sense, this course ignores the fundamental problem of the problems in the system that got us here. (i.e. Congress and the banking elites.)#2 Congress is a creature of the States. You could think of it as a holding company as far as the treaties and obligations go. There are numerous constitutional scholars evoking the concept of interposition and related ideas. My suggestion about bankruptcy (remembering that the US is already insolvent, especially considering Social Security obligations) simply says that the US government should be disbanded and the States then proceed in a loose coalition (more or less as intended by the Founders, relatively speaking). Banks lose! Other investor countries lose! Politicians lose! All good. The people, and particularly retirees, still face grave problems. But at least the roadblocks to prosperity are removed. (And I think a new but temporary form of social security (e.g. a pension) could be established for the baby boomers in order to be humane: the cost would be a lot less than the 50% taxes currently paid). Proposal #2 fixes the problem as well as incurs hardship. #1 and #3 suffer the consequences but don't remove the parasitic problems sitting on the faces of the American people.#3 … and this is the one in progress … in the late 80s the American people knew the country was in a fiscal mess, (remember Perot?). In the late 90s, after a brief spurt of surpluses from Clinton, I am pretty sure people in government read the writing on the wall — and gave up. The mess is hopeless. What choices did they face. Second-world status at best. The decline of the empire as they[2] then saw it. Intolerable. Now all of this is the fiscal equation, ignoring the balance of power. The US still has 9,000 nukes. It has the most advanced military technology in the world. It has bases all over the world and is encircling its two significant foes, China and Russia. NATO has been expanding in the last two decades like a malignant brain tumor.In short, the US is currently doing what every empire in decline does. And history shows that very often leads to a) depression, followed by b) major warfare.[3][1] So Congress can enact Social Security, draw people's funds, then radically alter or abolish Social Security when the going gets rough and the coffers have been pillaged. Entrust your future to a company and you have the law courts to fall back on. Never trust nor rely on the law-makers themselves.[2] the neo-conservatives, at least.[3] See The Rise and Fall of the Great Powers, by Paul Kennedy

  11. Even so, China has made a bad bet and will lose heavily.

    Here we disagree. My interpretation is that China is treating bond obligations in much the same way that they are treating oil exploration: they aren't in it to make a profit, but to ensure national security. Thus, by holding US bonds, China has us right where it wants us. Personally, I will not be frightened until China unpegs the yuan from the dollar. Not only will the yuan soar in value compared to the dollar, but the dollar will lose the implied support of the Chinese government.Naturally, this is exactly what many politicians want right now [1, 2]; they obviously have not thought through the consequences [3].
    John
    [1] The argument is that a weaker dollar will allow us to import to them, thereby easing the trade deficit.
    [2] If you are in the market for a bold but interesting bet, then buying yuan is it. The yuan is artificially low, so it has nowhere to go but up once it is unpegged. A conservative estimate is an increase of 25% in value. Of course, that requires you to hold yuan until China decides to let it float – good luck on that.
    [3] Sadly, this is the natural state for most politicians.

  12. My suggestion about bankruptcy (remembering that the US is already insolvent, especially considering Social Security obligations) simply says that the US government should be disbanded and the States then proceed in a loose coalition (more or less as intended by the Founders, relatively speaking). Banks lose!

    Sadly, that is already covered under international law; in essence, there is no way out. For example, the Federal Republic of Germany was held responsible for the debts of the Reich. Similarly, Argentina after Peron was responsible for the debts run up under Peron and Uganda after Amin still had to pay Amin's bills. More recently, you may recall the US's decision to forgive some of Iraq's debts run up under Saddam following our invasion. Even Balkanization is no escape.Unless the other countries are willing to let go of the debt, we have no way out but to pay our bills.
    John

  13. Ok, I may have put to fine a point on it. The way out from international law is to declare "international martial law" – a euphemism for "start WW3 and win it".

  14. Ok, I may have put to fine a point on it. The way out from international law is to declare "international martial law" – a euphemism for "start WW3 and win it".

    Even if we win, we lose. Ever since the middle of the last century, "to the victor go the spoils" has been outlawed. This was mainly our doing and it was (IMHO) a good thing, as it removed much of the incentive for countries to go to war [1]. In order to avoid Godwin, I will leave out the most notable example of a country that tried the approach you describe; suffice it to say that it didn't work.

    Just that natural forces propel the US in this direction and events bear out that this course is also being followed. Never underestimate the power of stupidity…

    We can be swept into such a conflict. My hope is that we will have learned the lessons from the last time we went off without good evidence, and avoid the conflict. If Israel and the others want to play, fine – but there is no law requiring us to do so. In fact, our refusal to play might act as a brake on the whole process.

    John
    [1] War is frequently cited as an example of a negative sum game with a positive incentive for playing. By removing the rewards of victory, war shifts to an entirely negative sum game.

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