Posted by: dstieglitz | November 1, 2009

FISCAL TIME BOMB

THE FISCAL TIME BOMB

    The fiscal direction of the U.S. is a ticking time bomb that is pulling us out of the banking and personal debt crisis by pushing us into an explosive government debt crisis. The potential for disaster is widely discussed, but the same spending decisions and tax policies continue. Three years ago economists warned about a collapse in sub-prime mortgages, but we ignored that warning and are paying for it with bailouts, unemployment, and a housing industry on life-support. Who will bailout Washington when this bomb explodes – the Chinese?

    The fiscal year 2009 deficit skyrocketed to a record $1.4 trillion, larger than the last four years of deficits combined. In 2009 the government spent $3.5 trillion, but collected only $2.1 trillion in taxes. The $1.4 trillion gap would have been a few hundred billion dollars more, except several large banks repaid their bailouts rather than face punitive salary cuts by Obama’s Compensation Czar. The tsunami of red ink jeopardizes the awakening economy and the long term outlook for more jobs.

    Future deficits look equally bad. The Congressional Budget Office (CBO) forecasts another $1.4 trillion deficit in 2010, and annual deficits of a trillion dollars or more each year through 2019. Even to get those numbers, the CBO and the President are doing what naïve business leaders do to justify overspending: they inflate projections of growth and revenue. The world (particularly China) is still willing to buy treasury bonds and, at today’s historically low rates, the interest is affordable. But when the ballooning national debt spooks foreign and domestic lenders into fears about rising inflation and defaults, soaring interest rates will divert tax revenues into interest payments.

    Last June, President Obama said: “Paying for what you spend is common sense. Perhaps that’s why here in Washington it’s so elusive.” But instead of choosing among new social programs, tax cuts, and war in Afghanistan, he wants all three and more. Congress is debating a health-care bill that would add hundreds of billions to the federal budget. The only recent idea that has bipartisan support is giving $250 checks to seniors (total cost of $14 billion) because the Consumer Price Index fell 1.3 percent and they weren’t entitled to a cost-of-living increase in Social Security. Actions also are in progress to extend unemployment payments and the $8,000 tax credit for first-time home buyers. No one disputes that Obama began his presidency in a difficult economy, but its problems have been exacerbated by a spending binge like a teenager at the shopping mall with her parent’s credit card – eventually we must pay the bill.

   Obama steadfastly repeats his “clear promise that families earning less than $250,000 will not see their taxes increase by one single dime.” But the CBO has issued data showing that income taxes are already near a historic low for all but the wealthiest Americans. The CBO says that the average American family paid about 9 percent of its earnings to the IRS in 2006, the latest year for which data are available. Middle-class families fared especially well. In 2006, the middle fifth of taxpayers (those earning about $60,000 per household annually) paid 3 percent in federal income taxes, down from a high of 8 percent in 1981. In a recent Gallup poll, 54 percent of the respondents said their federal income taxes were either “too low” or “about right,” the highest percentage since Gallup began that poll in 1956.

    One frightening trend in tax policy is that fewer and fewer people are paying any income taxes at all. According to the IRS, 45 million households (38 percent of taxpayers) paid no income tax in 2006. This year, because of tax credits in the stimulus bill, 43 percent of all households are likely to pay no income taxes at all. Obama wants to keep his no-tax-increase promise class and is reluctant to tell us the truth: if you want bigger government, you must pay for it. Unfortunately, with the percentage of non-taxpayers nearing 50 percent, the balance between those who receive government benefits and those who pay for them is being obliterated. Non-tax paying voters are the majority that elects candidates who promise new spending.

    The keys to restoring the budget surpluses we enjoyed during the dot-com era are more jobs and more innovative businesses. Since the recession began, 8 million jobs have been lost. Total employment is lower today than ten years ago – a 10-year decline in employment hasn’t occurred since the Great Depression. But what can the government do to produce jobs and business growth? The answer isn’t clear. If the economy rebounds and unemployment drops, tax revenues could increase and narrow the budget gap. However, if the economy recovers more slowly than after past downturns (as many expect),the  deficits could double. Economic projections are guesswork, of course. For example, the new health-care plan could cost more or less than expected. The cap-and-trade system for carbon emissions is another wildcard. Congress seems intent on passing a bill that essentially gives carbon credits away, while President Obama is counting on a bill that will generate hundreds of billions in new revenue. Many economists are afraid the exploding federal debt will trigger a new crisis that will destroy jobs.

    There appear to be three alternatives: (1) higher taxes, (2) program cuts, and (3) changes in the structure of social security and Medicare. If we do nothing, the U.S. might default on its debt payments and all three things will be forced on us. For me, the most palatable is higher taxes. Taxes on the wealthy must increase the most, but the revenue required to expand social programs is far too much for high earners to pay. There just aren’t enough of them. Topay for a trillion dollar health care program and keep the national debt from destroying an already weakened economy, federal income tax rates and the number of people who pay them must increase. The government will have to go where there are a hundred million taxpayers – the middle class. A viable alternative to income tax increases is a European-style value-added tax (VAT) that would raise the price of everything from cars to clothes. But Congress has shunned the VAT idea along with other usage-based taxes like the gasoline tax which hasn’t been increased since 1993. The fuse on the fiscal bomb continues to burn while Congress and the president spend.

   This type of fiscal blindness is not limited to government. Business executives face similar challenges when the basics of their industries change:

Conflicting priorities from doing too much. (Which is the government’s highest priority: the economy, unemployment, health care, global warming, or Afghanistan?)

Lack of Focus. When multiple priorities collide, worthwhile efforts fail.

Unrealistic expectations: Yes we can!  But what if we can’t or shouldn’t?

We all want things to change, but change doesn’t mean doing everything. Effective change means we must be willing to give up the old and embrace the new even when the leap from the old to the new is uncomfortable. To be successful in times of rampant change, anticipate what the changes will be, embrace the changes, and use them to produce renewed success – not bigger debts.

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