Redesign the Paradigm

In the previous blog U.S. Fiscal Responsibility – An Assessment of Growing U.S. Deficits and Debt Obligations I discussed the factors contributing to the U.S. debt, potential dangers if irresponsible fiscal policies continue, and a strategic direction for returning to fiscal responsibility. Of equal importance are receipts (tax revenues) and outlays (government spending) and how those allocations are distributed, which will be discussed in this blog.

As of October 2010 the U.S. debt has grown to $13.5 trillion, a 131% increase in a decade. Bush administration fiscal policy resulted in a record $4.22 trillion increase in U.S. debt. This was principally caused by lost revenue from the enactment of the 2001 and 2003 tax cuts, the wars in Iraq and Afghanistan, and increases in federal spending that added $700 billion a year to the budget. These spending increases were not matched with additional tax revenues expected from the economic growth the Bush tax cuts were projected to provide. The Obama administration soon outpaced the debt increases of the Bush era by racking up $3.53 trillion in less than 2 years. Debt increases from the Obama administration were driven largely by hundreds of billions in stimulus programs to spur the economy out of recession, a $1 trillion down payment on the new health care program, and escalations in spending for safety net programs and education. The $786 billion financial sector bailout (TARP) decisions were shared between both administrations in 2009. The following table lists the growth of the federal debt over the past decade, debt percentage of Gross Domestic Product (GDP), and the associated administration.

There are basically two recognized effective methods to control debt, increase revenues (taxes) or decrease outlays (spending). Increasing taxes is obviously unpopular. Serious independent analysis of the effects of increasing taxes versus a potential loss in tax revenue if the country is overtaxed should be conducted.  Reducing some taxes like capital gains and dividends may actually stimulate economic growth thereby generating more tax revenues in the long run, but widely implemented individual and even corporate tax cuts have not been proven to stimulate significant enough economic growth that would result in additional tax revenues. GDP percentage increases were only marginal after the 2001 and 2003 Bush tax cuts and were less than the GDP growth levels of the previous Clinton era.  GDP growth did peak  after the ERTA tax cuts in 1981 but only dropped a few percentage points after portions of those cuts were rescinded in 1986 (see table below). It could be argued that the 1981 and 2001 tax cuts were implemented during periods of recession which would restrict some of the GDP growth, but the recessions did not last the duration of the administration. In any case, tax revenue collection after the Reagan ERTA cuts averaged an increase of 6.5% a year from 1981 to 1986, the Clinton OBRA tax hike averaged a tax revenue was increased to 7.7% per year from 1993 to 2000, and the Bush tax cuts only generated an average tax revenue of 3.8% per year.  Tax revenue collections were not increased during tax cuts as many claim but during periods where tax receipts were increased.  Of more relevance are the significant increases in the debt levels during periods of tax cuts and the debt level increases in general during the Reagan and Bush administration’s policies on supply side economics – illustrated in the following table.

The belief that decreasing taxes will generate additional revenues or will not increase debt levels does not hold merit. A realistic tax policy that has fiscal debt reduction as one of its core principles should be created by independent experts without political agendas. This policy needs to address the best mix of tax maintenance practices combined with increases or decreases in those sectors that will only be allocated after careful analysis of long economic changes and their effectiveness in generating budgetary surpluses required for lowering debt. Current tax receipts for 2009 – 2010 plus projections for next year, 2015, and 2020 are listed in the table below. Data is according to the Office of Management and Government – Budget of the U.S. Government, Fiscal Year 2011 and may be subject to change depending on administration.

This budget increases taxes over the next decade presumably in accordance with economic growth projections but is a representation of a Democrat proposal not the work of an independent group and as illustrated in the following table accompanied by large increases in spending. Careful consideration should be assigned when taxes are increased in the private sector. The goal is to indeed to increase tax revenues but not at the expense of stifling growth in small and medium sized companies, the backbone of jobs in the U.S. Additions in tax revenues should be combined with strict analysis of spending programs to identify those sectors that would be identified to receive reductions in funding. Current outlays for 2009 – 2010 combined with projections for 2011, 2015, and 2020 are listed in the table below. The source is again Budget of the U.S. Government, Fiscal Year 2011 and projections may again be subject to change in the event of a change of power in Congress.

The next table is divided into non-discretionary and discretionary spending. Non-discretionary represents budgetary expenses that are required by law and have built into them cost of living adjustments (increases).  These types of outlays require new legislation in order for budgetary changes to take effect.  It is also the most politically difficult type of spending to make cuts in. Non-discretionary spending includes Social Security, Medicare, and Medicaid and represents 56% of outlays. Discretionary spending includes security (military) expenditures and non-security expenditures which consist of a variety of programs like net safety programs (assistance to families  / individuals for financial hardship), education, transportation agriculture, energy, etc. Combined discretionary spending equals 38% of outlays.

Clearly proposed outlays under the Budget of the U.S. Government, Fiscal Year 2011 continue the escalation of the debt and represent Democrat fiscal policies which like those of prior Republican policy are not in line with fiscal responsibility. Less spending is necessary but where to cut? Interest payments on the national debt are not up for negotiation. Failure to meet those obligations would produce rapid detrimental consequences. Non-discretionary expenditures represent the largest potential for cuts despite legislative difficulties and a political nightmare for any lawmaker foolish enough to try, but from a long term perspective may be exactly what is necessary. Social Security and Medicare outlays begin to increase dramatically by 2020 driven by increasing numbers of retiring baby boomers. This will be a very difficult decision; folks have paid into these programs for decades as a type of insurance for retirement. We may be witnessing the last generation of recipients that will collect the full amount of entitlement benefits as well as an increase in what constitutes retirement age in order to restrain from further deficit spending.

This brings us to discretionary spending of which military expenditures consist of more than 64%. Some sources claim that when military spending ($782 billion) is combined with military related national security expenses buried across all the government departments a more accurate picture of what the U.S. allocates for defense may be as much as $895 billion. The U.S. congress will soon have to decide whether to continue the funding for two potentially unending wars ($136 billion for 2010) while spending more than the next top 15 other countries combined and forward deploying to over 100 bases worldwide all in the name of maintaining a strong “defense” is more necessary than fiscal responsibility. As debt continues to grow many ask if it is necessary to spend $782 billion a year to fight low intensity wars and guerilla insurgents? The cessation of wars in combination with serious analysis of where spending is occurring combined with an assessment of the viability of the programs in a 21^st century environment will soon be required.

Non-military discretionary expenditures represent the final sector that will require budgetary cuts. There are numerous programs here, many essential to the stability of the country and some that have become far too bureaucratic and overfunded. The largest of these programs (25%) include a variety of net safety programs created to provide assistance to low income families and individuals that face financial hardship. Other programs that are currently under scrutiny are listed in the table below. There are numerous places where these programs can be cut. Many programs designed to provide aid in times of temporary hardship have become indefinite sources of social welfare. It will require more independent analysts to determine the realistic cost versus benefits of the programs and what the long term effects of cuts may result. Some programs may actually require increases, for example: additional allocations for programs that support innovation and promising new technologies that if developed would stimulate economic growth and increase jobs.

In light of the information above, increasing tax revenues is unpopular politically and the public is not on board. Some groups would like to see the reduction of entitlement and social programs, while some other groups want to limit what many consider run away military costs. The simple truth is that for our government to become fiscally responsible, all of the above measures, to some extent may be necessary. What is going on with our federal budget is similar to what took place over the past decade with individual citizens, we have been running up our debt and now many of us are faced with the painful challenges of paying off our individual debt or facing bankruptcy and years of poor credit which would effect our standards of living. The U.S. Government is no different, just on a macro scale. It is time to face the hard choices and do what is necessary before our debtors force us to do it and with potentially more painful consequences.

http://www.nationalpriorities.org/

http://www.cbpp.org/cms/index.cfm?fa=view&id=1258

http://www.wallstats.com/deathandtaxes/

http://www.grabgadget.com/wp-content/uploads/2008/11/wallstatsdatlarge.jpg

http://fc00.deviantart.net/fs29/f/2008/140/5/7/Death_and_Taxes__2009_by_mibi.jpg

http://www.mint.com/blog/wp-content/uploads/2009/07/DAT2010mint.jpg

http://www.gpoaccess.gov/usbudget/fy11/pdf/budget.pdf

http://www.gpoaccess.gov/usbudget/fy10/pdf/hist.pdf

http://www.cbo.gov/doc.cfm?index=11659

http://www.factcheck.org/taxes/supply-side_spin.html

Fiscal responsibility is rapidly becoming one of the most important issues facing the United States. Debt is growing at an unsustainable rate and unless decisive action is taken soon time may be running out to voluntarily change the financial course of our future. Failure to reign in debt could lead to a fiscal crisis where investors, both foreign and domestic, lose confidence in the U.S. ability to manage its budget. This in turn, would decrease the value of the U.S. debt financing instruments, i.e. Treasury Bonds, affecting the U.S. ability to borrow at affordable rates and driving up interest rates resulting in either severe inflation or deflation and high unemployment.  Without strict adherence to fiscal responsibility, which at this point equates to cuts in both discretionary and non-discretionary spending and increases in tax revenues, these outcomes may be unavoidable.

One of the main factors for the increasing U.S. debt is our political leaders. The decline of moral and ethical values combined with a lack of fiscal responsibility has produced a decade of unrestrained spending by both parties of congress. Special interest group’s driven primarily by large Multi National Corporations (MNC’s), their associated industries, wealthy investment groups, and a myriad of other interests have purchased and influenced legislation via campaign contributions and lobbying. The result has been a congress more interested in providing for the needs of financial contributors than for the interests of the country at large. This level of corruption has resulted in laws that benefit the short term profitability of these special interests at the expense of the citizenry, which was demonstrated with the inappropriate deregulation of the financial sector which required hundreds of billions in bailouts for irresponsible bankers.

Political maneuvering  that catered to special interests, generated years of reckless spending, and resulted in a disregard for fiscal responsibility has, according to the U.S. National Debt clock, raised the current level of debt (as of October 2010) to $13.5 trillion up from $5.6 trillion a decade ago. Our debt is increasing at a rate of $4.14 billion per day. The U.S. Gross Domestic Product (GDP) the measure of the U.S. overall economic output in 2009 was $14.25 trillion, expecting to increase to $14.7 trillion in 2010. At projected 2010 levels, the U.S. debt will reached 91% of GDP, an already alarming amount that is expected to increase further.

War is another factor that has increased U.S. debt. Wars prior to the Vietnam era were all repaid within a few decades. Vietnam however, saw a change to this practice and “The War on Terror” now called “Overseas Contingency Operations” was the first war in history largely financed through debt while accompanied by a cut in taxes. Combined, the War in Iraq and Afghanistan have already cost over $780 billion to over $1 trillion dollars (depending on the data source). It remains a significant contributor to the increase in debt and despite a troop scale down in Iraq, Afghanistan is ramping up forces and neither war appears to have a realistic end date.

U.S. military expenditures remain the largest source of discretionary spending at $662 billion for 2009 ($782 billion when military related national security costs are included). This expense exceeds the combined military expenditures of the top 15 countries which stand at a total of $611 billion. Cost of “Overseas Contingencies Operations” in both Iraq and Afghanistan for 2009 was $136 billion. There are also additional costs associated with the rapidly increasing use of independent contractors for troop support, logistics, and privatized security forces. These costs are already in the tens of billions and are expected to continue to grow. The U.S. is also overextending foreign operations abroad. The U.S. currently maintains 30 U.S. Air Force Bases or joint Air Bases in 15 different countries, 97 Army bases, command centers, and training facilities in 15 different countries, 16 Marine Corps camps, air stations, and training facilities in 5 different countries, and 16 naval bases, naval air stations, and command centers in 10 different countries.

The third factor contributing to debt is that the U.S. is consuming much more than it produces. This is leading to a massive trade deficit. This deficit increase has gone from 5% of GDP to 17% of GDP in the past 30 years. In our attempts to globalize and ensure free trade many of our largest companies seek access to cheaper labor and resources overseas which limits internal production. The result is that we are not producing at the levels needed to sustain our consumerism while allowing cheap products from abroad to flood our markets. Compounding the problem is the increasing trade imbalance with China, which is concentrating incredible wealth within the Chinese government and is creating a Chinese middle class largely from U.S. dollars, thus transferring wealth away from the U.S. middle class. The results of such imbalances are losses in U.S. jobs and subsequent tax revenues. It is also enabling China, our largest trading partner, the revenue to purchase a greater level of U.S. debt instruments. Almost half of our debt is now foreign owned, and China, owns most of the foreign debt. If we do not change these policies we could become increasingly dependent on other countries, namely China to keep purchasing our debt. When the trade imbalances reach a level where they represent too much risk, a real threat exists that those countries purchasing U.S. debt instruments would stop resulting in a potential devaluation of U.S. Treasury Bonds followed by a rapid drop in the value of the dollar.

There are other factors on the horizon whose long term potential may be as equally devastating as those afore mentioned. Social security surpluses have been used to help decrease the deficit each year, but within the next decade these surpluses will end and instead become possibly one of the largest contributors to the debt. This would be driven by increasing numbers of retiring baby boomers drawing upon their retirement benefits. Equally alarming are long term Medicare cost which are forecasted to dramatically increase due to rising health care costs caused by an aging population, increasing chronic illnesses, and obesity related diseases. If left on its current course, the potential increases in debt could become so deep that our children will experience tax levels prevalent in socialist countries (50% to 60% or more) and the U.S. will be forced into major fiscal reform requiring strict budget controls instead of a planned reform.

There is not going to be an easy or painless fix for the debt despite what congress is trying to portray. Political arguments such as “lowering taxes in the U.S. will lead to an increase in revenues” are unfortunately not a viable solution. Cutting taxes in some sectors such as capital gains and dividends has resulted in additional investing and increased higher tax revenues over the long run. However, the Bush Tax cuts of 2001 and 2003 generated tax revenue decreases from 2001 to 2004 totaling $591 billion when compared to year 2000. The $1,663 billion ($1.66 trillion) tax revenue increases from 2005 to 2009 were barely enough to return to the 40 year national average of recorded increasing tax revenues. This also does take into account the losses on revenue, if the tax cuts had never been implemented, which were $599 billion in only 2004 to 2006. In fact, supply side economics, prevalent in the Reagan and Bush era’s, which has been accurately associated with increasing GDP, tax revenues, corporate profits, and individual wealth has also during those same periods drastically increased the U.S. debt, and for the first time in U.S. history those increases came during peacetime.

The debt problem has become deeper than what the media and pundits are claiming. Many think that if The U.S. can stop wasteful spending, repeal pork barrel projects and earmarks, do away with the Bush tax cuts, and even end the wars in Iraq and Afghanistan, the U.S. should be well on its way to stopping a future potential debt crisis. That ship may have already sailed, and much more may be required. The true debt is in reality much higher than the $14.5 trillion dollars that has been disclosed on the world debt clock. If one considers the off balance sheet figures, there already exists at this point $7 trillion in unfunded obligations for Social Security, $26 trillion in unfunded Medicare promises, $8 trillion yet to be paid for the new prescription drug program and another trillion in miscellaneously unfunded items. This equates to over $55 trillion in real debt.

Under the current spending practices, even with the Obama stimulus programs removed from the equation, within 40 years (2050) this country may be barely able to pay the interest on its debt and only a small percentage of social security and Medicare. By 2040 the debt to GDP will be over 200%. Unfortunately, The U.S. would probably have declined into severe inflation before then. The U.S. congress must act now, it can no longer afford either runaway spending to accommodate the needs of special interests or indefinite and costly wars if there hope to reign in fiscal deficits and stop a potentially looming fiscal crisis. In addition, the U.S. should not continue the trade imbalances of the past. There may come a time of reckoning and a point when carrying to much debt and spending too much of GDP on interest payments could force foreign lenders to look for safer investments.

To reestablish fiscal responsibility would require cutting programs across the board, even in the politically unpopular areas like military spending, Social Security and Medicare. And equally important, reign in the increasing costs of health care. The ineffective “do nothing” plan of the past decade must be thrown out or the next generation of U.S. citizens could experience a lower standard of living as compared to what we currently enjoy today. Politician’s can no longer demand lower taxes while both political parties massively expanded government and increase spending. The recent recession has taught American consumers to finally begin to save more and it is now time that government officials follow suit. The U.S. should not continue to print money and issue treasuries without legitimate concerns about devaluating the dollar and experiencing high rates of inflation, or a potentially worse scenario such as deflation. Either outcome generally results in increased interest rates, less borrowing, and rising unemployment.

Congress needs to step away from practices that disproportionately benefit financial contributors and constituents and start doing what is right for the country. Since it appears unlikely that Congress, being so beholden to special interests and to concerned with reelections will be able to make the necessary politically painful decisions, it will be up to the American public to stop listening to pundits and talking points designed to keep the status quo in place and become the ones responsible for demanding fiscally appropriate action out of congress.

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