Avoiding Economic Armageddon

Avoiding Economic Armageddon

© David Burton 2012

Government Agencies

     The 2012 elections have come to an end. President Obama has been re-elected, the Democrats control the Senate and the Republicans control the House of Representatives. So be it. Congratulations to the President, the Vice-President and to all the other election winners!

     The time has now arrived for everyone to put aside political bickering and focus on the economic problems facing every one of us. This means Democrats, Republicans, Rainbow Coalition members, Green Party members, Socialists, Tea Party members, Independents, and everyone else that isn’t a member of any of the aforementioned groups. We either work together or we go down the toilet together. No more posturing; no more rhetoric; no more line-in-the-sand positions; no more “it’s my way or the highway”; and no more “them vs. us”! We are all Americans. We are all part of the United States.

     In order to avoid falling off or rolling down the fiscal cliff, all parties must agree to put aside their untenable positions. There must be increases in government revenues – call it a tax increase; call it elimination of tax loopholes; call it anything you want – but the truth remains – the government needs more revenue in order to pay off the debt and to continue to function. If this can be accomplished without raising tax rates, so much the better. If this can only be accomplished by raising tax rates, then tax rates need to be increased.

     There must be a decrease in government spending – everyone must share in the pain, and there will be considerable pain. We either bite the bullet now, endure the consequences of the needed budget cuts or we suffer a far worse fate later down the road. We need look no further than to Greece, Spain, Italy and those other countries that have spent more than they could afford to see the consequences of profligate living.

     America must be weaned off the entitlement and handout culture that has arisen over the past decade or two. Our addiction to unlimited government spending without a commensurate increase in revenues must be put to an end. Withdrawal from an addition is very painful and traumatic, but to continue with an addiction will ultimately prove more painful, if not fatal.

     The “fiscal cliff” awaits us if we keep on bickering. The simple facts are as follows:

  • The United States has now run up a deficit of more than $16.2 trillion, which means that every citizen of the U.S. is now in debt to the tune of over $51,600 and every single taxpayer in the U.S., rich or poor, owes more than $141,700. (Ref. 1)
  • Debt held by the public is currently about 72 percent of Gross Domestic Product – the highest in 62 years. It has doubled in the last five years. (Ref. 2)
  • Government outlays were $3.5 trillion in the 2012 fiscal year, and receipts totaled about $2.45 trillion. This means that our government spent more than a trillion dollars more than it took in in FY 2012. The federal deficit was $1.1 trillion in the 2012 fiscal year, down from about $1.3 trillion a year earlier. This is the fourth year in a row that the deficit has exceeded $1 trillion. Before the recession, the deficit had never exceeded half a trillion dollars. . The gap between government receipts and government spending was about 7 percent of economic output in the 2012 fiscal year. (Ref. 3)
  • The U.S. will pay “more than $5 trillion in interest payments over the next decade.” Over the next ten years, “more than 14% of all revenue the government is projected to collect will be sucked up by interest payments.” Between 2013 and 2022, estimated interest costs will be: higher than Medicaid spending; equal to half of Social Security spending; close to what is spent on all of defense. Also, “a lot of the money paid in interest will go abroad . . . That's because more than 40% of the country's public debt is owed to institutions and individuals outside the United States.” (Ref. 4)
  • In 2012, the GDP increased at a rate of only 1.3 percent in the 2nd quarter and 2.0 percent in the third quarter. (Ref. 5) Historically, from 1947 until 2012, the United States GDP Growth Rate averaged 3.25 Percent. (Ref. 6) GDP growth rates must return to the 3 to 4 percent range.
  • “Official” unemployment as of November 2012 was 12.1 million (Ref. 7 ) or around 8% (closer to 14% in reality). The “official” unemployment rates from 2008 through May of 2012 are: 2008: 5.0%; 2009: 7.8%; 2010: 9.7%; 2011: 9.1%; 2012: 8.2%. The “real” unemployment rates from 2008 through May of 2012 are: 2008: 9.2%; 2009: 14.2%; 2010: 16.7%; 2011: 16.1%; 2012: 14.8%. (Ref. 8) The “official” unemployment rate must be reduced to the 5 to 6 percent level, or better.
  • While the “official” unemployment rate in the overall economy has grown from 5.0% in 2008 to 8.2% in May of 2012, the number of government workers has remained essentially unchanged from 22.4 million in 2008 to 22 million in May of 2012. (Ref. 8) This means that essentially all unemployment has occurred in the private sector.
  • Unless Congress and the president act by the end of 2012, there will be “a return to recession and an increase in unemployment from 7.9 percent to 9.1 percent next year, with the typical household paying an additional $3,500 in taxes.” (Ref. 9)
  • Under current legislation, if nothing is done, virtually all tax rates will rise, sucking more than 3% of GDP out of households and businesses. In addition, automatic cuts in government spending on defense and non-defense programs will subtract nearly another 1% of GDP in 2013 and similar amounts in future years. The Congressional Budget Office warns that falling off the fiscal cliff would push America’s economy into a serious recession next year. (Ref. 10)
  • The United States has an enormous fiscal deficit – now about 7% of GDP and predicted to grow rapidly in future decades as an aging population and rising health-care costs increase government outlays for the “entitlement programs” that benefit middle-class seniors. Although politicians recognize that these programs’ growth must be slowed to avoid massive deficits or very large tax increases, their growth is unlikely to slow enough to prevent the national debt/GDP ratio from rising. (Ref. 10) At the least, the growth of “entitlement programs” must be slowed. Better yet, their growth must be stopped or reversed.
     In the future, under normal conditions, the government’s annual budget must be balanced. But today we do not have normal conditions. Until the debt is substantially reduced there must be a budget surplus.

     Congress and the President need to move beyond catch-phrases, such as:

Closing tax loopholes: “This is a favorite of both parties, but these days it is being used mostly by Republicans who are looking for an alternative to raising tax rates on high-income households.” The phrase appears regularly in Republican Speaker of the House of Representatives, John Boehner’s presentations.
     “It is true that the tax code includes loopholes that should be closed. But these are narrow and usually unintended gimmicks that allow a handful of sophisticated taxpayers to avoid tax.
     “Congress will need to raise more than half-a-trillion dollars over a decade to protect top-bracket taxpayers from Obama’s plan to let their tax breaks expire without adding to the deficit. To get there, it will need to cap popular, broad-based tax preferences, such as deductions for mortgage interest, charitable giving, and state and local taxes. It isn’t going to get far by closing a few loopholes. [Emphasis mine]

Entitlements: “When politicians use the word entitlement, they really mean Medicare, Medicaid, and Social Security. At least two of those programs, Medicare and Social Security, are enormously popular. So nobody talks about slowing the growth of these senior health care and pension programs. “Entitlement” carries with it a sense of privilege and greed. So much easier to cut entitlement than to trim promised Social Security benefits.” [Emphasis mine]

Shoring up entitlement programs: This is another Boehnerism. It is not enough, it seems, to say entitlement instead of Medicare and Social Security. Now, pols insist they are “shoring up” these programs when they really mean they want to trim promised benefits.” [Emphasis mine]

Making people like me pay a little more: This was an Obama favorite in the campaign. And it never seems to go away. The Tax Policy Center estimates the top one percent of households (who make an average of about $1.7 million) would end up paying almost $94,000 more in taxes under Obama’s 2013 budget, or about 6 percent of their income. I know these folks make a lot of money, and probably can manage this higher tax bill, but a nearly six-figure tax hike is a tad higher than “a little more.” [Emphasis mine] (Ref. 11)

     “The Republican position is that no taxes should ever be increased and that the budget can and should be balanced with spending cuts. That is impossible.” (Ref. 11)
     “The Democratic position is that we should increase federal spending and increase taxes, but only on the very rich. That is an important point because the Democrats are not willing to let all of the Bush temporary tax cuts expire and return to the broad tax base that gave us balanced budgets in the Clinton years.
     “How much would raising taxes on the very rich help the deficit? Here is the answer from an editorial in the New York Times: ‘Letting all of the cuts expire at the end of 2012 would save $3.8 trillion over the next decade. Letting the tax cuts expire for those making more than $250,000 would save $700 billion.’
     “Now, $700 billion over 10 years is only $70 billion a year, truly a drop in the bucket and inconsequential in terms of the trillion-dollar-plus annual deficit. The effect of raising taxes on the very rich is mainly symbolic and will not reduce the deficit very much.” (Ref. 11)
     “Raising taxes on the very rich sounds good in speeches but won't make a significant dent in the deficit. (Ref. 11) If taxes need to be raised, then they will have to be raised on everyone!

     “All of this rhetoric is intended to make deficit reduction sound painless.” It won’t be! It will be painful to just about everyone. Strong medicine tends to be bitter and the side effects can be unpleasant. But in the end, strong medicine is what’s needed to cure the malady. We just can’t take an aspirin and call the doctor in the morning. Our lawmakers have some obligation to prepare {the American public} for what will be some tough decisions over the next few years. Honest talk is a good way to start.” (Ref. 12)

     Both extreme positions - Democratic and Republican – are likely wrong. The real solution realistically lies somewhere between the two positions.


     If our elected officials act in a responsible manner, what should we expect? We should expect some, or all of the following to happen, plus a few more actions that I haven’t thought of:
  • Nearly everyone’s taxes should increase. This includes “the rich”, “the not-so-rich”, and the “middle class”. These increases may not be called tax increases, but our tax payments will go up.
  • Government spending should decrease. This spending reduction will have to occur in many popular “entitlement programs”, as well as in many, if not most, other government programs.
  • Benefits for the already-retired and ready-to-retire and for the truly needy should be untouched. The rest of us can expect to lose benefits or see them reduced. Should someone who is able to work collect unemployment because he/she would rather be paid to not work? Should the elderly hide or gift their savings so as to have the government pay all their nursing home costs instead of first paying for nursing home costs with their savings and then receiving government assistance when their savings are exhausted? Do the truly needy need food assistance money to buy cigarettes and alcohol?
  • Government employment should decrease.
  • The Tax code should be simplified, “tax loopholes” eliminated and tax rates should be adjusted so that American companies are not at a disadvantage relative to foreign competitors. Many special features of the tax code are equivalent to government spending. If I buy a hybrid car, install a solar panel at my home, or upgrade to a more efficient water heater, I get a tax credit. And if I buy a bigger home or just increase the size of my mortgage, I receive a larger deduction that reduces my taxable income, lowering my tax bill. While the government is not giving me money, these special targeted tax breaks are no less “government spending” than they would be if the government sent me a check. While these features may be called “tax expenditures,” eliminating or reducing these tax expenditures would cut government spending. Although the effect is to raise revenue, that is just an accounting convention. The fundamental economic effect is to reduce government spending. (Ref. 2)
  • “The debt share of GDP must decline steadily.” (Ref. 2)
     Will the elected officials in Washington stop the partisan politics that have been an unwelcome feature of modern American government? Can the Republicans and Democrats come to a reasonable accommodation? “A deal is easy if Obama stops obsessing about tax rates.” (Ref. 2) Let’s not forget - It is the tax revenue that is crucial and not the tax rate!

     A deal is easy if the Republicans stop obsessing about “no tax increase.”

     A deal is easy if both Democrats and Republicans remember their obligations – it’s to the American people and not to their political parties.

     One possible compromise in the tax debate would be to “cap” the benefit that individuals could get as a percentage of their total income (their “adjusted gross income,” or AGI). Applying a 2%-of-AGI cap to the total benefit that an individual can receive from tax expenditures would have a very powerful effect. For someone with a 15% marginal tax rate, a 2%-of-AGI cap would limit total deductions and exclusions to about 13% of AGI. Even if the cap were applied only to “itemized deductions” and the health-insurance exclusion, it would raise about $250 billion in the first year and about $3 trillion over the first decade. There are many options in designing such a policy. The cap rate could be higher, or it could start higher and be gradually tightened, or it could vary with an individual’s income level. (Ref. 10)

     Because neither the Obama administration nor Congress wants to be responsible for pushing the country over the “fiscal cliff,” it’s highly likely that “the fiscal cliff will be addressed before the end of 2012. At the same time, given the lame-duck session’s short time frame, the prospects for a “grand bargain” that provides a comprehensive solution to tax, deficit and entitlement issues are minimal at best. Rather, it can be expected that Congress will “kick the can” with an agreement for a short-term delay of the fiscal cliff’s component parts, thereby providing time for the parties to negotiate a more complete and long-term fix in 2013.
     A six-month extension has the greatest likelihood of being adopted during the 2012 lame-duck congressional session, as Democrats will likely view a 12-month extension (the Republicans’ preference) as too long. President Obama and the Democrats will be motivated by a desire to avoid a protracted and potentially devastating debate over an increase in the debt ceiling limit. Congressional Republicans want an extension of Bush-era tax breaks for taxpayers at all income levels, as well as a delay in military spending cuts forced by sequestration. While neither side will fully embrace the lame-duck deal, it is nonetheless the easiest path to negotiate at this late stage of the 112th Congress. (Edited and abbreviated from Ref. 13)

     Assuming this Congress delays the timing of the fiscal cliff and increases the debt ceiling to cover another 12 to 24 months, the 113th Congress will face the task of addressing tax and spending issues in a more permanent manner. This obligation should lead to a serious effort at meaningful tax and budgetary reform beginning early next year.
          - - -
     On the business side, a reduction in the corporate tax rate is possible.
     With respect to individual taxes, the income tax code needs to be simplified. Simplification could take the form of lower marginal rates coupled with a broadening of the tax base. Such a broadening could affect capital gains and dividends rates, municipal bond treatment, and other tax benefits enjoyed by individual taxpayers.
     Tax reform for simplification’s sake is important. President Obama campaigned on the need to increase marginal rates on upper-income earners as a way to promote tax “fairness” and generate revenue. The administration will likely pursue this brand of tax reform as a key element of its deficit reduction plan. Congressional Republicans, on the other hand, oppose any increase in marginal rates, and instead hope to couple spending cuts with tax simplification that is focused on lower rates and an expanded tax base—to facilitate economic growth while maintaining or increasing overall revenues at today’s percentage of our economy.
     Tax reform may be achievable in the 113th Congress, but compromise between the White House and congressional Republicans is needed. Ultimately what is needed is a compromise that addresses tax, spending and entitlement issues in a single legislative package. (Edited and abbreviated from Ref. 13)

     “House Republicans have a majority and some leverage, but cannot hope to prevail on all fronts. They may decide that higher tax rates are tolerable if they can make significant progress toward spending discipline and changing the trajectory of entitlements.” (Ref. 14)

  1. U.S. Debt Clock, http://www.usdebtclock.org/, Accessed 13 November 2012.
  2. Getting serious on debt, Op Ed, Boston Herald, Page 12, 17 November 2012.
  3. Federal Deficit for 2012 Falls to $1.1 Trillion, Annie Lowrey, The New York Times: Business Day, 12 October 2012.
  4. Washington's $5 trillion interest bill , Jeanne Sahadi , CNN Money: http://money.cnn.com/2012/03/05/news/economy/national-debt-interest/index.htm, 12 March 2012.
  5. United States GDP Growth Rate, Trading Economics: http://www.tradingeconomics.com/united-states/gdp-growth, Accessed 13 November 2012.
  6. National Income and Product Accounts Gross Domestic Product: Third Quarter 2012 (advance estimate), U.S. Department of Commerce: Bureau of Economic Analysis, 26 October 2012.
  7. Jobs Report: U.S. Economy Adds 114,000 Jobs In September; Jobless Rate Down To 7.8 Percent , Christopher S. Rugaber, Huffington Post – Business: http://www.huffingtonpost.com/2012/10/05/jobs-report-unemployment-rate_n_1942067.html, 6 October 2012.
  8. A scorecard on the economy under Barack Obama, Louis Jacobson, PolitiFact.com (Tampa Bay Times), 1 June 2012.
  9. President Obama claims election mandate to tax the rich to avoid 'fiscal cliff', Joseph Straw, New York Daily News, 9 November 2012.
  10. Fixing America’s Fiscal Problem, Martin Feldstein, Project-Syndicate; http://www.project-syndicate.org/commentary/us-obama-romney-entitlements-cliff-by-martin-feldstein, Page 12, 30 September 2012.
  11. GUEST COLUMN: Both Democrats, Republicans have created America's economic crisis, Harold T. Muir, Heritage.com: http://www.heritage.com/articles/2012/08/25/opinion/doc5038e6bb22a75624573163.txt, 25 August 2012.
  12. Weasel Words Atop Fiscal Cliff: Congress Can't Avoid Tax Hikes By Closing 'Loopholes', Howard Gleckman, Forbes, 13 November 2012.
  13. A Post-Election Look at Fiscal Challenges, Andrew Michienzi, investor Insights; Morgan Stanley Smith Barney Newsletter, November 2012.
  14. Give ground to avoid ‘fiscal cliff’, Op Ed, Michael Barone,Boston Herald, Page 23, 20 November 2012.


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