The Skeptical Optimist

Growth versus class warfare in the tax system debate

"Don't tax you, don't tax me.  Tax that guy behind the tree."
—Russell B. Long 

It should be obvious by now that no tax rate increase is necessary to "fix" our current fiscal situation; economic growth is making the deficit disappear.  The economy should soon be growing faster than the debt, which will make the debt clock (at upper right) tick backwards.  The power of economic growth, I hope by now, is unarguable.   

How might our leaders enhance the private sector's ability to grow the economy?  Growth-minded people invariably agree that one of the biggest obstacles to growth is the complexity of our tax system; simplification, one way or another, would be very growth-friendly, for about a million reasons. 

Unfortunately, growth-friendly tax simplification ideas face formidable political opposition, fueled by extremely effective class warfare rhetoric.  Although there are several proposals for simpler tax systems (e.g., single- and dual-rate flat tax, sales tax, and others), the single rate flat tax proposal will serve as a good example of how we might overcome the stalemate and rid ourselves of the status quo tax system we're saddled with.  Here's the single-rate flat tax example...

Proponents of a single-rate flat tax lead with their strength: simplicity. 

It's so simple, all it takes is a postcard-size form to do your taxes each year.  All income over and above an exempted amount is taxed at the same flat rate, no matter how much you make and no matter who you are.  The private sector can stop wasting resources on tax compliance and redirect those resources to innovation, job creation, and growth.  Because every taxpayer pays a single marginal rate, the divide-and-conquer class warfare strategy would no longer be available to tax-hiking lawmakers—because a rate increase would affect every taxpayer, not just a small fraction of them.

Opponents immediately counter with their strength: class warfare. 

Tax system fairness requires progressive tax rates, not a flat rate; the rich can and should pay a higher percentage.  A flat tax would cause a huge shift of the tax burden from the rich to the middle class and poor.  Besides, a flat income tax does nothing about the regressive payroll tax, which is especially unfair to the non-rich.  We will fight the flat taxers with everything we've got, to protect the middle and low income taxpayers, and make sure the rich are shouldering their fair share of the tax burden.

History tells me that this particular duel is a stalemate.  Result: We are still saddled with the status-quo.  But I strongly dislike the status-quo, and prefer a more growth-friendly, special-interest-unfriendly taxation system, so I took some time constructing the beginning of a compromise that would address most of the purported concerns against the idea. 

The basic idea of the compromise is to retain the growth-friendliness of the proponents' ideas while deflating the opponents' purported objections.  For starters, we need to include the payroll tax in the analysis instead of isolating just the income tax.  Here's a chart showing total tax dollars paid by a self-employed individual for various levels of taxable income (note the hypothetical income tax scenario at bottom of chart):

The higher one's income, the more tax one pays.  No surprise there.  But look at the bend in the payroll tax line.  That's where the FICA tax stops, even though the Medicare tax keeps going.

Now the bad news: look at how that translates into effective tax rates.  Although the effective rate on the so-called flat income tax is progressive, due to the exempted amount, the regressive payroll tax drags the total tax into a regressive shape.  As history has demonstrated, that is politically untenable. 

If growth-minded people can't think of a way to fix the total-tax regressivity, we might as well get used to the status quo.  I don't care how good the economic argument might be, because politics trumps economics.

But guess what: I thought of a way to fix it (...and yes, it requires a change of thinking on both sides).  To get the desired flat rate on the income tax side (above the exempted amount), replace the payroll side's regressive rate with a revenue-neutral, reduced flat rate that never runs into a cap.  Here's the result (for the hypothetical scenario):

The entire system is progressive, because the payroll tax is no longer regressive; admittedly, we'd have to reconstruct the explanation of FICA taxes paid in versus SS benefits paid out, but that was coming our way within a decade or two anyway.  Is the system not progressive enough?  Okay, then tweak the exemption amount to adjust that.  Still not progressive enough?  Okay, then think up a rebate scheme on the spending side of the budget.  Just do something, because the additional growth this would foster would pay for any transition headaches many times over.

Last but not least: My fear
The above measures are economic remedies for the purported flaws in the single-rate flat tax system chosen for this illustration.  What I fear is that the true agenda of the opponents of tax simplification is not above-board economic concerns, but hidden political concerns.  A simplified tax system would shift power from favor-dispensing lawmakers to a huge, unified block of private sector taxpayers, all of whom pay a single flat rate (above the exempted amount).  That would be a double-whammy to power-broker politicians experienced in working today's complex system: it would mean (1) more difficulty dispensing tax goodies to special interests; and (2) more resistance to any proposal to increase the single tax rate (i.e., all taxpayers, not just a small group, would protest).  That's a double-whammy that many politicians would find impossible to take.  But at least we'd flush out the true agenda by proposing the compromise, wouldn't we? 

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End note:
I've been writing for years about why growing incomes and productivity are so important to our economic future; it's time I started addressing how our government could help the private sector enhance our country's economic growth rate.  This is the first article in a series I've been planning on the subject of taxation systems.

Deficit Watch, July 2007

This is very strange: The White House has "lowered" its deficit forecast for fiscal 2007 to $205 billion. 

The White House must be looking at a different set of numbers than the Monthly Treasury Statement I'm looking at.  Not only is the most recent 12-months' deficit of $163 billion already a lot lower than $205 billion, it is also trending toward $135 billion three months from now (...at which time the "most recent 12 months" happens to coincide with the official "fiscal year"). 

The White House's $205 billion forecast is foreboding to me, because if correct, it would mean that we are in for a sudden and unpleasant change in trend for tax receipts or outlays (or both) within the next ninety days.  The simple diagram below illustrates my point: to change a favorably-trending 12-month deficit from $163 billion to $205 billion in three months, something dramatically negative has to happen very soon.

I doubt that's the problem, though; it's rare for a rolling 12-month trend to reverse itself so sharply and suddenly in the absence of some kind of unexpected shock.  I therefore suspect one of two things: (a) intentional padding of the deficit forecast—unsurprising in the game of politics—or (b) unintentional padding due to excessive caution by those calculating the forecast. 

In either case, I think the deficit for fiscal 2007 will be a lot lower: $135 billion (i.e., a harmless 1.0% of GDP).  I also see that if the current trends continue, the unified budget would move into balance in October 2008.  [The Democrats are still saying there's "no way" the budget will balance even by 2012; I don't know which numbers they're looking at, either, but I will be listening closely to their reaction if the budget does balance in 2008 or 2009.] 

Here's the usual chart; click to enlarge. 

Unfortunately, I can think of several things our politicians could do in the interim that would unfavorably disturb the current trends.  As a result, I'll refrain from making "budget balance in 2008" my official forecast until a few more months of momentum make the trend virtually impervious to political blunders.  But I do remain optimistic that the disappearing deficit we are witnessing under the current tax rate structure will become undeniably obvious to every voter prior to the 2008 elections.

International Debt Thermometer

It's been a year since I posted this snapshot of how various countries rank on the debt scale, according to the CIA World Factbook, so it's time for a refresh. 

This is usually a pleasant surprise to anyone who's been hearing about the USA's "crushing" debt burden from people who don't place it into proper context.  And it's usually an unpleasant surprise to those who like to use fear of debt as a political lever, and therefore intentionally refrain from placing into context. 

Although the USA's "total" national debt is 66.3% GDP (see note 1 on the graphic; it's based on the "$9 trillion debt" that always appears in the headlines), the more important number is the publicly held debt level of 37.5% GDP (see note 2), for reasons I've explained many times at this blog. 



After WW-2, publicly held debt was 121% GDP; although the debt level has increased many times over since then, the debt ratio has dropped to 37.5% because of sixty years of economic growth.   

By the way, I haven't found anyone yet who can justify an estimate as to how high that ratio could go before the markets would start giving unmistakable negative signals, and that includes me.  At least we know that our current debt level is perceived favorably, because interest rates, inflation rates, and exchange rates are remaining steady in safe territory.  I've always wondered if a ratio of 150% or more might be a tipping point (still lower than Japan's)—but am not sure I want to find out empirically.  I do think 40%-80% would be a good target for objective, long-term fiscal policy—even though I have no argument as to why 80% should be a ceiling, and little hope of finding objectivity in the fiscal policy debate, especially in an election year. 

In any case, the USA appears to be in very safe territory—especially considering that the outstanding public debt is denominated in US dollars. 

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End note:
The data came from the CIA World Factbook's Public Debt Ranking page.

If you have questions about any of the numbers, especially Canada's number (which is always controversial for some reason), please take it up with the CIA Factbook folks.  Last year I tried several times, with no success; maybe you'll have better luck than I did.

Deficit Watch, June 2007

The latest Monthly Treasury Statement shows that the trend towards a balanced budget has a little less momentum than last month.  October 2008 is when revenues and spending would move into balance if the latest trends continue.  (For the last two years, the projected balance date has been oscillating between early 2008 and mid 2009.)

Here's the usual chart; click to enlarge:

On the spending side, I thought the following numbers were interesting. 

• Military, most recent 12 months:
$520.2 billion, growing at 4.7% annual rate.

• Dept. of Health and Human Services, most recent 12 months:
$660.4 billion, growing at 9.2% annual rate. 

Seems to me the HHS numbers are not getting their fair share of attention from the spending-conscious mainstream media.  Or maybe I'm not checking the right news outlets(?).

Taxpayers "on the hook for $59 trillion." Wait; is that a big number, or a small one?

USA Today's reporter Dennis Cauchon knows how to sell newspapers: just put a huge-looking number like "$59 trillion" in a headline about how much US taxpayers will have to come up with to cover social insurance programs.  Here's the article that got so much attention yesterday. 

Conspicuously absent was any mention about how much time taxpayers would have to come up with the money, or the estimated tax receipts that would flow into the government over that time period. 

I hunted and hunted in Cauchon's article for a reference or link to those (and other) important assumptions behind the $59 trillion; no luck.  Then I hunted and hunted for Dennis Cauchon's email address or telephone number, so I could ask him directly; no luck there, either.

I hope he sees this article, so he can send me an email explaining those important little tidbits behind their analysis.  Reason: Just as any mortgage holder plans to pay the mortgage gradually over a period of years out of future income—instead of coming up with the money tomorrow—so does the federal government plan to pay the social insurance costs gradually over a period of years out of future tax receipts—instead of coming up with the money tomorrow.  The scary-sounding "unfunded promises" really means "future costs to be funded out of future tax receipts"—although the article doesn't explain that. 

Just for fun, I added up how much tax revenue the federal government would collect between now and 2052 (the approximate timeframe it looks like USA Today's analysis covered), for various productivity growth scenarios.  After verifying the timeframe, all I'll need to know is the discount factor USA Today used on the way to their $59 trillion result.  After that, we can see what portion of future tax receipts will be required to pay the future social insurance costs.  For reference, it takes 15% of tax receipts today. 

If anyone knows Dennis Cauchon's email address or telephone number, please send it to me via private email.  My gut feel is that $59 trillion will look small compared to tax receipts over the same time period, using reasonable assumptions about productivity growth, but I can't confirm or disprove that without some help from him. 

Until then, I'll have to file this story in the folder I titled "Single Entry Accounting."

It's productivity, stupid.

Which economy will our grandkids inherit from us: Doomsday, or Easy Street? 

Here's a hint, inspired by a successful political campaign mantra designed to keep the candidate on-message throughout the 1992 campaign:

It's productivity, stupid. 

This article is a follow-up to "The Baby Boom Crunch" I posted last week.  Click on the thumbnail below to watch a movie about the effect productivity will have on our grandkids' economy—in spite of boomer retirements and Medicare cost escalation. 

The Baby Boom Crunch, part 1

According to the doom peddlers and their faithful scribes in the popular press, Medicare and baby boom retirements will be the one-two punch that puts our grandkids in the poorhouse.  If I remember their message correctly, our grandkids' tax rates will have to be a hundred percent or so just to cover the interest on the debt; there won't be anything left for national defense, education, or social security—let alone for building walls to keep people out, or for subsidies to automakers for reducing CO2 emissions.  In short, it sounds bleak.  And it's all my generation's fault... supposedly, anyway. 

So, I decided it was time to look into this topic, too.  [Whenever I do that, surprises invariably surface.]  This article is the first of two or three (TBD); It's just a concise depiction of the demographics problem everyone has been fretting about.  The two charts below show that, when we baby boomers retire, we will automatically increase the percentage of social-insurance-collecting retired people, and reduce the proportion of FICA-paying working-age people. 

The US Census Bureau has projected the population two ways: total including net immigration, and total assuming zero cross-border migration.  The boomer crunch happens largely between 2010 and 2030.  If zero migration is assumed, the crunch is more pronounced—obviously because there would be fewer working-age people to produce the goods and services necessary to support my generation in our retirement years (to the degree we so richly deserve). 

Contrary to what we hear from the popular press, the important question is not "How much will we have to raise taxes, assuming GDP growth of 2.5%?"  The important question is, "What kinds of productivity growth, income growth, and taxation structure would make this problem go away?" 

I'll be ready to tackle that question in a few days.

Deficit Watch, May 2007

The trends for spending and tax receipts improved versus last month.  At this rate, the budget would balance in April 2008.  Here’s the monthly chart; click to enlarge.

There are three main reasons I’d love to see these trends hold up, in this order:

1.    Partisans on the left would lose the “justification” they’ve touted publicly for tax hikes in 2010; namely, “fixing the deficit.”  If they still wanted to hike taxes, they’d be forced to think up a different reason;

2.    It would happen in time for the party conventions and fall ’08 campaign; tax-hiking politicians would then have a lot of on-camera stuttering to do;

3.    I would win a thousand dollars worth of treasury securities (“national debt”) for my granddaughter’s education fund.   

Any time now, the overwhelming importance of economic growth should be working its way into the so-called "fiscal responsibility" debate, ending the false-dilemma we’ve been saddled with for so long.  At last, it would become a three-way debate: “raise taxes” versus “cut spending” versus “grow the economy.” 

I’m keeping track of the ideas coming from both sides of the presidential race regarding “growing the economy.”  So far, just a few Republicans are the only ones who seem to think it deserves a spot on the talking points list.  I expect the Democrats to wake up sometime soon, however, now that the evidence is near-undeniable. 

A brain-teaser on deficit spending for the GAO and CBO

As I was exchanging emails with a friend and monetary expert, we came across some puzzling assertions by the GAO (Government Accountability Office) and the CBO (Congressional Budget Office).  Both organizations were saying the same thing in two separate documents intended to “help” the public understand federal debt. 

Unfortunately, we had to conclude that the opposite of “help” was achieved by those documents. 

Below are two puzzling passages, one from each; both are marked up with the same simple question.

First the GAO document (see p.6):

Next is the CBO document (see p.1):

Now for the brain teaser.  The diagram below should be self-explanatory.  I hypothesized the tax and spend amounts so that each arrow could represent a half-trillion dollars worth of financial flow. 

The challenge is to find the financial resources that have been “absorbed” by the federal government.  I bet you can’t—and I bet nobody at the CBO or GAO can, either.

Not only does deficit spending not absorb financial resources from the private sector, it creates additional financial assets.  Those additional assets are in the form of Treasury securities (“future money”).  And when the private sector grows the real economy at the same rate the Fed turns those new bonds into real money, inflation remains under control while the nation gets wealthier—in both real and financial terms. 

When do you think the GAO and CBO will correct their “help” documents?

Six indicators—okay, nine

A reader asked me what I thought were the most important indicators of the nation’s economic and financial health.  I quickly rattled off six of them, sent the email—then contemplated that list for a few days, spotted a weakness, and added three more. 

Here are what I consider the six most important indicators of the USA’s financial health—the ones I rattled off at the beginning of this three-day exercise—with some brief remarks on each.  These are not prioritized; in my head, they are all tied for first place.

1.  Interest rate on the 10-year Treasury note.
An indicator of the world’s investors’ opinion of the dollar and the safety of US Treasury securities. 

2.  Inflation rate.
An indicator of the value and stability of the US dollar, and therefore of our economy’s ability to support the value of the dollar.  (If only there were a single reliable reading on current inflation, let alone a predictor of future inflation . . . but there isn’t, so I track several inflation indicators.) 

3.  Foreign exchange rates.
An indicator of our trading  partners’ opinion of the dollar’s current and future value, and therefore of the strength of our economy now and in the future.   

4.  Size and growth rate of real GDP, and real GDP per capita.
Indicators of the wealth-creation performance of the US economy.  (If only we were a little better at isolating quality improvements from true price inflation, we’d be better at deriving “real” GDP from nominal GDP.)

5.  Net interest as a percent of federal tax receipts.
An indicator of the federal government’s creditworthiness.  The inverse of “times interest earned.”  (A purer indicator than #6, I think, but not as well known.)

6.  The ratio of nominal federal debt to nominal GDP.  A proxy for #5.  Some say “publicly-held debt” is the important numerator—but I prefer to track that ratio and the “total debt” ratio, because demographics are likely to begin transforming intragovernmental debt into “publicly-held” debt rapidly within the next two decades.  See the debt clock at the upper right of this page.

[Each one of those six deserves at least a full article; this is just a quick summary.]

I thought about that list for three days, and noted that, for the most part, they are snapshots of the bottom-line results of years, even decades, of momentum driven by the marketplace and tweaked by policy decisions.  That snapshot was a little weak on indicators of the underlying causes.  Trends are easy to calculate for GDP, tax receipts, spending, etc., but mechanical extrapolation always gets more dangerous the farther out one extrapolates, unless one has a thorough grasp of the underlying drivers.  (I keep my fingers crossed when I extrapolate out eighteen months; any guess what I think about CBO projections looking thirty years out?)  Anyway, I decided I should add three or four more indicators to provide a few sanity checks regarding the underlying strength of the economy—the fundamental driver of every one of those six indicators.  Here are the sanity checks I decided to add:

•  Productivity (real output per labor hour).
This will be a key factor in how well we pull through the coming demographic changes.  (Again, if only we were better at measuring inflation, we’d have a better handle on this one.)  Capital productivity might deserve a place on the list, too.

•  Employment levels and trends.
Indicates how well our creative destruction process is working; i.e., how much faster we create new, better jobs than we destroy or export old, obsolete jobs. 

•  Unemployment levels and trends.
Those who are in the job market but don’t have jobs aren’t producing much GDP (…duh), or consuming as much; as a result, the measurable economy isn’t as strong as it could be. 

Again, those three extras will help shore up any tentative conclusions I draw from the first six. 

Notice anything that’s absent?  If so, feel free to add a comment below—although I must point out that I rejected several headline-grabbing stats, intentionally, right off the bat.  Examples:

• dollars of debt outstanding;
• dollars of interest payments;
• debt held by foreigners;
• the size of the fiscal deficit;
• the size of the trade deficit; and
• the value of trust fund “IOUs.” 

Reason: those headline-grabbers are large numbers with no context; they are emotional diversions resulting from single-entry accounting, which—notwithstanding its vitality in the world of propaganda and political rhetoric to this day—died a well-deserved death in the objective accounting world nearly five hundred years ago.  Good riddance. The key to our future is economic growth, not misleading emotional rhetoric.   

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[Thanks to Loire Marteney for asking the question.]