The Congressional Budget Office has just issued the report ”The Budget and Economic Outlook: 2014 to 2024”, giving its usual objective and nonpartisan look at our prospects for the next ten years. My purpose today is to give a simple interpretation of its basic data. In my next post I will address the implications of this interpretation. The first chart above shows a forty year history of government deficit spending. The average deficit for this time period is 3% of GDP. From 1982 – 1987 the deficits were worse than this and from 2009 – 2013 they were much worse. The real problem is the accumulated deficits, i.e. the debt. The second chart above shows the public debt (what we pay interest on) all the way back to 1940 as a percent of GDP. As recently as 2008, the public debt was below 40% of GDP. Now it is 73% and climbing. This is very serious for two reasons. Right now our public debt is almost free money because interest rates are so low. But when interest rates return to their normal level of about 5%, interest payments will explode and be a huge drain on the economy. In addition, these CBO predictions assume continued steady growth of the economy. If and when we have a new recession or some other financial crisis, there will be much less flexibility available for dealing with it. Now look at the last two charts. The first one shows the rate of GDP growth since 2000 which has averaged about 2% since the end of the recession in June 2009 and is projected by the CBO to level off at this same rate over the next 10 years. This is an historically low rate of growth for our economy. The final chart shows the gradual decrease of the labor force participation rate over this same time period. These two graphs are related! When fewer people are working, the economy simply will not grow as fast.
High debt and slow growth are big problems for an economy. We’re falling more deeply into this perilous state of affairs all the time. We need to take strong measures to break out of this dangerous trap!
The Yale Tax Law Professor, Michael Graetz, has proposed a new tax system “100 Million Unnecessary Returns: A Simple, Fair, and Competitive Tax Plan for the United States” which would do wonders towards straightening out the huge fiscal and economic problems now facing our country. How do we rev up the national economy in order to put more people back to work and, at the same time, raise the revenue needed to operate the government in the 21st century without mountains of debt? Mr. Graetz’s basic idea is to tax consumption rather than relying totally on an income tax. Under his plan both savings and investments will be taxed at a lower rate which will encourage more of both. The Plan has these features:
A broad based Value Added Tax of about 14% is enacted on goods and services. The U.S. is the only advanced economy without a VAT.
Families earning less than $100,000 are exempted from the income tax. For incomes between $100,000 and $250,000, the tax rate would be 15%. For income over $250,000, the rate would be 25%.
The corporate income tax rate is lowered to 15%.
The Earned Income Tax Credit (EITC) is used to provide relief from the VAT burden to low-income families by using payroll tax offsets.
The plan is designed to be revenue neutral as verified by the Tax Policy Center.
This plan has many advantages including:
Taxing consumption and lowering the corporate tax rate to 15% from its current level of 35% would dramatically encourage investment in the U.S. thereby stimulating the economy and creating both new jobs and higher wages for American workers.
It would eliminate more than 100 million of the 140 million U.S. tax returns.
With many fewer Americans paying income taxes there would be far less temptation for Congress to use income tax exclusions, deductions and credits to try to address social and economic problems.
The plan retains all of the progressive features of our current tax system whereby higher income earners pay higher tax rates.
The point of describing the Graetz Plan in some detail is not to suggest that it is the best way to implement tax reform but rather that here, at least, is one attractive way to do it. The purpose is to move the discussion forward. We badly need to make changes along these lines!
I have been writing this blog for just over a year. It addresses what I consider to be the two biggest problems faced by our country at the present time. First is our enormous national debt, now over $17 trillion, and the huge annual budget deficits which are continuing to make it worse. The second problem, of equal magnitude, is our slow rate of economic growth, about 2% of GDP annually, ever since the Great Recession ended in June 2009. These two problems are closely related. If the economy grew faster, federal tax revenue would grow faster and the annual deficit would shrink faster. Not to mention that a faster growing economy would create more jobs and lower the unemployment rate, which is still a high 7%.
The impediments to solving these problems are huge. Our public debt, on which we pay interest, is now over $12 trillion or 73% of GDP. Although it may stabilize at this level for a few years, it will soon begin climbing much higher, without major changes in current policy. This is primarily because of exploding entitlement spending for retirees (Social Security and Medicare) who will increase in number from about 50 million today to over 70 million in just 20 years. As interest rates return to normal higher levels, just paying interest on the national debt will become, all by itself, a larger and larger drain on the economy.
The impediments to faster economic growth are increasing global competition, such as inexpensive foreign labor, as well as rapid advances in technology, such as electronics and robotics. Both of these trends reduce the need for unskilled workers in America which in turn holds down wages and slows down economic growth.
At the same time we have an antiquated tax code to raise the huge sums of money necessary to pay for a large and complex national government. It worked fine through the post-World War II period, as long as the U.S. had the dominant world economy with little significant competition from others. But this situation no longer exists. We now have a tax system which doesn’t raise enough money to pay our bills and at the same time is so progressive that the highest rates (39.6% on individuals and 35% for corporations) are not sufficiently competitive with other countries. This discourages the entrepreneurship and business investment we need to grow the economy faster and create more jobs.
We have an enormous problem on our hands! Is it possible to fundamentally change our tax system to turn things around? My next post will answer this question in the affirmative!
After five years of enormous deficits, our national debt now stands at over $17 trillion. The only spending restraint that Congress has been able to achieve so far is an approximately one trillion dollar “sequester” over ten years, therefore amounting to about $100 billion per year in spending cuts. Federal expenditures have actually dropped for two years in a row now so the sequester really does work. Of course, almost everyone complains about cutting spending in such a “dumb” way. Why not make intelligent budget cuts by eliminating the least effective programs instead of having to make small percentage cuts in all discretionary spending, good and bad alike? Well, this really should not be all that difficult to do if Congress would try a little harder.
The Congressional Budget Office has just released a helpful report, “Options for Reducing the Deficit: 2014 to 2023”, which lists 103 ways for either decreasing spending or increasing revenues over the next decade. Amazingly, enacting all of these proposals would amount to a budget savings of $13 trillion over 10 years, ten times what is required by the sequester! Here are some examples of what could be done (along with the 10 year savings):
Eliminate direct payments to agricultural producers $25 billion
Increase federal insurance premiums for private pensions $5 billion
Reduce the amounts of federal pensions $6 billion
Tighten eligibility for food stamps $50 billion
Use more accurate measure of inflation for all mandatory programs $162 billion
Replace some military personnel with civilian employees $19 billion
Limit highway funding to expected highway revenues $65 billion
Eliminate grants to large and medium sized airports $8 billion
Eliminate subsidies for Amtrak $15 billion
Reduce the size of the federal workforce through attrition $43 billion
Tax carried interest as ordinary income $17 billion
Limit medical malpractice torts $57 billion
Raise the age of eligibility for Medicare to 67 $23 billion
Modify Tricare fees for working-age military retirees $71 billion
Total $566 billion
Right here is more than enough to offset half of the sequester. You don’t like these cuts? Then replace them with others from the CBO report. There are lots of options to choose from!
Two economists, John Dearie and Courtney Geduldig, have just published a very interesting new book, “Where the Jobs Are, Entrepreneurship and the Soul of the American Economy”. In April 2011, Mr. Dearie and Ms. Geduldig launched an effort to understand the nature and scope of the damage to the U.S. labor markets caused by the Great Recession and, if possible, identify new ways to enhance the economy’s job-creating capacity.
They quickly “learned of research that demonstrates how virtually all net new job creation in the United States over the past 30 years has come from businesses less than a year old – true ‘start-ups.’ Investigating further, they also learned that America’s job creation machine is faltering, with the rate of start-up formation declining precipitously in recent years. To find out why, they launched an ambitious summer road trip – conducting roundtables with entrepreneurs in 12 cities across the nation.” Here is what they learned.
First of all, the U.S. labor market is tremendously dynamic, as existing businesses create new jobs and eliminate others. “In 2011, for example, 47.5 million separations occurred while 49.6 million Americans took new jobs.” But “existing firms, of any age or size, in aggregate, nearly always produce more separations than hires. … Indeed, existing businesses shed on a net basis a combined average of about 1 million jobs each year as some businesses fail, others become more efficient, and as separations simply outpace new hires. By stark contrast, new firms in their first year of existence, create an average of 3 million new jobs.”
Unfortunately, there has been a huge drop off in the number of new businesses created annually since 2007. Furthermore, the historical average of seven new jobs created by a new firm in its first year, has now fallen to less than five new jobs.
The obvious question which this discussion raises is: what policy changes are needed to boost the creation of new businesses? This will be the topic of my next post in a couple of days!
Several of my recent posts have been pretty gloomy. “Average is Over,” “What, Me Worry?” and “The Age of Oversupply,” for example. Here’s another gloomy one. The British economist, Stephen King, has an Op Ed column in last Monday’s New York Times, “When Wealth Disappears.”, based on his new book, “When the Money Runs Out.”
Our GDP grew at 3.4% per year in the 1980s and 1990s, then dropped to a growth rate of 2.4% from 2000 – 2007. Since the Great Recession ended it has averaged barely 2% per year. The Democrats say we just need more fiscal stimulus and monetary easing to boost the growth rate. The Republicans say deficit reduction including entitlement reform, slashing regulations and tax reform is what is needed to revive the economy.
“Both sides are wrong,” says Mr. King. “The underlying reason for the stagnation is that a half-century of one-off developments in the industrialized world will not be repeated.” These one-off developments are: the unleashing of global trade after World War II, financial innovation such as consumer credit, expansion of social safety nets which reduces the need for household savings, reduced discrimination which has flooded the labor market with women and, finally, the great increase in the number of educated citizens.
What Mr. King recommends is “economic honesty, to recognize that promises made during good times can no longer be easily kept. What this means is a higher retirement age, more immigration to increase the working age population, less borrowing from abroad (by holding down deficit spending), less reliance on monetary policy that creates unsustainable financial bubbles, a new social compact which doesn’t cannibalize the young to feed the boomers, and a further opening of world trade.”
“Policy makers simply pray for a strong recovery. They opt for the illusion because the reality is too bleak to bear. But as the current fiscal crisis demonstrates, facing the pain will not be easy. And the waking up from our collective illusions has just begun.”
It is obviously time to bite the bullet, lower our expectations, and start doing the hard work needed for even incremental economic progress.
This week’s cover story in Barron’s, by Gene Epstein, “What, Me Worry?”, attempts to create more attention for our impending fiscal crisis. “Stop all the dithering, D.C. The baby-boom budget bomb could destroy the economy within 25 years. The time to act is now.” As Mr. Epstein says:
Obamacare is part of the problem but so are Medicaid, Medicare and Social Security.
The latest budget report from the Congressional Budget Office, published on September 17, makes an “optimistic” forecast that the federal debt will grow to 100% of GDP by 2038 from an already high 73% today.
But its more realistic forecast is a debt of 190% of GDP by 2038, worse than the current debt of Greece, which has a 27% unemployment rate.
“By 2038 there will be 79.1 million U.S. residents 65 and older, up from 44.7 million today. The working age population, 18 to 64, will grow at a much slower rate, to 214.7 million from 197.8 million today. As a result the dependency ratio will plummet to 2.7 working age people to support each senior in 2038, from 4.4 today.”
“Since the elderly population won’t begin to reach critical mass until the mid-2020’s, the rising tide of red ink will be relatively modest over the next ten years.”
“The nation thus might be likened to a family with about 10 good working years left which needs to cut spending in order to save for a rapidly approaching old age. But alas, it’s a dysfunctional family incapable of rational planning.”
Today we have the option of simply containing the growth of entitlement spending. If we don’t act now, tomorrow we will be forced to make deep cuts in entitlement spending. Today we have the option of making intelligent cuts in discretionary spending. Tomorrow we’ll be forced to make drastic cuts across the board which will make the slowdown in the economy due to the budget sequester “look like a Sunday afternoon walk in the park” (Bill Clinton, May 2013).
What does it take to knock common sense into our national leaders?
Today’s New York Times reports that “Health Care Costs Climb Moderately, Survey Says”. The average annual insurance premium for a family rose 4% in 2013 compared with a 1.1% overall rate of inflation, according to the Kaiser Family Foundation which conducted the survey. Since 1999 health insurance premiums have increased by almost 300% while consumer prices have increased by 40%. As insurance premiums rise, deductibles are also getting bigger. About 38% of all covered workers now face an annual deductible of $1000 or greater. Dr. Drew Altman, CEO of the Kaiser Foundation, refers to this “quiet revolution” as an attempt by consumers to keep the cost of health insurance from rising even more quickly.
A 4% increase in insurance costs may seem moderate, but at almost four times the rate of inflation, it is really very large. Obama Care is unlikely to have any impact in holding down such a rapid increase and, in fact, is likely to make matters worse because of massive new health care regulations which are coming. The basic problem is that America spends 18% of GDP overall on health care, almost twice as much as any other country.
What can we do about this? One major step would go a long way. We need to remove the tax exemption from employer provided health insurance. Employers could still provide health insurance for their employees, but the cost would be added to an employee’s salary for tax purposes. This can be offset with a lower tax rate, of course. But it would make employees, i.e. all consumers, far more conscious of the cost of healthcare and therefore to have a direct incentive to hold down these costs. For example, Dr. Altman’s “quiet revolution” would pick up steam as employees raise deductibles even higher in order to lower overall costs.
How can we get going in this direction? The Employer Mandate of Obama Care should be repealed, and not just postponed for a year. Ideally, removing the tax exemption for employer provided health insurance would become part of the broad based tax reform which is so badly needed to stimulate the economy.
Our fiscal and economic problems can be addressed with smart leadership. We should insist that our national leaders get going on such badly needed reforms!
A front page article in yesterday’s Wall Street Journal, “An Ohio Prescription for the GOP: Lower Taxes, More Aid for Poor”, describes how Ohio’s Republican Governor, John Kasich, a former congressional spending hawk, has expanded Medicaid coverage in Ohio and steered millions more dollars into local food banks. Mr. Kasich says, “When you die and go to heaven, St Peter is probably not going to ask you much about what you did about keeping government small. But he is going to ask you what you did for the poor.”
There are good reasons why we should shift programs and responsibilities from the federal government back to states and localities. At the federal level there is little fiscal restraint and therefore little incentive for making sure that governmental programs operate efficiently and effectively. Study after study by the Government Accounting Office, as well as by private think tanks, demonstrate enormous waste and duplication in virtually all areas of federal government. This long lasting fiscal irresponsibility at the federal level has now led to a massive national debt which will have a perverse effect on our nation’s prosperity for many years to come.
At the same time, all state and local governments are required to balance their budgets. This means that they have to pay attention to the costs of all programs and set spending priorities. They have to make sure that all functions of government are effective and be prepared to cut back or eliminate any program which is performing poorly. States such as Illinois and California, and cities such as Detroit, Chicago and Philadelphia, which have huge operating deficits year after year, will eventually be forced to declare bankruptcy (such as Detroit has just done) in order to reorganize their finances and make a fresh start.
It has long been a practical axiom that government should be as close as possible to the people. But now it is a fiscal necessity as well to shift as much as possible from federal control back to state and local control.
An article in yesterday’s New York Times, “Obama Says Income Gap Is Fraying U.S. Social Fabric”, quotes the President that “If we don’t do anything, then growth will be slower than it should be. Unemployment will not go down as fast as it should. Income inequality will continue to rise. That’s not a future that we should accept.” He says that “I will seize any opportunity I can to work with Congress to strengthen the middle class, improve their prospects, improve their security.”
A recent editorial in The Wall Street Journal, “The Inequality President”, shows with a chart that median household incomes have fallen from $54,218 in June 2009 as the recession ended to $51,500 in May 2013. As the WSJ says, “For four and a half years, Mr. Obama has focused his policies on reducing inequality rather than increasing growth. The predictable result has been more inequality and less growth. … The rich have done well in the last few years, thanks to a rising stock market, but the middle class and poor have not.”
There are many things that Congress and the President could do to boost the economy if they were willing to work together and compromise. Obamacare doesn’t need to be repealed, just modified by dropping the employer mandate which is a job killer. Broad based tax reform, with lower tax rates, paid for by eliminating tax preferences, would be a big boost to investment, risk taking and entrepreneurship. A reasonable compromise would be to use a part of the revenue raised from eliminating loopholes for deficit reduction.
But little progress will be made unless the President is willing to show leadership by rising above partisanship. There are all sorts of ways he could do this. One simple way would be to show that he understands the seriousness of the rapidly growing national debt by supporting some of the many thoughtful proposals for more government efficiency.
A large majority of people want our first African-American President to be successful. But right now he is not on track to achieve this.