My recent posts about the American Idea have argued that our country has a great future before it. We have a strong and prosperous economy and are the world’s leading innovator. Furthermore there are clear cut and effective ways to address the income inequality and poverty which hold back many Americans from fully sharing the benefits of our remarkably successful society.
But there is one huge problem our political system is ignoring which will lead to a major crisis if left unattended much longer.
I am referring, of course, to our gargantuan:
National Debt, now sitting at 77% of GDP (for the public part on which we pay interest), the largest it has been since the end of WWII. It is predicted by the Congressional Budget Office to keep steadily getting worse without major changes in current policy. Right now all of this debt is essentially “free money” because interest rates are so low.
Economic growthis created by tax cuts but only 10-20% of the lost revenue from tax cuts is offset by new growth.
Democrats, on the other hand, don’t take the debt seriously, except when arguing against Republican tax cuts. Debt deniers claim that the risk of government overspending is inflation, not bankruptcy. What they don’t understand is that
Interest rates will return to more normal (and much higher) historical levels eventually and, when this happens, interest payments on the debt will skyrocket by hundreds of billions of dollars every year. This will crowd out all sorts of spending on popular domestic programs. It is likely to lead to a new fiscal crisis, much worse than the Financial Crisis of 2008.
Conclusion. For all of our nation’s great strengths, we are in a very serious fiscal pickle, with no clear cut path of orderly resolution. Realistically our debt problem cannot be wound down without committed Presidential leadership and this is unlikely to happen anytime soon.
Not only is Washington politics already hyper-partisan, but both parties are continuing to move to even greater extremes, see here and here.
Here are two examples of extreme positions now being espoused by major elements of one or the other of the two parties:
Single payer healthcare. The failure of the GOP effort to repeal the Affordable Care Act this past summer means that (the goal of) universal healthcare is here to stay. The ACA expands access to healthcare but does nothing to control costs. Single payer, Medicare for All, would control costs but then we end up with socialized medicine. The only way to establish a cost efficient free market healthcare system is to remove, or at least limit, the tax exemption for employer provided care and to set up high deductible catastrophic care supplemented by health savings accounts to pay for routine expenses. This would compel everyone to pay close attention to the cost of their own healthcare.
Tax cuts instead of tax reform. Tax reform, i.e. lowering both corporate and individual tax rates, paid for by closing loopholes and shrinking deductions, is an excellent way to speed up economic growth and thereby create more and better paying jobs. But it is imperative to do this in a revenue neutral manner, i.e. without increasing our annual deficits. Our debt (the public part on which we pay interest) now stands at 77% of GDP, the highest it has been since the end of WWII, and is predicted by the Congressional Budget Office to keep getting larger without major changes in public policy.
Conclusion. The U.S. badly needs a more cost efficient healthcare system and a simpler and more efficient tax system. But there are right ways and wrong ways to do both of these things. Single payer healthcare and (unpaid for) tax rate cuts are the wrong way to proceed. In each case, no action at all is much better than getting it wrong.
The general theme of this blog is major fiscal and economic issues facing the U.S. such as slow economic growth and huge debt. But our currently low unemployment rate of 4.4% and several trends, here and here, suggest that economic growth may already be starting to pick up.
This means that our huge debt, now 77%, for the public part on which we pay interest, the highest it has been since right after WWII, is now one of the very biggest problems facing our country.
The only practical way to “solve” our debt problem (so to speak) is for each year’s annual deficit to be less than economic growth for that year. When this happens, then the debt will decrease as a percentage of GDP. If this pattern were to hold year after year, then debt would continue to shrink. This is exactly what happened from 1946 until about 1980 but since then the pattern has reversed and the debt has increased. It has grown especially fast since the financial crisis in 2008 (see chart).
The Fiscal Year 2017 deficit is $700 billion out of a total GDP of $20 trillion, which computes to 3.5% of GDP, well above the 2% annual growth of GDP for the 2017 FY. This means that our debt got worse in 2017.
Congress has already approved $15 billion in disaster relief for Hurricane Harvey. Now the White House is asking for $29 billion more ($12.8 billion for new disaster relief, especially for Puerto Rico, and $16 billion for the National Flood Insurance Program). Congress has also approved a big increase in the Defense Budget, to $700 billion, for the 2018 FY.
Congress will soon be approving a budget for 2018 and then start working on a tax reform package. Given the likely increases in both military spending and disaster relief described above, it is now even more important for the new budget to show overall spending restraint and for the tax reform package to be revenue neutral.
Conclusion. Let’s hope that Congress gets the message about the new urgency of our debt problem and acts accordingly!
In my last post I made the case that the two fundamental principles for effective tax reform are:
Faster economic growth, to create more jobs and bigger pay raises.
Revenue neutrality, since more debt at this time is just too risky.
And then I went on to suggest the specific changes in the tax code which would achieve these goals:
Reducing the corporate tax rate to approximately 20%.
Full expensing for business investment replacing depreciation spread out over many years.
Simplification of rules for individuals such as fewer tax rates and fewer credits.
Achieving revenue neutrality by eliminating as many deductions as necessary to pay for the above tax rate cuts.
There are different ways to accomplish all this and I recently described one attractive plan put together by the Tax Foundation. The Republican Congressional Leadership (Big Six) has proposed a different plan which has been analyzed by the nonpartisan Committee for a Responsible Federal Budget. Unfortunately CRFB concludes that this plan will cost $2.2 trillion over ten years in lost revenue. But it could be modified in the following ways to become revenue neutral:
The mortgage interest deduction is maintained but limited to one dwelling and $500,000, down from the current limit of two homes and $1 million.
The tax exemption for employer provided health insurance is limited. This not only increases tax revenue but also forces the 150 million Americans who receive health insurance from their employer to take an active role in holding down the cost of healthcare.
Drop the proposal of establishing a maximum “pass through” rate of 25% for business owners. Any such proposal would be subject to wide spread abuse. Businesses would be benefitting from the full expensing provision above and their owners should pay taxes at the same rates as everyone else.
Keep the estate tax until annual deficits are greatly reduced. It only brings in $20 billion per year but every little bit helps.
Conclusion. These common sense changes in the Big Six plan would make it revenue neutral and still capable of achieving a significant boost to the economy.
As Congress turns its attention to tax reform, there is a clear bipartisan consensus on the fundamental principles to employ, see here, here, here, and here.
Promote growth and increase wages for working families
Modernize our outdated business and international tax system.
Rely on reasonable economic assumptions
Make sure that any rewrite of the tax code is revenue neutral
The Tax Foundation has outlined several different approaches to tax reform which meet the above guidelines. Their Option A is especially attractive:
The corporate tax is reduced to 22.5% and full expensing for business investment is allowed.
GDP increases by 7.1% long term which translates to a .7% increase per year for ten years, which is substantial economic growth.
All income groups, except for the top 1%, will see an after-tax increase in income.
Individual Tax brackets are consolidated into the three rates of 12%, 20.5% and 37% and the standard deduction is nearly doubled (from $6350 to $12,000).
All itemized deductions are eliminated except for home mortgage interest (limited to $500,000) and charitable contributions.
Capital gains and dividends are taxed as ordinary income with individuals being allowed to deduct 40% of qualified dividends and long-term capital gains.
The estate tax is eliminated.
This tax plan is revenue neutral on a static basis.
Conclusion. There are many attractive features in this plan. Being revenue neutral, with strong economic growth, means that the increase in tax revenue will shrink our huge current annual deficits. Only the very wealthy top 1% of taxpayers will see their income (slightly) decreased. The substantial decrease in the corporate tax rate will incentivize multinational corporations to bring their overseas profits back home for reinvestment.
Experts across the political spectrum agree that the U.S. tax code is a huge mess and needs to be reformed as well as simplified. It is also generally accepted that lower tax rates will lead to faster economic growth.
As Congress turns its attention to tax reform, Senate Democrats have stated the basic principles which they would like to see included in any changes which are made:
Increase the wages of working families. This could be accomplished by lowering tax rates for all individuals across the board, paid for by eliminating (or at least shrinking) many of the personal deductions in the tax code. The approximately two thirds of all taxpayers who do not itemize deductions would then receive a tax cut, equivalent to a wage increase.
Promote domestic investment and improve middle class job growth. Lower tax rates will give businesses and entrepreneurs a bigger incentive to invest in business expansion and therefore grow the economy faster and create more new jobs.
Modernize our outdated business and international tax system. Our corporate tax rate at 35% is the highest in the developed world and, at the same time, produces below average revenue (see chart). Another reform would be to adopt business expensing (immediate tax write-off for new investment). Again, all such changes should be paid for by eliminating loopholes and shrinking deductions.
Any rewrite of the tax code must be deficit neutral. As important and valuable as tax reform is, it has to take into account our country’s most fundamental problem: our huge and rapidly growing national debt and therefore end up being deficit neutral overall.
Conclusion. The above principles, stated by the Senate Democrats, represent a sound approach to reforming the U.S. tax system. I hope that the Republicans are willing to recognize the validity of these proposals and include the Democrats in developing a bipartisan tax reform plan.
From a reader of my blog: I think he is too flawed, self-centered and sociopathic to accomplish much. I believe that tax reform will become tax cuts for the wealthy (no inheritance tax, etc.) and dealing with budget deficits will not happen. I know you think Trump will be contained by the conservative members of Congress. The Republicans seem unwilling to confront him or speak out as long as his base continues to be very loyal. I think he is so wounded now that it will be hard to accomplish much.
Granted that Donald Trump is hopelessly ensnared in controversy and incapable of changing his ways, he still has many opportunities to do something positive. For example regarding our extremely serious debt problem, he could focus on:
Coming up with a budget that reduces the debt path. No one expects the budget to be balanced in one year. Last year’s Republican plan would have taken ten years to get the job done. The important thing is to clearly move in this direction.
Focusing healthcare reform on cost control. Give the Democrats credit for expanding healthcare access with the Affordable Care Act. But now focus on reining in the cost of healthcare in America.
Enacting fiscally responsible tax reform. Most people agree that the tax code is a complicated mess and, especially, that the corporate tax rate is too high. There are many ways to achieve lower tax rates and simplification in a revenue neutral way.
Stop digging the debt hole deeper by just adding new initiatives. There will always be attractive new programs which are worth pursuing. But in adding them to the federal budget, other programs which are no longer effective need to be phased out.
Reforming entitlements such as Social Security, Medicare and Medicaid. These are the big drivers of national debt. Without entitlement reform, all other efforts to restrain federal spending will be insufficient.
Conclusion. There is nothing easy about pursuing the above agenda. Implementing it will be highly controversial with lots of vociferous opposition. It will take strong leadership to push it through. But it represents a huge opportunity for a controversial president to do something worthwhile.