A Solution to the Federal Government Debt: End Income and Payroll Tax

American’s have become uneasy about the amount of Federal Debt that is stacking up in Washington and for good reason. This month the debt total topped $13 trillion and will reach $14 trillion within six months. Although these numbers are impressively large and hard to accept, the path to reverse them is not terribly hard.

To demonstrate that the debt problem could have been easily handled during the height of the crisis lets crunch some numbers. The cost of the government bailouts and guarantees the federal government granted was $7.7 trillion dollars. That’s what I said, $7.7 trillion and that does not include the $16.3 trillion of federal government guarantees that were made by many government agencies. After all that money was spent our economy is still weak and unemployment is still high.

Instead with that money the government could have protected the credit system with the $ 700 billion TARP fund and then canceled income and payroll taxes for two years. Sound crazy?

The world operates on incentives, especially the economy. If underlying economic indicators are weak than there is little incentive for investors to invest, for businesses to expand, and for creation of new jobs. However, if income taxes were canceled people would be able to spend and save much more rather than having to pick wither to save or to spend. If payroll taxes were cancelled corporations would be willing to risk expansion and hire more workers. Demand would grow due to increased savings rates and consumer spending. The country would experience an economic boom almost overnight.

To pay for the 50% decrease in federal government revenue a very small nationwide sales tax could be implemented and spending could be cut drastically. Ending the wars and cutting military spending, create a means test for social security and increase retirement age to 70, and deregulate healthcare which would make healthcare cost decrease. Those three tasks would cut the projected 2010 $3.7 trillion budget by 50 percent.

Alas that is not what happened, instead we received a stimulus package that has done little and spent a lot, bailouts of corrupt and greedy bankers, and no major decrease in unemployment. Since hindsight is 20/20 what could be done now? The answer is still the same one as above but just a little different.

Use the $700 billion TARP funds, use the remaining 45 percent of the stimulus package, end the wars and cut military spending, cancel the $800 billion dollar healthcare reform, and cut social security spending. Take all of that money and cancel the income tax and payroll taxes.

I am 100 percent confident that there would be unintended consequences but this plan would create positive incentives on the individual level rather than a trickledown effect. In a complex organization such as the economy solutions have to be regulated to the individuals in the free markets. With less federal government spending and nationwide sales tax there would be no real reason to bring back the income tax but if we did, it would be much lower and go directly to paying off the debt. America would once again become the greatest economic power in the world instead of coming in second to the social European Union.


Sources:

http://www.usfederalbailout.com/
http://usgovernmentspending.com/#usgs302a
http://www.usgovernmentrevenue.com/#usgs302a
Think Twice, Michael J Mauboussin

The False Concept of Tax Cuts

There seems to be a rule of thumb among many Republicans lately that has caused me large amounts of confusion. Apparently, cutting taxes will increase government revenue when the economy improves due to the tax cuts. Republicans hold Ronald Regan up as a shining example of the success tax cuts have as economic stimulus. However, this simple explanation of success falls short of historical accuracy.

This belief of tax cuts to encourage economic growth is known as “supply side economics”. The economic theory postulates an increase of government revenue at a lower tax percentage due to a growing economy. This theory is dependent on economic expansion resulting from new tax cuts yet if an economic contraction occurs, government deficits increase drastically. This risky maneuver has backfired every time since 1980 but the belief tax cuts help the economy stems from false concepts of what has caused economic recoveries in the past thirty years.

Ronald Regan implemented supply side economics during his first year in office by cutting $39 billion from the federal budget; created a 25% tax cut over three years, and faster write-offs for capital investments. The gamble was that such a huge tax cut would shock the economy from its stagnant state and the result would be a growing economy which would cover the cost of the government tax cuts. Instead of economic expansion the country fell into a recession and a mounting federal deficit forced Regan to increase budget cuts and increase taxes.

During the recession in 1982 the Federal Reserve Chairmen Paul Volker had worked to decrease the double digit inflation and lower the double digit interest rates that were crippling the economy. When Volker’s many painful reforms started to lower inflation and interest rates the economy boomed while Regan was increasing taxes and cutting spending to handle the federal deficit. The economy flourished during Regan’s Presidency but the federal debt was growing at a frightening pace. The promised increased government revenue was not materializing.

Republicans claimed that supply side economics had created the economic boom of the 1980’s although lower inflation and lower interest rates were the real drivers of the economic expansion. This Republican propaganda spin allowed George H.W Bush to win the election in 1988, fortunately, Bush did not hold to the “Voodoo” economic policies of Regan.

President Bush felt that America could not grow and prosper with the growing federal debt. Bush pushed for more federal spending cuts but the Republican congress also wanted to cut taxes again which would have increased the deficit in 1989 to $500 billion. Instead of increasing the debt levels, Bush signed a Democratic bill that raised taxes to battle the deficit left by Regan. The Republican voters felt betrayed by Bush who had promised “no new taxes.” Bush’s political career was killed when he signed the bill. Although Bush’s broken promise cost the Republican Party the election in 1992, the tax increases halted the budget deficit and helped Bill Clinton and the conservative congress to create a large federal surplus in the 1990’s. The 1990’s saw a long economic expansion with no tax cuts, instead, low interest rates and low inflation once again spurred economic growth.

This decade of prosperity came to an end when George W. Bush won the election in 1999 and returned the political agenda to supply side economics. In his first year Bush passed a slew of new tax cuts and championed many new financial reforms focused on easing the accounting standards of large corporations. At the same time he increased welfare programs with no balancing tax increase to cover the spending. The country entered the Tec and Telecom recession which reversed the federal surplus in two years. By 2005 the country was engaged in two military conflicts while more tax cuts took place.

During this period of increasing debt levels the US economy recovered from the 2001 recession but this success was not due to the many Bush tax cuts. The new fed chairman Alan Greenspan kept interest rates artificially low to stimulate economic recovery and this was mixed with Bush’s increased mortgage spending through Fannie and Freddie Mac. The mixture led to an economic recovery which eventually caused the housing bubble burst in October of 2008. Faced with economic depression due to his tax cuts and increased mortgage borrowing, Bush passed the $700 billion TARP bill to rescue the nation’s credit markets further increasing the national debt.
By looking at the historical timeline since 1980 it seems that cutting taxes did little to stimulate the economy and increased the federal debt levels astronomically. In addition, entitlement programs such as social security, welfare, and Medicare were expanded with no tax increases to balance the new entitlement spending. Every major tax cut since 1980 happened before or during an economic contraction. Each recovery was due to a combination of lower inflation or low interest rates and not from large tax cuts.

For me to say that lower tax rates are bad for the economy would be a false statement. Lower tax rates over long time periods encourage less government spending and increases a strong and vibrant economy. That said, large tax cuts in short periods of time while increasing spending has led the large debt America has created.

America has to decide if we will pay off our debt and cut spending or cut taxes in political retaliation to a liberal president which will place a tombstone over our fiscal grave. When will America put aside our political differences and realize we have a responsibility right now to pay for our borrowing? I guarantee if we cut taxes more our nation will be forced to default before end of the decade. The discussion should not be about taxes but about entitlement spending that is bankrupting this nation. I personally choose responsible taxes and spending cuts rather than a second great depression.



Some Sources:

http://www.reagan.utexas.edu/archives/reference/reference.html
http://www.reagan.utexas.edu/archives/reference/pressketch.html
http://www.investopedia.com/terms/v/voodooeconomics.asp
http://yellowroad.wallstreetexaminer.com/blogs/files/2008/06/inflation.gif

States Should be Taking Responsibility

November might be a long way off but the ominous political summer storm will soon engulf the entire nation. I can already hear the political radio adds blasting over the airwaves and see the polarized television commercials between innings of baseball games. Even in this remote area of Colorado the political bashing will reach uncomfortable levels and stress the community to the breaking point. In fact, political rage might be worse in smaller rural areas due to recent popularity of the Tea Party movement.

From my removed prospective, the fundamental issues for our national and local governments is lost in political polarity of both major parties. The issue is really a simple concept for most people on an individual level but due to political positioning the concept has been twisted and manipulated into large scale arguments and complicated solutions. So what is this simple issue that faces our nation?

It is paying for what we receive. All taxes have an associated expense in government, from the local level all the way to Washington. American society expresses what public goods that we want and governments respond by estimating the cost and collecting taxes for each public service. For example, Americans love roads because it allows the freedom to go where we want, when we want. Having well maintained roads is an American tradition that started at the foundation of this nation. In return, the roads provide more than personal freedom, it connects cities, towns and individual houses and allows commerce to flourish. These fee-free roads have helped America become an economic power house.

Paying for what we receive is not a complicated concept. However, both political parties use misleading statements to paint the idea that taxes are bad, instead of taxes being a basic price tag on a good or service. The Tea Party movement owes its popularity to the concept of evil taxes and the opinion taxes should be kept to an absolute minimum.. Far left Liberals on the other hand think of taxes as a corrective tool to punish large companies or wealthy individuals, taxes are ok as long as the rich pay. These two extreme understandings of taxes have diluted the middle of the political spectrum to a point that politicians can buy votes by promising but never paying.

This ongoing process has resulted in citizens who no longer remember why we pay taxes. Citizens want more services and no taxes. The concept of a negative change to the status quo of taxes is known as psychological price anchoring. Humans usually use a starting number to determine the value of a good or service. The starting number does not have to reflect the true cost or value of the good or service but it always effects what the individual thinks of the value.

For example, if I paid $50 in taxes a year (including sales taxes) due to a tax relief program, then I would use that $50 as my anchor in determining the value of public goods I received. The next year a new government was elected and repealed the tax break due to a rise in the state deficit. My taxes are now $1500 a year. Due to the anchoring effect my brain uses, my first reaction would be outrage due to the raise in my taxes. I received all the same services the year before for $50 and now I have to pay $1450 more this year. However, if I took an account of the services I received and then calculated the cost of my share of those services. I would discover that the $1500 was a really good deal. So instead of anger, I might feel good about the services I am receiving.

What am I getting at with this lengthy description of taxes? As a society we enjoy the benefits of public goods and services. So instead of trying to get more without paying we need to account how our tax dollars are used. Right now America can see how inefficient the national government has become and it is not because everyone in congress is corrupt. (although there are many examples of corruption) It is due to the fact one city cannot provide all public services for 300 plus billion people.

States and local governments can effectively handle how much to tax vs. how many services communities want and need. The benefits of having local economies handle their own taxes and finances are enormous. Taking a quick account of service provided to citizens and adding in future goals and projects, local government can then tax the population accordingly. If there is corruption or serious mismanagement of taxes the local population can take action quickly and not have to worry about lobby groups, corporations and other stalling tactics that are present in Washington. Taking responsibility for our taxes is the best way to improve this nation over a long time horizon.

The sad truth is the majority of local governments would rather receive “free” money from the federal government because it helps in elections. Why tax for something when you can get it for free? Well, rational people understand that nothing is free and by delaying payment for a service, we only hurt ourselves in the future. It is time for people to stop complaining about taxes and hold states and local governments accountable for the services we receive. Until then, politicians will promise more and pay for less. America will continue to add to the debt until we are forced to cut most services or raise taxes to unattainable level. Either way, citizens will pay for our lack of fiscal responsibility.