Of Course They Are

Democrats push tax hikes first in deficit talks

Or so says the Reuters headline. More "dog bites man" stuff, as discussed previously. But it appears that the Democrats haven't demanded that the tax rises be front loaded, only that they be discussed first.

To reiterate, the Republicans should say, "Sure, phase out all deductions starting in 2016 and lower marginal rates somewhat while were at it. Vastly simplify the tax code. This will increase taxes on the rich, just like you want. Now can we discuss some budget cuts to take immediate effect and agree on some entitlement reform while were at it? Because we're only going to accept $1 in tax increases if there is a matching $3 in spending reduction." After the Republicans blow out the Democrats in 2012, because there will be punishment for their handling of the economy, then keep the simplification and lower the rates further.

Republicans shouldn't be idiots, they could easily turn these negotiations to their advantage. This could be a teachable moment after all.

The Wimpy Way to Deficit Reduction

"I'll gladly pay you Tuesday for a Hamburger today," Wimpy of Popeye fame is often quoted as saying. The implication of course, was that Wimpy was never going to come up with the cash on Tuesday. With the Gang of Twelve meeting the last two days, but apparently having no comment on their actual discussions, Rodger Hedgecock helpfully summarized things today. The Democrats will offer three dollars of future spending cuts for a dollar of tax increases today. The Republicans will be split between this "bipartisanship" approach and those who want to stand firm on any tax rises. It reminded me of Wimpy's proposition. Rodger reminded us that this is the standard Democratic trick, used against George H.W. Bush when he reneged on his "no new taxes" pledge. The spending cuts never come.

But why can't the Republicans reverse this game. We'll give you a dollar in tax rises tomorrow for three dollars of spending cuts today. Now Grover Norquist might start screaming that we shouldn't vote for any tax increases, ever. But he needs to understand my methods. First, as a matter of good politics, if we don't at least promise modest tax rises to pay for the coming spending cuts, then we will lose the political battle. The Economist makes this argument persuasively in this week's leader. Second, this presents an opportunity to reform the tax code. We should back load a phase out of all deductions and all of the other special goodies in the tax code. We should offset some of the increased revenue with lower marginal tax rates, which would be permanent. Third, if spending cuts and entitlement reforms produce the economic recovery that I expect, we can later vote for even lower marginal rates, in effect cancelling the tax hikes. Finally, we can argue that tax hikes now would harm the economy, so they have to be back loaded.

I have always believed that no tax hikes are needed to balance the budget. But sometimes the packaging is very important in selling the plan. Phasing out the deductions after giving people warning is a fair way to reform the tax code and reduce cronyism. Further, if we calculated decreases in the marginal rates that were exactly offset by the phase out of deductions in a static analysis, it would actually result in revenue growth for two reasons. First, the inefficiencies that are caused by hiding income would be wrung out of the system, resulting in greater growth than static analysis would predict. Second, because people would not have ingenious means of hiding income, but marginal rates were actually lower, reported income would rise.

The deficit commission can easily achieve the $1.2 trillion in cuts over ten years if such an approach were taken. The hard part would be to get the Democrats to go along, but I think the public would like it.

Addendum on Paul Ryan and the Deficit Commission

I didn't fully understand why Paul Ryan objected to the Deficit Commission recommendations, but I published his video yesterday anyway, because he has a good reputation as an "anti-progressive." (In this day and age, could there be a more reverential honorific?) Today's WSJ gives more detail on why Paul Ryan made the right move:

Longer-term, the problems are the liberal entitlements of Medicare, Medicaid, Social Security, and, starting in 2014, ObamaCare, which will add about 20 million to the Medicaid rolls. Democrats want to keep these programs as they are and pay for them with much higher taxes—first by balancing the budget at 25% of GDP, and later by necessity at 30%, 40% or more. The alternative—which we support—is to reform the programs and reduce their scope.

Yet, incredibly, the Simpson-Bowles report has almost nothing to say about the runaway health-care entitlements. This is a bow to the left and the White House, which cut Medicare by $500 billion to finance a corner of ObamaCare and wants its signature achievement untouched. But this is like doing a Pentagon budget review and excluding Iraq and Afghanistan. Republicans ought to reject the report on those grounds alone

This is the key failure of the commission, and why its work, however worthwhile, doesn't go far enough in addressing the key problems at hand.

Look at the graph from my previous post on this subject and you see that without addressing social security, and medical entitlements there is no long term hope for deficit reduction. My biggest fear is that a short term recovery, which seems to be in the offing, will remove the sense of urgency over the issues at hand. I am a firm believer in the long term prospects for America, but the debt issues are going to take a decade to work out, IMHO. If a recovery gives some breathing space, we better use it to repair the balance sheets of the federal government.

A not small consolation in this whole exercise was that using the commission as a stealth means to get a VAT into the political discussion never happened. No wonder the Democrats have little good to say about the commission.

Dana Milbank Has a Point

. . .For a change. Actually, he is one of the few left of center commentators that I occasionally enjoy, not always, but enough. The point he makes concerns the Deficit Commission.

Not yet two weeks after the voters delivered a clarion cry for change in Washington, we're already back to business as usual.

Millbank goes on to slay right and left for the mindless opposition to the Deficit Commission's recommendations. But on the right, it seems that only Grover Norquist, for whom I once had a great deal of respect, is bad mouthing the initial recommendations. He rightly pillories Pelosi, the AFL-CIO, and NOW on the left. He applauds Obama's early support:

Triangulation?

The questions are whether Obama is willing to stand up to Pelosi and whether he can weather the consequences of triangulating against the liberals. So far, so good. "Before anybody starts shooting down proposals, I think we need to listen," he said from Seoul, in an implicit rebuke of Pelosi. He also said that he's "prepared to make some tough decisions" and that "we're going to have to take actions that are difficult and we're going to have to tell the truth to the American people."

Unfortunately, Obama's track record is that he will cave to his base. But wouldn't it be ironic if he saved his Presidency with an about-face that embraced fiscal responsibility. And as Tea Partiers, would we support such a move by Obama? Would we push to get an omnibus spending reduction bill passed that he was pushing? Or would we follow Mitch McConnell's advice and do anything in our power to deny him re-election?

Solving the Deficit Crisis

In my previous post on this subject, I tried to give a sense of how vast and difficult solving our deficit problem has become. To recap, even with draconian measures, closing the gap to 2.2% of GDP is the best that the co-chairs of the deficit commission can come up with. Putting it into family budget terms, it is like having a family income of $100,000, spending $150,000 and funding the difference with a line of credit on which you already owe $575,000. Except it's even worse, because that only includes the debt that is admitted to, other unfunded liabilities might put your future liabilities closer to $4,500,000.

Clearly drastic action is needed, but it will not be enough. As the graph below shows, the gap is monstrous. What is to be done?

It seems obvious to me that trying to increase tax receipts by raising the tax rate that each individual pays is self defeating. This is because those taxes become a drag on economic growth, and because people are incredibly ingenious at avoiding them. KT has often blogged on the need to avoid debt in financing the government, and I agree. But that need not imply that raising marginal tax rates is a particularly good way of doing so. Further, we have seen an historical trend where federal income tax receipts have been unable to break the 20% of GDP barrier, regardless of the marginal rate structure. I previously discussed Hauer's Law last June and why increased tax rates are useless.



But the need for additional receipts can not be denied. This is why I believe that aggressive action is needed to grow the economy and the work force. Lest the reader think that I am suggesting that growth alone will pull us out of this crisis, I am not. The recommendations of the deficit commission co-chairs or something like them will also be needed. The problem has grown so large that growth alone won't solve it. But it is also so large that it is unlikely that the cuts proposed will not solve it either.

In broad brush, the federal budget requires many more people to contribute to receipts. That means that work force participation must rise dramatically from where it is today. By work force participation, we must mean in the legitimate work force, because that is what generates the revenue. Getting Americans back to work is key, but so is increasing the total size of the work force. Look at this graph from economicpopulist.org


We are on a scary trend line that is causing federal receipts to fall. Is part of the trend demographic? In other words, is an aging U.S population causing the labor force participation rate to fall? Since those 65 and over have only a 15% chance of being employed, this sound plausible.

It seems likely that the only way to bring in new receipts to the federal government to close the deficit is to bring participants into the work force. Where should they come from?

The Unemployed. This is the most pressing need. The official unemployment rate is at 9.6%, but this vastly understates how bad the problem is. economicpopulist.org says it best:

U6, defined as total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force, (table A.15), was 17.0%, a -0.1% decrease from last month. This number is obscene.

Getting these people back to work has to be the most important task. However, as Sharon Angle pointed out, government can not directly create the needed jobs, but has to get out of the way. Government can promote business by the consistent application of the rule of law and protection of property rights. Here are some things to aid in job creation.

• Uncertainty over the effects of Obamacare and other new regulation. A moratorium on new regulation for at least four years is needed.
• The housing market was not allowed to hit bottom. Only when prices are low enough to attract investors will new money pour into the market. I have seen this locally, where prices are not low enough for me to want to invest. Prices are still sitting at well over 20 times rent. Bust up Freddie and Fannie and let housing prices fall. With new investors in the market, then home improvement will start helping the economy.
  
• Stop rattling the markets with inflation fears through quantitative easing. I don't agree with the abolish the fed movement, but if they keep this up, I might change my mind. The fed should be most interested in a stable money supply, which will help businesses plan. Drudge links to a supposedly secret Walmart study that inflation is already here.
  
• Simplify the tax code or better yet, abolish the income tax and replace it with a value added tax (having both is unacceptable, however.) The efficiency of the tax code is relevant to economic growth, because it allows people and business to plan their economic activity in a non-distorted manner. Further, the more complex the tax code the more chicanery and bribery accrue to those getting the tax breaks. It is no coincidence that Reagan and Rostenkowski's success in simplifying the tax code and reducing rates resulted in one of the great uninterrupted economic expansions since World War II.
• Repeal Obamacare since it is responsible for both new complexity in the tax code and absurd amount of new regulation.
  

Those over 65 currently not working. It may seem cruel, and I am not advocating using force, but many of those over 65 are still able to work. Note the trends in this graph:


Labor force participation is already on the rise for those over 65. We need to look at policies that discourage that trend. For example, we tax social security benefits based on earnings of those already receiving social security. This discourages work by the elderly. Wouldn't we be better off if they were working. Raising the retirement age is a good idea, but will take significant time before that has any impact.

Immigrants. Here is the sticky wicket. First, illegal immigrants mostly participate in the labor force, however, only two-thirds of them pay social security taxes according to the only source I could find on this subject. While the article was emphasizing the two-thirds who do pay, I am concerned about adding 4-5 million people to the roles who do not.

But right now, we can't solve this problem, because we will undermine the rule of law through an amnesty. The American people deserve a secure border. But the secure border can also allow us to have the discussion needed about the role of immigrants. Those who are here illegally should not be granted citizenship, that would reward their illegal behavior, but we need to get them to all pay their share of social security taxes.

Further, a discussion of legal immigration is also needed. To help prevent the outsourcing of jobs and to increase the ratio of those paying social security taxes to those receiving, we need a massive influx of new immigrants with salable skills. The H-1B visa program has been a joke for a long time, more a lottery than a policy. I would like to see us bringing 5 million new young, skilled immigrants per year to jump start the economy. That will make a significant dent in the deficit gap and also create more jobs in America. This country still provides the greatest opportunity for upward mobility in the world. Attracting skilled immigrants should not be a problem.

I have put out a lot of opinion that is sure to be controversial. But we Tea Partiers said that we were serious about tackling the deficit. The problem is massive and challenging. Cuts alone won't do it. Cuts and tax hikes won't solve the problem. Time to think out of the box and create some growth.

A Reason to Like the Deficit Commission

. . . Or the National Commission on Fiscal Responsibility and Reform as it is formally known, Paul Krugman hates it. From today's New York Times article:

Count me among those who always believed that President Obama made a big mistake when he created the National Commission on Fiscal Responsibility and Reform — a supposedly bipartisan panel charged with coming up with solutions to the nation’s long-run fiscal problems. It seemed obvious, as soon as the commission’s membership was announced, that “bipartisanship” would mean what it so often does in Washington: a compromise between the center-right and the hard-right.

Even if I don't agree with everything Bowles and Simpson have proposed, they are certainly making the right enemies. Adding Paul Krugman to a list that includes Nancy Pelosi is certainly a major achievement.