Update on GOP Debt Limit Strategy

I put a short post on Wednesday that the Republicans ought to get a little something out of the debt limit rise.  Keith Hennessey has an Op-Ed at the WSJ that lays out an even better strategy.  The whole thing is worth a read, but the gist of goes like this:

1. Obama can have a choice of real spending cuts and he gets a long term debt limit rise.  Alternatively, he can have a three month debt limit increase, if he doesn't want to get serious.
2. Republicans would only guarantee enough votes to allow the measure to pass, making Democrats responsible for raising the ceiling.  To date, House Democrats have been shielded from this bit of unpleasantness.

Keeping the focus on the debt every three months will suck the air out of any other Obama agenda item.  So will meaningful spending reductions.  Both options are great.  I doubt the GOP will be that smart.

National Debt Crossing $16 Trillion

Congratulations kiddos, the national debt clock to the right will likely cross the $16 trillion mark in the next few days. Happy trails. To quote the Joker in the Dark Knight, "It wasn't cheap. You oughta know, you bought it!" Yeah, we the people bought it by constantly re-electing feckless Republicans and Democrats who cared more for their own re-election than for the country. We were happy to vote for politicians who in turn voted for a never ending expansion of the federal government, when the means to pay for it was never going to materialize. Republicans have been guilty as well; but I know this: re-electing Democrats, including Obama, will make the problem larger and bigger and give us less time to deal with it.

Complaining About the National Debt is well, Racist

The tea party movement still gets tagged with the racist label, which is of course total crap, but its main concern has been the U.S. debt bomb. I have added the U.S. national debt clock to the right to illustrate our main concern. Congratulations, check out how fast your share of the debt is rising under Obama. Meanwhile let's break down the facts. Last fiscal year the federal government reported it had paid $454 Billion on the national debt. The Congressional Budget Office projects that this interest will rise to consume 2.5% of GDP by 2020, up from 1.5% today. But read the fine print, the CBO is using low interest rate projections:

As a result of persistently low interest rates, payments for net interest are expected to remain low despite the burgeoning debt.

Really? Isn't that a nice bedtime story. They are counting on the federal reserve to continue to keep borrowing costs down. The average interest rates the feds pay is around 2%. But the fed's quantitative easing is likely to ignite inflation eventually. As recently as 2000, the treasury paid an average of 6.5%. So instead of a mere $454 billion hole in the budget, under more normal conditions, we might be liable for well over a trillion dollars per year in interest. That would be bigger than the entire defense budget, bigger than social security payments.

The Federal Reserve can't keep interest rates low forever. Eventually, inflation will ignite and force their hand. This debt will become a huge drain on the economy, far greater than the budget projections of the CBO show. Interest rates in the early 80s spiked at the 12% range. It was bitter medicine needed to ring inflation out of the economy, and it worked. Can today's economy survive the almost $3 trillion per year hit that 12% interest rates would cause? That's more than the entire revenue of the federal government in 2011. Who would loan the U.S. money under those conditions? The country survived a hyperinflation scare in the late 70s. We had a much more manageable debt ratio. I don't think we could handle it now.

So, what do you think, bigots? Is this a race tinged discussion or what?

Super Difficult Draconian Security-Threatening Cuts to Start. . . in 2013

Well, no wonder they failed. In political terms, 2013 is a lifetime away. Obama will probably not be President by then. There is no immediate impact other than to credit ratings. It gives the new President and a new Congress time to deal with the problem. It even gives the current President and Congress time to deal with the problem. If pork barrel spending in their districts was going to end next month, maybe some compromise would have been reached. For all of the press and attention given to the so called Supercommittee, the actual immediate impact will be nil.

Billy House of The National Journal got the important fact correct.

But the nation’s debt crisis will continue – with the deficit now at about $15 trillion. It also is likely no coincidence that the committee waited until the financial markets closed for the day to make the announcement. The Dow Jones industrial average had already tumbled by more than 300 points earlier in the day partly in anticipation of the acknowledgement of failure.

In case you thought that the Supercommittee meeting its goal would be a significant victory for deficit reduction, consider this.

By law, 18 percent of the automatic savings are assumed to come from interest costs the government would save from reducing the debt. If the Super Committee fails completely, out of the $1.2 trillion in automatic savings, $216 billion would be assumed interest savings.

That would leave $984 billion in automatic spending cuts over 10 years. That works out to around $55 billion annually each from defense and domestic programs though a CBO analysis shows that comes out to 10 percent of the Pentagon budget in 2013 alone, a huge hit.

$55 billion annually? Really? The national debt is increasing at a pace of close to $2 trillion per year, with an official budget deficit of $1.5 trillion per year. (I never figured out that discrepancy, the official deficit is always less than the annual increase in debt, go figure.) To put this into household terms, its as if you were borrowing close to $200,000 against your house, year after year, and an adviser came up with bold plan to reduce your expenditures by $5,500 $11,000* per year. Not even a really credible first step. What a game politicians, with the connivance of the press, are playing on us all.

Only serious decreases in spending and increased revenue from a recovering economy are going to fix this. So every job killing, economy destroying decision by this administration starting with Obmacare, the Boeing plant in SC, ending most recently with killing the Keystone XL pipeline, has hurtled the country towards increased and unsustainable debt.

The Democrats were their usual retarded selves in this deal, but I thought the Republicans could have smarter about offering some revenue increases that would accrue to eliminating loopholes/deductions as a step towards comprehensive tax reform, earlier in the process. It appears that Sen. Pat Toomey (R-PA) offered such a plan at the last minute, but it didn't raise enough revenue to satisfy the Democrats.

Toomey’s plan would raise $300 billion in new tax revenues while overhauling the federal tax code. Republican officials say it would drop the top tax rate on personal income to 28 percent from the current 35 percent. It would reduce or eliminate some well-known itemized deductions and reduce the corporate tax rate.

If Republicans had offered the plan earlier, and got agreement to score it with dynamic, not static analysis, it would raise far more revenue than the $300 billion advertised, and we might have been much closer to a deal. The Republicans are right to keep trying to push down marginal rates, but they should be coupled to eliminating deductions to move towards more of a flat tax, because this will also be a reform that reduces corporate influence on Capitol Hill.

Just in case there was any doubt about my discussion on the fact that spending and revenue are both problems, but spending is more of the problem, I offer this chart from the Heritage Foundation.



*Post publication correction. I failed to account for the fact that there are two categories of spending reduction, so the total per year needed to be doubled. However, $11K per year against a household deficit of $200K per year is still pathetic.

Leveraging the Debt Ceiling

Pat Toomey is proposing a way to ensure that freezing the debt ceiling will not result in a default on government obligations. I like the way he is thinking, because the debt ceiling is one of the best levers the Republicans in the House have of forcing a real debate on spending cuts. Here is a part of his proposal:

In fact, if Congress refuses to raise the debt ceiling, the federal government will still have far more than enough money to fully service our debt. Next year, for instance, about 6.5% of all projected federal government expenditures will go to interest on our debt, and tax revenue is projected to cover about 67% of all government expenditures. With roughly 10 times more income than needed to honor our debt obligations, why would we ever default?

To make absolutely sure, I intend to introduce legislation that would require the Treasury to make interest payments on our debt its first priority in the event that the debt ceiling is not raised. This would not only ensure the continued confidence of investors at home and abroad, but would enable us to have an honest debate about the consequences of our eventual decision about the debt ceiling.

The Tea Party should get behind this legislation. It takes straight aim at our most important assertion, that the never ending expansion of government debt is a threat to the foundations of the Republic.

On the same page of today's WSJ, Dick Armey and Matt Kibbe, of FreedomWorks, propose a series of spending cuts that could be accomplished with the leverage that a frozen debt ceiling might bring. They also remind us of the wisdom of the late, great Milton Friedman:

Milton Friedman correctly argued in 1999 that the "real cost of government—the total tax burden—equals what government spends plus the cost to the public of complying with government mandates and regulations and of calculating, paying, and taking measures to avoid taxes." He added, "Anything that reduces that real cost—lower government spending, elimination of costly regulations on individuals or businesses, simplification of explicit taxes—is a tax reform."

On to the savings. I like the way they are thinking, here are some I can endorse:

• Stop stimulus spending, $177 billion per year.
• Repealing Obamacare, $898 billion over 10 years.
  
• End the bailouts of Fannie Mae and Freddie Mac. $389 billion.
• End ethanol subsidies. $170 billion over 10 years.
• Scrap Commerce and HUD, $550 billion over 10 years. (Although I would keep NIST and "weights and measures" as constitutionally allowable.)
• End Amtrak subsidies, $38 billion.
• Defense spending cuts of $145 billion over 5 years as Secretary Gates proposes.

Read the whole thing here.

They also make the argument that the entitlement mess is the biggest problem in the federal budget. With respect to the health care spending, they are arguing in favor of Paul Ryan's approach to convert medicare spending into capped contributions to individuals. Perhaps more on that in another article.

One area where I disagree is to convert some portion of Social Security into optional personal accounts. I once liked this idea, but now believe it will result in mischief, because the government will be too tempted to regulate or raid those accounts. Better to ween the public off social security by steadily eroding its benefits, in order to "save" it. For example, slowly raising the retirement age, capping increases below the rate of inflation, and means testing benefits by taxing them reduce the benefits. As the country inevitably grows richer, social security will eventually be seen as anachronism. Forty years from now, if I live that long, we won't be having this debate.

Expanding Deficit - Revenue or Spending Problem? UPDATED

Steve commented on my BWD post that the reason that the federal deficit is growing is due to decreasing federal revenue. Because of Hauser's law, I opined that it must be due to rising spending. I pulled up this chart from the Heritage Foundation to check the facts. What do you think?



In case I lose the link:



However, I am a little mystified at the rate at which the debt is climbing, it does not appear to be fully explained by either the rise in spending nor the fall in revenue. The deficit is climbing at a rate of $2 trillion per year, where as the gap between revenue and debt only recently peaked at $1.5 trillion per year. From CBS News:



Anyone who knows the answer to this mystery, I am anxious to hear from you.

UPDATE

W.C. points out in the comments that I am not the first person to have noticed that the debt is growing faster than the deficit would suggest, pointing out that Zero Hedge and Denninger had commented, without concise conclusion, there seems to be a general consensus that the difference is accounting gimmicks. Adam Freund suggests that it is a failure to account for interest on the debt. Thanks for the further insight.

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.

Debt and Deficit - Leaks from the Panel

"Depend upon it, Sir, when a man knows he is to be hanged in a fortnight, it concentrates his mind wonderfully," or so says Samuel Johnson. Doing some reading about the math surrounding the Federal debt has done the same for me. First a little from the "Debt Commission." The leaders have leaked some of their recommendations, and they are challenging. But despite the immediate negative reaction and the sweeping nature of the proposals, they don't fully close the gap, the federal deficit would still be 2.2% of GDP in 2015.

Before I get into the details released by the commission's co-chairs Erskine Bowles and Alan Simpson, we should review the magnitude of the problem. KT recommended an article on Monty Pelerin's World that gives a sense of the magnitude of our debt problem:

If the Government confiscated everything, the social programs would still be $50 trillion short and the Government would still be bankrupt. Furthermore, no company or individual would be left with anything.
. . . The Federal Government has nothing left from their “gross pay.” Their “living expenses” actually exceeded their gross pay by $1.2 trillion last fiscal year. That is, they spent almost 50% more than they made. Comparable behavior is budgeted for the next ten years. . .The Federal Government is in what is known as a Debt Death Spiral. They are unable to pay the actual and implied interest on their debt. Hence, the unpaid balance is added back to the amount owed, making the problem worse next year.

The raw numbers are very bad. Federal spending for the last fiscal year was estimated at $3.55 trillion and federal receipts at $2.38 trillion, leaving a deficit of $1.17 trillion. Relating it to your family budget, this 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, according to the linked article above, the real value would be closer to $4,500,000, however, I am unable to independently confirm that figure.

Some pictures:

2010 Federal Outlays, Estimated.

Here's a summary of the $3.8 trillion in deficit reduction measures proposed by the leaders.

• Gradually raise social security retirement age.
• Various cuts in social security benefits.
• More taxes on wealthier incomes (presumably for social security).
• $410 billion in various discretionary spending cuts.
• Earmarks - $16 billion.
• Cut the federal work force by 10%.
• $100 billion in Defense spending cuts.

Already the commission catching grief from right and left. Both Grover Norquist and Nancy Pelosi have criticized the preliminary recommendations. The full commission seems unlikely to vote for these recommendations. As you can see from the graphic above, there are few easy answers. I don't like all of the recommendations either, but it's time to get serious.

Assuming for a moment that all the recommendations were implemented, it still leaves the country with a huge overhang of debt that is only continuing to grow. Apparently, there is no combination of spending cuts and tax increases politically acceptable enough to solve this crisis.

Exit question: What's to be done?

Strangely enough, I think part of the answer lies in solving the immigration problem. More on that in another article.

British Tea Party?

Well who would have thought it? First the Greeks go in for some austerity, then the Irish, French and now the Brits? The country that was the object of a rebellious party in 1773, is now on the bandwagon? From the UK Financial Times.

The UK’s Conservative-led coalition has announced the most drastic budget cuts in living memory, outstripping measures taken by other advanced economies which are also under pressure to sharply reduce public spending.
. . .
The UK cuts of £81bn ($128bn) over four years are the equivalent of 4.5 per cent of projected 2014-15 gross domestic product. Similar cuts in the US would require a cut in public spending of about $650bn, equal to the projected cost of Medicare in 2015.

What the heck is happening to Europe? Simple, reality is setting in. Things that can't go on, don't. One must ask if U.S. politicians that are elected this November will show similar fortitude and rise to the occasion. I especially like the way the spending cuts are being handled:

Declaring that “today is the day where Britain steps back from the brink”, George Osborne, the chancellor of the exchequer, revealed dramatic reductions to core departments over the next four years, a £7bn fall in welfare support and 490,000 public-sector job cuts by 2014-15.

All of the inchoate hatred inveighed against the Tea Party fails to respond to our central question: How is the current path of spending and deficit sustainable? Where is the plan to change the shape of this curve?

Even the rosy picture painted by the White House shows a deficit far worse than any ever produced by George W. Bush for every year in perpetuity after Obama was sworn in. How much more damage to the economy do we want to allow?

Note to Republicans, you better start showing you are as serious as David Cameron, or the Tea Party will be coming after you.

Financing the Deficit

At the Scratching Post, KT has some nice graphics showing the mushrooming debt under Obama. Unfortunately, it also shows that the Bush administration, while not nearLY as bad, still did us no favors. Bush inherited a surplus and turned it quickly into deficit.

KT also has some comment on the impact of the manner of financing the national debt, as in short term (think ARM) versus long term (think 30 year fixed). I used to not worry one way or the other, but with the deficits increasing without end, we will either get big increases in inflation, or a severe tightening by the Fed, or both. The end result will be huge increases in short term interest rates.

I have liberated the rest of my commentary on KT's post.

All other things being equal, ARM funding is usually less expensive than long term debt (even in the long term), but it exposes the borrower to more risk. It is a classic trade off between risk and benefit. The federal government theoretically could manage its own risk in this regard as it has the power to keep inflation under control. From one perspective more short term debt is a rational outcome.

However, government is run by politicians not accountants or economists. The actual effect of the ARM financing has been to minimize the impact of the debt on the federal cash flow, thus encouraging larger deficits. As a result, we are doubling down on the risk, because high deficits lead to higher inflation risk, which in turn lead to higher risk that debt servicing will become unsustainable.

I think the bigger question is how long will it take for these monster deficits to work their way through the whole economy and re-ignite inflation. Hopefully in time to influence the 2010 elections, so that voters can feel the true consequences of stimulus and vote accordingly and perhaps put the brakes on these huge deficits. Unfortunately, the Republican party has yet to adequately re-brand itself in image and in fact as a party of smaller government and reform, so they may not reap the benefit of inflation turning the Obama presidency into Carter II.