U.S. debt: how is it going to end?

I've not written on this blog for several months, but reading another article on the debt got me started again.

According to a recent article in the USA Today, the U.S. government has $61,600,000,000,000.00 of unfunded liabilities as of the end of 2010 (using GAAP). How do we get out from under this mountain of debt?

Can we just raise taxes for those making more than $250,000 per year?
Let's think about the numbers a bit more. $61.6 trillion works out to each household in the country owing $527,000 -- more than 10 times the average annual gross household income! Even if we decided to take 100% of EVERYONE's personal income in taxes, it would take more than 10 years to pay off that debt. Obviously this is impossible. Raising taxes on everyone won't do it, much less raising them only on the "rich".

Can we reduce the debt directly?
We could eliminate roughly half of it with some fairly straightforward reductions in the two largest sources of this debt: Medicare and Social Security. Since both program were introduced to help care for people living beyond their expected lifespan, the current qualifying age is artificially low. Gradually increasing the qualifying age for both medicare and social security would dramatically reduce future obligations. It could be done so that people within 10 years of the current qualifying ages are unaffected, perhaps increasing it 1 year for those 10-20 years away, 2 years for those 20-30 years away, and 3 years for those 30-40 years away (and so on until the qualifying age is older than the expected lifespan, as it was when Social Security was established).

Even though this seems reasonable intellectually, it is politically untenable. Look back at the reaction to the President's bipartisan National Commission on Fiscal Responsibility and Reform's proposal to raise the Social Security qualifying age by 2 years starting in 2075 (for those currently 64 years away from retirement!) Dozens of Senators and Representatives quickly made announcements they would not support such "radical" reform and instead "protect" Social Security (by letting it go broke :(

As I've written before, a huge reduction in the Social Security liability could be made by retaining the current maximum benefit limits (still adjusting for inflation). Simply eliminate the regressive maximum annual contribution limit (in 2011, only the first $106,800 of income is subject to Social Security taxes). However, this doesn't fully solve the problem for Social Security and it does nothing to reduce the even larger Medicare obligations. Raising qualifying ages seems the most rational approach.

Can we inflate our way out of it?
By printing more dollars, the U.S. government makes the value of each individual dollar less: production costs increase, goods and services become more expensive, employees demand higher salaries, etc. You can already see the beginning of this, with the U.S. Dollar losing roughly 20% of its value against other currencies in the past year. Things we import from elsewhere (such as oil) cost more. Oil price inflation is particularly insidious, as it dramatically impacts transportation costs for everything. Although inflation greatly hurts savers (such as retirees living off their savings), it's beneficial to debtors (since they pay back their debts with currency that is worth less).

Unfortunately, nearly all of our obligations are adjusted for inflation, with automatic "cost of living" adjustments. So, while we end up paying back the debt with lower-value dollars, we end up owing more, so inflation doesn't help. Overall, because of the effect of inflation on the rest of the economy, it's more detrimental than beneficial, unless perhaps we could break the automatic inflation increases to benefits. However, we know that is politically infeasible and harmful to recipients.

Can we grow our way out of it?
Theoretically, this would be a great solution. A strong economy would generate more business income, jobs, personal income, and thus increase the taxes available to pay these debts. However, this appears extremely unlikely. We seem to have little control over our economic growth, and as the well respected research of economists Carmen Reinhart and Ken Rogoff show, once debt reaches a certain level near 100% of GDP, economic growth declines dramatically. By the way, if you don't mind a lot of data and charts, check out their book: This Time Is Different: Eight Centuries of Financial Folly. Our national debt (not the $61.6 trillion in future obligations, but "only" the $14.4 trillion we explicitly owe now) is now over 95% of our current $15.1 trillion GDP. So, no, we almost certainly can't grow our way out of this debt.

Will we end up defaulting?
Defaulting means that we would not pay our obligations. We'd probably continue to pay our external debt as long as possible, so we could continue to borrow money. However, without another solution, we'll be forced to stop paying for something. What would go first? Would we start by cutting Medicare coverage, perhaps actually creating the "death panels" that were fictionalized in the 2009 national health care discussions, and then continue reducing medical benefits? Perhaps repeated cuts in pay for all government employees? Fire lots of them? Eliminate most of the military? Gradually reduce Social Security payments until we have to eventually get rid of the program altogether? The choices would not be easy and they would hurt lots of people. And then what happens? Increased suffering, poverty, illness, homelessness, and even starvation?

Yet, if we can't make the difficult decisions to be financially responsible now, it will be worse when we are finally forced to do so later. Every year we delay reducing our obligations, the cuts have to be bigger and the likelihood of passing them in Congress decreases. Sadly, default seems the most likely scenario to me, and I am frightened by the prospect.

What do you think?
Please leave a comment with your thoughts on the subject.

Draft Proposed Debt Reduction Plan Released Today

The slides from a proposal by the co-chairs of the President's National Commission on Fiscal Responsibility and Reform can be found at http://www.fiscalcommission.gov/sites/fiscalcommission.gov/files/documents/CoChair_Draft.pdf

I am actually fairly impressed with the proposal. Unfortunately, some Senators and Representatives have already spoken out against it, saying they will not support it, even though they offer no effective alternative suggestions other than increasing debt. Sigh :(

Basic summary is that they propose eliminating all special interest tax deductions for individuals, and nearly all for businesses (keeping research tax credit, etc.) This allows them to simplify and lower marginal tax rates while still increasing overall tax revenue. They enumerate several health care cost savings proposals and save social security by gradually raising the full retirement age to 69 in 2075, gradually increasing the wages subject to social security taxes, and reducing social security benefits for those less in need.

Overall, the reductions are made up about 2/3 from reduced spending and about 1/3 from increased taxes, which seems a reasonable tradeoff.

Take a look, and if you think it's a step in the right direction, as I do, contact your Senators and Representatives to tell them you support such reform.

For more information on the National Commission on Fiscal Responsibility and Reform, you can find their website at http://www.fiscalcommission.gov/.

more about new health care law

This morning I read an excellent article on the effects of the recently enacted Patient Protection and Affordable Care Act, also known as "Obamacare".

You can find it here: http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2010/11/08/the-effects-of-obamacare.aspx

After reading it and learning more about the new law, I find my previous strong support of this legislation was naive. Yes, it does some great things: eliminates pre-existing conditions as a valid reason to deny health insurance, eliminates lifetime maximum benefit limits, expands health insurance coverage to more people, and attempts to reduce overall health care costs. However, the positive effects appear to be offset by more negative ones than I expected.

Inevitably, every article has a bias to support the points intended by the author, and this one does, too, but the factual data and arguments are persuasive. Please read the article and make your own judgment.

Washington State Initiative 1098

One of the initiatives in Washington State this year is 1098, which would impose an income tax for the first time in Washington. Washington is one of 7 states that do not currently have an income tax.



If I-1098 were to pass, beginning in 2012, it would impose an excise tax based on federal adjusted gross income (AGI). For individuals and married couples filing separately, the tax rate would be 5% for AGI above $200,000 up to $500,000 plus 9% for any AGI above $500,000. For married couples filing jointly, the tax rate would be 5% for AGI above $400,000 up to $1,000,000 plus 9% for any AGI above $1,000,000.



The tax receipts would be used to provide a tax credit to offset business and occupation (B&O) taxes on business gross income for the smallest small businesses, to reduce state property taxes, and to fund education and health services.



FYI: Small businesses are defined by the state of Washington as those business employing 50 or fewer employees.



I thought I'd look at the claims on both sides of this initiative, try to evaluate them for accuracy, and put my perspective on the issue.






SUPPORTING I-1098



Here are the primary claims of those who wrote and support the initiative:



1. I-1098 eliminates the B&O tax for small businesses.



SOMEWHAT TRUE: It does eliminate the B&O tax for the smallest (in terms of gross income) estimated 118,000 small businesses and reduce the B&O tax for an additional estimated 39,000 small businesses.



BUT ALSO FALSE: At the same time, the largest small businesses will end up paying higher taxes, due to the excise tax. Sixty-eight percent of those earning more than $200,000 or more are small business owners. They would gain no B&O tax reduction and have to pay the new excise tax.



2. I-1098 reduces everyone's property tax by 20%.



DECEPTIVE: It reduces only the state portion of everyone's property taxes, but that is only a small portion of the overall property tax. In Seattle, the effect is expected to be only a 4% reduction in overall property tax. In addition, local property tax districts will then be able to increase their property taxes to take advantage of this drop while remaining within the constitutionally mandated limit of 1% increase per year in property taxes without voter approval. Property taxes might not drop at all in some areas.



3. I-1098 provides $2 billion per year for education and health care.



TRUE, BUT MAYBE NOT: It does require the net increase in tax revenue to be spent 70% on education and 30% on health care. However, there is nothing to stop the legislature from reducing budget allocations to those services from the general fund by similar amounts and using these "savings" in the general fund for other purposes. They shouldn't, but they can. The legislature could also use those funds for other purposes, as they have in the past: taking educations funds designated from I-620 (death tax), I-728 (class sizes), and I-732 (teacher pay), and health services funds designated from cigarette taxes.



4. I-1098 taxes apply only to the wealthiest 1.2% of Washingtonians.



MOSTLY TRUE: Wealth is generally considered to be net worth and not current year income. However, income does not correlate perfectly with wealth. People with much lower than $200,000 average annual income will be subject to the new taxes whenever their AGI rises above those levels. For example, those who have volatile incomes (e.g., farmers) and those who may have an unusual one-time bump in AGI (such as converting all of their Traditional IRAs into Roth IRAs, or selling long-term stock holdings for a big capital gain) will have to pay the new excise tax.






OPPOSING I-1098



Here are the primary claims of those who oppose the initiative:



1. I-1098 could result in income taxes for everyone in as little as 2 years.



LITERALLY TRUE, BUT GREATLY EXAGGERATED: I-1098 does not allow changes to the rates or income levels for the excise tax without a public vote. Of course, two years after I-1098 is passed, the legislature can change it by a simple majority vote, and then apply any income tax rates at any levels, but they wouldn't do that all at once. The legislature will inevitably desire in the future to spend more, and adjusting an existing income tax will be a tempting means of paying for it.



Even if a public vote is required, you can be pretty much assured that once in place, an incremental change is likely to pass. The funds will be intended for another good purpose, and mostly only the people who would be newly subject to the tax would vote against it -- the people already subject to the tax likely would vote for it (on principle of fairness) and the people who would still not be subject to the tax would likely vote for it because it costs them nothing.



2. I-1098 proceeds will be spent for other purposes.



UNLIKELY: While the legislature can change the use of funds in dedicated accounts, they don't do this often. However, see my comments about claim #3 of the supporters.



3. I-1098 B&O tax relief will not be permanent.



DECEPTIVE: Yes, the legislature can take it away the tax credit, but it seems improbable they would do so anytime soon, given the huge state revenue increase from I-1098.



4. I-1098 will result in lower job growth.



PROBABLY: The new B&O tax credit is good for start-ups and low income small businesses, but it is bad for highly profitable small business and high income small businesses (that may or may not be profitable), where you would expect much of the job growth. It's probably a net negative on jobs, with fewer private sector jobs partially offset by some additional government jobs.



5. I-1098 will make it harder to attract great talent.



UNLIKELY: State income tax rates are not a primary consideration for most potential employees, although it may increase the costs for businesses to attract and keep the best high wage employees in highly mobile fields such as technology and upper management executives.



6. I-1098 will reduce charitable contributions.



LIKELY TRUE: Since charitable contributions are not deducted before calculating adjusted gross income, it seems likely that there will be some reduction in charitable contributions. According to 2007 IRS returns, 85% of all charitable contributions were made by those with adjusted gross incomes of $200,000 or more.






MY OPINION



Although in its current form it may never apply to me, I am voting against I-1098.

• Based on history with other taxes in Washington (sales tax, property tax, gasoline tax, etc.) and income taxes in other states, a new Washington income tax will inevitably be expanded.
• Washington has a regressive tax system in which people with lower incomes pay a much higher percentage of their income in tax that those with higher incomes. Ideally, we'd have a fair tax system, in which everyone paid the same percentage of their income.  A progressive tax such as that proposed by I-1098 would improve the tax fairness situation in Washington, but I don't believe this is the way to achieve it.
• There are better alternatives to an income tax for raising revenue, such as increasing use taxes and luxury taxes.
• I-1098 seems more likely to hurt the Washington economy than to help it.
• We should stop creating restricted government funds and instead let our legislators do their best to prioritize across the entire budget.
• We should require budget surpluses that are saved during expansions and allow limited budget deficits during recessions that may use up those savings.

Please let me know if anything above is incorrect, if you think I've made an error in evaluating a claim, or if you just have an opinion to share. Thanks!



Here is the full text of Initiative 1098 and here is the Washington State 2010 General Election Voters' Guide.

FDIC and NCUA insurance permanently increased to $250,000

Yesterday, the temporary increase in FDIC insurance from $100,000 to $250,000 was made permanent. It was previously set to expire at the end of 2013.

The press release announcing the FDIC insurance from the Dodd-Frank Wall Street Reform and Consumer Protection Act is here: http://www.fdic.gov/news/news/press/2010/pr10161.html

The press release announcing the NCUA insurance is here: http://www.ncua.gov/news/press_releases/2010/MR10-0722$250KNCUAShareInsuranceProtectionNowPermanent.pdf

Another FDIC press release (http://www.fdic.gov/news/news/press/2010/pr10162.html) announced that the increase was made retroactively back to January 1, 2008. This provides additional insurance coverage for depositors whose banks failed between January 1, 2008, and October 2, 2008. The six banks that qualify for this retroactive insurance are: ANB Financial, Columbian Bank and Trust, First Priority Bank, Hume Bank, IndyMac Bank, and Silver State Bank.

According to Q&A page http://www.fdic.gov/bank/individual/failed/dodd_frank_q_and_a.html, checks were mailed today for qualified depositors of those six banks.

For those of you with more than $250,000, note that you can qualify for multiples of $250,000 FDIC or NCUA insurance coverage by using different ownership categories. An individual account qualifies for $250,000 coverage. A joint account (e.g., with a spouse) qualifies for separate $500,000 insurance ($250,000 each). A revocable trust account (e.g., a "payable on death", or POD, account) with three beneficiaries (e.g., a spouse, child, and parent) qualifies for separate $750,000 insurance (3 x $250,000). Thus, at a single bank, with the three account ownership category examples above, you could qualify for $1,500,000 of FDIC insured deposits. For more information, read all about ownership categories at http://www.fdic.gov/deposit/deposits/insured/ownership.html.

The NCUA has their insurance information here: http://www.ncua.gov/Resources/ShareInsurance/YourInsuredFunds.pdf