“Lets Get Fis-i-cal” Olivia Newton-John

The good news about the impending “fiscal cliff” is that it has cast attention on the rather dire fiscal condition of the US and the need to ultimately close the deficit. Unfortunately, the bad news is that there is still little consensus about what to do even at this late date AND predictably, what is being discussed is woefully short on what actually needs to be done. 

With only about two weeks to go, the two sides are at least talking now, though from all accounts the discussion is not going well. President Obama has offered (publicly at least ) a plan with virtually all tax increases with an estimated $1.6 trillion in new revenues thru increases in income tax rates and reducing and phasing out deductions for the “wealthy few” (currently defined as though earning more than $250 K). In contrast, the Republicans have offered (again “”publicly”)  to raise taxes on the wealthy by capping deductions for a total of $0.8 trillion in new revenues and have also offered significant long-term reductions in spending and particularly entitlements ($600 billion in Medicare cuts and long-term cuts in Social Security expenditures).

While reasonable people can argue about how much new tax revenue is needed to help close the deficit, virtually no one argues that we don’t need more tax revenues. I have consistently made the point in this blog that in order to increase tax revenues one MUST focus on the EFFICIENCY of the tax code. This extremely important concept seems to be largely lost on most politicians who after all are not exactly trained in dealing with  numbers or strange concepts like economics and finance. This seems to be particularly true with President Obama whose mantra of raising tax rates on the wealthy few is the ONLY tax idea he seems to have or at least the only one he wants to talk about. Never mind that we have had the Simpson-Bowles recommendations out for two years, which though by no means perfect, would represent a major improvement in the tax code and its revenue-raising ability, while actually reducing tax rates. This would have been an excellent place to start a dialogue with Congress, but the President has largely ignored it.

The sad part about all this  is the idea of simply raising the top two income tax rates seems to have gained credence with some as the key part of closing the deficit. But, the $800 billion in revenues over the next 10 years that increasing the top two rates would raise under the President’s estimate is less than 7% of the total deficit gap that we are likely to face. However, even this estimate is probably optimistic because it assumes that there will be NO change in how much reported income will occur in these top brackets. This ignores some important realities about the current tax code and who pays the top rates. The Congressional Budget Office (CBO) recently released a report on this very issue with regard to businesses. (See “Taxing Businesses Through the Individual Income Tax” December 2012). Since 1980, there has been a huge growth in receipts from proprietorships, S Corporations, general and limited partnerships and limited liability corporations with receipts from these businesses now accounting for 38% of total business receipts (vs only 14 % in 1980). These business entities pay taxes thru the individual tax code and account for a very significant share of total individual tax receipts and in particular, those filers that pay the top two rates. The amount of this business income that is reported under the individual tax code is likely to go down if the top two rates are raised, because of the very thin margins that these typically small businesses operate under. Some won’t expand as previously planned and even curtail operations; others may simply close up shop and, if their businesses are portable, end up overseas; and some of larger entities may actually convert to being C corporations to pay a lower tax rate. In the end, what is certain is that the increase of the top two rates will result in significantly less tax revenue than the projected $800 billion. 

Further, the focus on taxes has largely left the necessary cuts in federal government expenditures  along with entitlements largely out of the discussion. As I have noted, in my past posts, we MIGHT be able to increase tax revenues as a share of GDP from today’s current low levels (around 15 percent) perhaps up to the most recent peak of 18.5% in 2007 in the next few years. However, we will have to be willing to make major reforms in the tax code to get there. Even so, at best we can hope to cut 30-40% of our future deficits thru increased tax revenues.  This means the other 60-70% must come from federal budget cuts below CURRENT levels.  

How do we get there? Here the federal government needs to look to the private sector where many companies have successfully downsized , survived and in some cases thrived. Here are a few ideas which collectively should help us get most of the way there.

1. With the possible exception of entitlements, measure all cuts relative to current actual spending levels–This seems pretty obvious to most of us and is exactly how the private sector reins in budgets. In my own personal case at AEP, I am asked to cut a certain $ amount or % below my current year budget. This results in an actual cut or reduction in the amount of $ spent next year relative to the levels I spent this past year. However, amazingly enough, the government in its bureaucratic wisdom measures all cuts relative to what it projects it “would have” spent in the future. For example, an agency that spends $100 billion in 2012 and projects spending of $150 billion in 2015 can claim “cuts” of  $20 billion if it increases its spending “only” to $130 billion.  (For more on this insidious practice , go to wsj.com and look for the “The Budget Baseline Con” on December 4th.)
2. For ALL federal agencies, immediately freeze ALL salaries and benefits at current levels until the total budget cuts required by agency are met.
3. Freeze all new hiring unless explicitly mandated by Congress until the total budget cuts are met.
4. Cut all agency budgets (excluding entitlement spending) by 20% below current levels by FY 2016 (with a 5% cut in each of the next four years).–This is my own rough estimate of what is needed at the agency level. However, the number can be raised or reduced depending on what we are willing to do on entitlements.  
5. Implement a voluntary severance program for the next two years which provides additional benefits and incentives for some to take early retirement. This program would be available for only the first 10% of government employees.
6. Agency, departments or divisions within agencies (if eligible) that move to a direct “user fee” system can avoid the budget cuts and all other requirements noted above. But ONLY to the extent they are funded by the user fee system. This would include departments like the Bureau of Land Management or the National Park Service which should be able to fund most of their operations thru direct user fees or for that matter, the Energy Information Agency(EIA) whose data and models are mostly used by the private sector.
7. Make immediate changes to entitlement spending. Increase eligibility age for Social Security AND Medicare to 67 by 2015 and 70 by 2020. Make ALL social security benefits immediately taxable the same as regular income. “Means test” social security benefits so that they are phased out for those with high annual incomes. Reduce inflation adjustment for Social Security to equal CPI  minus 1 percent. Move Medicare to a voucher-based system more along the lines the Ryan plan.

To those who say that agencies can’t make 20% cuts over four years , I say “baloney”!  ( I actually said something else, but this is a  family blog). After all, we spent “only’ $2.7 trillion on government as recently as 2007 as compared to $3.6 trillion today or some 25% less. In addition, we need to consider getting rid of agencies or departments or divisions within agencies that have outlived their usefulness and provide little to nothing for Americans. The Departments of Agriculture, Transportation and Energy comes to mind as a prime candidates for either elimination or at least getting rid of many of their functions or divisions. However, virtually ALL government agencies have some departments or divisions that have long since outlived their usefulness.

In short, we can cut government spending substantially, while retaining essential government services and entitlement protection which ensure that the poor and disadvantaged have access to health care and welfare assistance.

Sadly, we are NOWHERE NEAR this discussion as Christmas approaches. Lets hope that the discussions on spending become more serious after the New Year. As Olivia Newton-John sang back in 1981, its time to “get fis-i-caL”