America The Unsustainable?

The official word from America's top financial cop is that our nation is facing a very simple 50/50 proposition:  stop massive government spending or risk going broke.

While the passing of the King of Pop grabs the headlines,  something far more shocking came out of Washington last night in the form of the latest long-term budget outlook from the Congressional Budget Office.

At more than 80 pages the report is lengthy, but I'll summarize:  Government spending is out of control and unless we rein it in or raise taxes to never before seen levels our national debt could put us on the road to economic ruin.

The report opens by stating:

'Under current law, the federal budget is on an unsustainable path—meaning that federal debt will continue to grow  much faster than the economy over the long run. Although great uncertainty surrounds long-term fiscal projections, rising costs for health care and the aging of the U.S. population will cause federal spending to increase rapidly under any plausible scenario for current law.   Unless revenues increase just as rapidly, the rise in spending will produce growing budget deficits and accumulating debt. Keeping deficits and debt from reaching levels that would cause  substantial harm to the economy would require increasing revenues significantly as a percentage of gross domestic product (GDP), decreasing projected spending sharply, or some combination of the two.'

Spending up, revenue down.   Bad combination.

We've already walked through the math of the 2010 budget.   Any way you slice it, we are spending more.   While the Administration touts some $17 billion it found in cuts, that is just 0.5% of the total $3.4 trillion budget.   It's a whopper that keeps on giving, and keeps on spending.  While all budgets tend to rise from previous levels due to inflation and a growing population, let's not forget that the 14% increase from the previous budget is one of the largest jumps in history.   Spending as usual.

Most of this spending is on the Big 3.    Not GM, Ford and Chrysler, but rather the new "Big 3" of Social Security, Medicare and Medicaid.

Page 9 of the report states:

'In the future, projected growth in entitlement spending explains almost all of the projected growth in total  non-interest spending—and the two big government health care programs largely drive that increase. Medicare and Medicaid are responsible for 80 percent of the growth in spending on the three largest entitlements over the next 25 years and for 90 percent of that growth by 2080.'

Medicare and Medicaid costs are out of control.     The CBO estimates that spending on health care alone could rise from 5% of the total economic output of America to as much as 17% toward the end of this century.    By the time your kids are senior citizens, health-care entitlement programs will have more than tripled in size and cost in relation to the entire economy.   That's clearly unsustainable, and it is why the President has made health care one of his key platforms.    Pardon me for being skeptical, but if Medicare is our biggest financial problem, how exactly would an even larger government-run health care plan help us solve our financial woes?   Most of the guests we have had on the program say it won't, and indeed will likely only make matters worse.   Americans know the government is not exactly a model of fiscal discipline.

With these higher costs come higher debts.    Anyone with a debt knows that debts require interest payments.   The government works the same way.  We issue debt and must pay interest on it.   And as debts soar, so do our interest payments.    More from the report:

'But CBO estimates that in fiscal years 2009 and 2010, the federal government will record its largest budget deficits as a share of GDP since shortly after World War II. As a result of those deficits, federal debt held by the public will soar from 41 percent of GDP at the end of fiscal year 2008 to 60 percent at the end of fiscal year 2010. Higher debt results in permanently higher spending to pay interest on that debt (unless the debt is later paid off ). Federal interest payments already amount to more than 1 percent of GDP; unless current law changes, that share would rise to 2.5 percent by 2020.'

A debt-to-GDP ratio in the 60% range would put us on par with the spending levels of most European nations.    Those socialist countries have high taxes to pay for all the entitlements.    As our programs begin to look more like theirs, it's reasonable to believe our taxes will too.

The CBO directly addresses taxes and the need to raise money in its report:

'CBO’s long-term budget projections raise fundamental questions about economic sustainability. If outlays grew as projected and revenues did not rise at a corresponding rate, annual deficits would climb and federal debt would grow significantly. Large budget deficits would reduce national saving, leading to more borrowing from abroad and less domestic investment, which in turn would depress income growth in the United States. Over time, the accumulation of debt would seriously harm the economy. Alternatively, if spending grew as projected and taxes were raised in tandem, tax rates would have to reach levels never seen in the United States.'

Tax levels never seen in America?    History reminds us that America has in the past had an individual income tax rate as high as 91%.    That is history we will not and cannot repeat, and clearly we won't hit those astronomical levels again.   But make no mistake, taxes are going up.   Not just on the rich, but on everyone, through charges such as higher state and local taxes, 'sin' taxes, excise taxes, possible taxation of health-care benefits, a reduction in the amount of deductible interest on certain mortgages, small charitable donation breaks, higher tolls on roads, the carbon tax from cap & trade, and even reduced purchasing power through the devaluation of the U.S. dollar.   You name it, governments are trying it.    The $1 gallon of gas price increase since the election alone has likely more than wiped out the meager $400 tax cut the President gave many Americans.

And even those higher taxes on high earners are unlikely to help much.   As Maryland recently learned, raising taxes on the wealthy does not guarantee more money comes in.    Certainly recessions impact wealth, so income tax receipts will likely come back a bit once the economy recovers,  but on the whole the rich tend to be smart with their money and hire good financial advisers specifically to avoid paying taxes.   Additionally, as former White House spokesman Ari Fleischer wrote in an excellent piece recently in The Wall Street Journal, having a very small percentage of the population pay most of the taxes while nearly half of a voting majority pay next to nothing is damaging not only from a productivity perspective, but also it is bad for democracy.

Can we raise the cash though higher corporate taxes?    It's being considered.  While the President hasn't said he wants to raise the actual tax rate, he has proposed cutting breaks corporations use to lower their effective taxation.    This presents a paradox which, like Maryland, may result in the opposite intended effect.   As companies' costs go up, they alter their balance sheet by either cutting costs, often through layoffs, or raising prices.   As the New York Times noted last year:

In fact, a corporate rate cut would help a lot of voters, though they might not know it. The most basic lesson about corporate taxes is this: A corporation is not really a taxpayer at all. It is more like a tax collector.  The ultimate payers of the corporate tax are those individuals who have some stake in the company on which the tax is levied. If you own corporate equities, if you work for a corporation or if you buy goods and services from a corporation, you pay part of the corporate income tax. The corporate tax leads to lower returns on capital, lower wages or higher prices — and, most likely, a combination of all three.

If lower corporate tax rates help voters, it is logical to assume higher effective tax rates would hurt American workers and consumers.    Not only through higher prices, but also by paying for the costs of the newly jobless.   Any additional revenue the IRS is able to squeeze out of corporate America will likely be wiped out by having to cover a variety of costs associated with those fired by the companies who now have to lay them off to protect their balance sheet.

So if higher individual and corporate taxes won't cover the massive fiscal gap, the only other way to raise money is sell more debt or print more money.   And with alarms being sounded on what we have already done in those areas, it is dangerous to suggest more.   We cannot risk destroying the United States' credit rating by issuing more and more debt, or further devaluing the dollar.    And since inflation is a monetary phenomenon, ask Zimbabwe or post World War I Germany how well massive money printing worked.

The bad news is that this leaves us in a financial bind.    The CBO clearly states we will not have the money to cover the promised spending, while at the same time we are coming to the realization that higher taxes, debt sales and money printing aren't going to cover the costs.

The good news is that this leaves us with only one answer to the 50/50: we must stop spending at these unsustainable levels.   If you can't alter one side of a balance sheet, the only alternative is to change the other.   Having a government agency question the economic sustainability of the country should open our eyes to just how important this is.  And the message is clear: the spending must slow down, even if some voters don't get all they were promised. Leadership is not about giving everybody everything.   It is about making hard decisions.   It is about having to say no.