Diary

Taxes, Deficit, Debt & Money to Run the Government

The budget sent to the Congress by the President on February 4th would spend a record $4 Trillion, raising taxes by $2 Trillion and projecting that the deficit will decline to about $474 Billion. This is slight of hand of the type often engaged in by Democrats who will bet that increasing taxes will actually generate more cash for the government.   The CBO will reinforce this belief through static analysis of the proposal. But it won’t happen. In this case the increased taxes are said to apply mostly to high earning individuals and corporations and we already know that they won’t be the only ones paying those taxes. The proposal itself is merely a way to make a class warfare argument. (http://americanthinker.com/2010/01/dont_tax_you_dont_tax_me_tax_t.html).

The proposed budget contains some other interesting data showing that the President projects a deficit of $583 billion in 2015, up significantly from last year’s $485 billion imbalance. Obama’s budget plan never reaches balance over the next decade and projects the deficit would rise to $687 billion in 2025. (http://www.pbs.org/newshour/rundown/president-obama-send-congress-4-billion-budget-plan/).

If more enlightened measures are not taken the deficits projected for 2015 and beyond will be even bigger and we will have runaway debt. It should be apparent to anyone watching that the only way out of this is a drastic cut in Federal spending that is not included in the President’s budget proposal and very likely will not be in the final budget approved by Congress.

In addressing this problem in Congress, the responsible committees and eventually the members must realize that reality shows us that no significant part of deficit reduction can be achieved by raising tax rates on some individuals and corporations.

Historically, the Federal Government has been able to raise a maximum of about 18% of GDP via taxes and fees imposed on individuals, corporations and importers. This has been true in modern times whether the highest marginal tax rates were 90% or 28% or any number in between. If we study history, it would appear that the only way to increase government revenue is to increase GDP, not to monkey with tax rates.

With this historical fact in mind, it would appear that the only sure way to reduce deficits, and eventually to reduce the debt, is to reduce government spending to the point where it is less than 18% of GDP. Any other approach is doomed to failure because it ignores history and real world economics.

This will spawn an argument over whether reductions in government spending will help or hurt the economy and the continued (very anemic) recovery from the late recession. If we again consult history, we find that GDP grows best when there is less government activity in the economy (especially via taxation and regulation) and less uncertainty concerning the actions of government and the soundness of the currency. Deficit spending increases the debt and the likelihood of inflation. (Historically, the likelihood of inflation increases with the size of the debt). When the government spends, it must first take that amount out of the economy (via taxes) or borrow it (via deficit spending). So it would appear that reducing government spending and thereby reducing the government debt will contribute to economic growth and the reverse will not.

The President’s proposal decreases the value of deductions for some high earning individuals. This will just make tax calculation more difficult and expensive. A better solution is to simplify tax regulations and flatten rates. Since this would reduce compliance costs to taxpayers it might even boost GDP and allow government to collect more via taxes. As we have seen above, there is almost nothing except economic growth that will allow the government to collect more via taxes. However, reduction of loop holes and simplification of taxes could reduce the tax drag on economic growth and eventually result in more government revenue because of increased economic activity. For this reason, tax simplification, flattening of rates and elimination of tax incentives (the loopholes) would be a good thing.

The fact remains that reduction of deficits and the eventual reduction of the debt will, even by itself, contribute to economic growth. But there is only one way to get there. Reducing government spending!

 -30-

Jeff Scribner is president of ASI Enterprises, Inc., an investment bank serving small- and medium-sized businesses. He can be reached at [email protected]