The SimpleTax

November 2010

 

 

SAFE’s SimpleTax proposal would vastly simplify the existing tax system as an alternative to scrapping it and starting over.  It would avoid major problems of the flat tax or FairTax proposals, and will hopefully appeal to most fiscal conservatives.

 

The proposal was rolled out in two blog entries, which are here reproduced in chronological order:

 

11/1/10 – Part one (payroll taxes, excise taxes, corporate income tax, other revenues)

 

11/8/10 – Part two (individual income tax, assessment of proposal)

 

11/1/10Internal Revenue Code 2.0

 

If our proposal for a Spending Reduction Commission clicked, the federal budget could be balanced by 2015 – ideally without raising taxes.  Getting down to brass tacks on spending, 10/25/10.

 

Streamlining of the tax system could contribute to renewed business confidence, a robust economic recovery, and rising federal tax revenues over time. Accordingly, SAFE has also suggested a Tax Simplification Commission.

 

This analysis will (a) state some premises for tax simplification, (b) review three alternative approaches, and (c) present a specific proposal for consideration

 

PREMISES: What is the purpose of the tax system?  We take it to be collecting revenue in a manner that is simple, efficient, and perceived as fair – not achieving social goals or influencing economic decisions.

 

How much money should be collected?  Presumably the amount that is intended to be spent, or perhaps more (any excess can be used to reduce debt).  So with a spending ceiling set at 20% of Gross Domestic Product, as we have recommended, a logical target for tax revenue would be 20% of GDP as well.

 

The tax system is only collecting about 15% of GDP at present – but this percentage should rise as the economy recovers.  See the following revenue recap for selected years.  Source: Office of Management and Budget, Fiscal Year 2011, Historical Tables.

 

http://www.whitehouse.gov/omb/budget/Historicals/

 

Sources of revenue

1990

2000

2010 est.

2015 est.

Individual inc. taxes

8.1%

10.2%

6.4%

9.0%

Corporate inc. taxes

1.6%

2.1%

1.1%

2.1%

Payroll taxes, etc.

6.6%

6.6%

6.0%

6.2%

Excise taxes

0.6%

0.7%

0.5%

0.5%

Other receipts

1.0%

0.9%

0.8%

1.1%

TOTAL REVENUE

18.0%

20.6%

14.8%

18.9%

 

Note that tax revenue in 2000 was extraordinarily high.  Total revenue has not hit 20% of GDP or higher in any other year since World War II.  With a 20% of GDP spending ceiling, a marginal tax increase would probably be needed to balance the budget. 

 

ALTERNATIVE APPROACHES: Advocates of tax simplification often suggest a brand new system (options 1 & 2 below) instead of proposing changes to the current one (option 3), and with some logic.  Focusing on details of the current system might tend to inhibit the boldness of proposed changes due to a psychological phenomenon known as “anchoring,” which could reduce the overhaul to ineffectual tinkering.  On the other hand, defects of a new system could be overlooked in the push to get it adopted.

 

Option One – Replace the current income tax with a “flat tax,” as has been done in Russia, Hong Kong, and elsewhere.  Numerous tax deductions and credits would be abolished, ditto double taxation of business earnings, and there would be only one tax rate (17%).  Exempt interest income, dividends, capital gains, and employer fringe benefits from taxation.  Abolish the Alternative Minimum Tax (AMT).

 

Raise personal exemptions sharply (to $13,200 per adult, $17,160 for an unmarried head of household, and $4,000 per child or dependent), with the result that about half the population would pay no income tax.  Those who did owe tax could supposedly file their tax return on “a postcard.” 

 

The flat tax would not actually be “flat.”  Average tax rates would range from 0% (for people whose exemptions exceeded taxable income) to nearly 17% (for high earners).  Some people would continue to receive net tax refunds, as the Earned Income and Child tax credits would be retained.

 

Corporate income taxes would also be greatly simplified. There would be one tax rate, again 17%.  Interest income, dividends and capital gains would be exempted from tax. There would be no deduction for interest expense or employee fringe benefits.  Capital expenditures would be currently deductible (in lieu of taking depreciation). Numerous tax preferences would be eliminated, and also the corporate AMT.  Flat Tax Revolution, Steve Forbes, Regnery Publishing (2005). 

 

http://www.s-a-f-e.org/flat_tax.htm

 

What’s not to like: (1) Refundable tax credits should be eliminated; there is no good reason for anyone to “pay” negative tax.  (2) A tax exemption for fringe benefits could result in different tax liabilities for taxpayers with the same economic income.  (3) A sharply reduced number of income taxpayers is not necessarily a plus; non-payers would be inclined (as is already evident with the current tax system) to favor expanding government programs that someone else was perceived to be paying for. (4) The corporate tax changes would predictably be labeled as a gift to business interests, making the flat tax proposal nearly impossible to sell.

 

Option Two – There has been growing interest in replacing all income (individual and corporate) and payroll taxes with a federal retail sales tax (aka “the FairTax”) levied at a rate estimated to raise the equivalent amount of revenue.  The necessary rate has been estimated at 30% of sales prices, which is equivalent to 23% of the sales prices + tax.  (Example: Sales price $100, tax $30; tax = 23% of $130.) 

 

 The logic: It is economically beneficial to tax consumption instead of taxing income.  Also, undeclared income (the “hidden economy”) is currently escaping taxation, which is unfair to those whose income is fully declared.

 

FairTax advocates envisage that the 16th Amendment would be repealed to ensure permanent elimination of the income tax.  There would be no change in federal excise taxes or state & local taxes.

 

To minimize the burden of the FairTax on lower income Americans, all households would receive a monthly rebate on poverty level (as determined by the government for the household size) expenditures.  Thus, a person who consumed only the poverty level amount would wind up paying zero tax.

 

Some drawbacks: (1) There is little chance of the 16th Amendment being repealed, so the upshot might well be a federal sales tax and an income tax.  (2) Imposition of a sales tax of over about 10% of sales value could spark massive tax evasion, so the IRS would not be abolished as advertised (although it might be given a different name). (3) The monthly rebate program would represent a new entitlement program, which would require a bureaucracy to administer.  (4) Elimination of payroll taxes would break the existing linkage (however tenuous) between the amount of Social Security and Medicare taxes collected and the benefits these levies are supposed to cover, thereby heightening the perception that these programs are welfare plans rather than insurance arrangements. Forbes, Flat Tax, Chapter 5.

 

Only a few politicians have touted the FairTax, generally with negative results for themselves, and the prospects for FairTax candidates in the future appear bleak.  FAIR Tax Trap, Wall Street Journal, 10/29/10 (link not available).

 

Our advice to the FAIR taxers is that voters will start to take the idea seriously once the income tax is on the way to repeal.  Until then, our advice to candidates would be to avoid the FAIR tax and focus on goals that are more achievable and less politically self-destructive.

 

• Option Three – A thorough overhaul of the current tax system could achieve some of the same benefits as the flat tax or FairTax with less collateral damage.   Also, it would be nice to develop a proposal that all fiscal visionaries could support without an intramural debate about theoretical purity. 

 

Surely we could all get behind a proposal to slash tax rates, eliminate arcane tax preferences, and junk 80% of the Internal Revenue Code and associated regulations.  A specific proposal follows.

 

SIMPLETAX – We are not about to propose a truly flat tax, any more than Steve Forbes did.  Labeling our tax proposal as “fair” might seem presumptuous, and in any case that name is already taken.  Nor will our proposal be touted as the key to being competitive in the 21st Century global economy or whatever, because no tax system is truly beneficial from an economic standpoint.

 

The goal should be more modest, namely a tax system that will minimize the damage from withdrawing money from the private sector to pay for the agreed level of government spending. To this end, we should avoid favoring specific industries or economic activities, reduce the clerical burden for taxpayers and the government alike, and hopefully reduce the incidence of noncompliance.

 

Tax rules should be understandable, and, while not necessarily “permanent,” not in constant flux – which undermines confidence in the private sector.  Tax rates should be kept low.  The tax base should be broadened.  The vast majority of the population should pay taxes, even if the burden varies with ability to pay.  For lack of a better name, our proposal might be labeled the SimpleTax.

 

Existing taxes would be systematically reviewed vis-à-vis these principles, as suggested by the following review (which saves individual income taxes for last).

 

• Payroll taxes – Roughly 1/3 of total federal revenues come from social insurance and retirement receipts (SIRR), principally payroll taxes for Social Security, Medicare, and Unemployment Compensation (paid by employers only).  Here is as SIRR recap for selected fiscal years:

 

($ in billions)

1990

2000

2010 est.

2015 est.

2015 GOAL

Social Security

$282

$481

$635

$856

$856

Medicare

69

137

180

251

251

Unemployment Comp.

21

27

52

79

79

All other

8

9

9

9

9

TOTAL

$381

$653

$876

$1,195

$1,195

% of GDP

6.6%

6.6%

6.0%

6.2%

6.2%

 

Departing from the design of the FairTax, we do not advocate elimination of payroll taxes for Social Security and Medicare. Unemployment compensation benefits should be controlled more carefully than they have been recently, but covering them with payroll taxes seems appropriate.   Ergo, no changes are recommended.

 

Payroll taxes represent a drag on employment, however, and the current rates are at about the maximum tolerable level in our judgment.  Any proposed increases should be intently scrutinized.

 

In that regard, the OMB data series we are working away from does not reflect a sharp hike in Medicare taxes for high-income taxpayers, scheduled to take effect in 2013, and other GovCare tax changes.  Tax Foundation analysis, 3/21/10.

 

Broaden Medicare Hospital Insurance Tax Base for High-Income Taxpayers - additional HI tax of 0.9% on earned income in excess of $200,000/$250,000 (unindexed), and Unearned Income Medicare Contribution on 3.8% on investment income for taxpayers with AGI in excess of $200,000/$250,000 (unindexed).

 

http://www.TaxFoundation.org/news/show/26037.html

 

This Medicare tax increase will hopefully be eliminated via repeal of GovCare, an action needed to clear the way for real healthcare reform.  Even if there is no such repeal, there are surely better ways to raise tax revenue than haphazardly increasing the tax bills of high earners (versus, say, the idle rich) as a means of pushing the cost of the GovCare legislation under the rug.

 

Excise taxes represent a comparatively small share of total revenue, as shown in the following table.

 

($ in billions)

1990

2000

2010 est.

2015 est.

2015 GOAL

Alcohol*

$6

$8

$10

$10

$0

Tobacco*

4

7

17

17

0

Gasoline#

14

35

36

40

90

Air Transport#

4

10

12

16

16

All other*#

7

9

(2)

5

0

TOTAL

$35

$69

$73

$88

$106

% of GDP

0.6%

0.7%

0.5%

0.5%

0.6%

            *Federal funds, #Trust funds

 

To raise a more revenue in a much simpler fashion, we would suggest (a) hiking the federal tax on motor fuels to 50¢ per gallon (now 18.6¢ per gallon for gasoline and 24.4¢ per gallon for diesel fuel), crediting the added revenue to general revenues vs. the highway trust fund, (b) continuing air transport taxes at current levels, and (c) eliminating all other federal excise taxes. 

 

While it may be appropriate to impose special taxes on alcohol and tobacco, aka “sin taxes,” these taxes are highly regressive and in the case of tobacco products have been raised to unreasonable levels.  Exclusive jurisdiction in this area should be ceded to state and local governments, which are in dire need of more tax revenue these days.

 

Trust funds to cover anticipated outlays, e.g., black lung disability, inland waterway, superfund, oil spill liability, aquatic resources, leaking underground storage tanks, tobacco assessments, and vaccine injury compensation, could be eliminated or replaced with mandatory private insurance.

 

GovCare excise taxes are not reflected in the projected data, e.g., a 10% tax on indoor tanning (2010), annual fees on drug companies (2011), 2.3% tax on medical devices (2013), annual fees on healthcare insurance (HCI) providers (2014), and 40% tax on “excess” HCI coverage (2018). Tax Foundation analysis, 3/21/10.  As with the increase in Medicare taxes, we would recommend that these levies be stricken (via repeal of GovCare or otherwise).

 

Other receipts – Here is a recap of this catchall category:

 

($ in billions)

1990

2000

2010 est.

2015 est.

2015 GOAL

Estate & gift taxes

$11

$29

$17

$28

$0

Customs duties & fees

17

20

24

39

39

Federal Reserve deposits

24

32

77

48

48

All other

4

11

6*

92*

18

Incremental leasing

0

0

0

0

10

TOTAL

$56

$92

$124

$207

$115

% of GDP

1.0%

0.9%

0.8%

1.1%

0.6%

*Includes “allowances” re proposed legislation of $(6) in 2010 and $74 in 2015.

 

Somewhat surprisingly, given the long-running debate about the “death tax,” the amount of federal revenue at stake is “only” about $30B a year gross (surely much less on a net basis).  It would make sense, in our opinion, to eliminate federal estate and gift taxes and cede tax jurisdiction in this area to the states.

 

We have no suggestions with respect to customs duties and fees or Federal Reserve deposits. 

 

“Allowances” of $74B have been purged from our 2015 GOAL data; these were merely placeholder entries and have no economic significance.  No breakdown of the “all other” category is available, but revenues from oil and gas leasing are probably included.  This activity brought in some $6B (principally from offshore leases) in 2000, and it is said to be one of the federal government’s largest sources of non-tax income.  American Petroleum Institute fact sheet.

 

http://www.api.org/aboutoilgas/sectors/explore/oilandnaturalgas.cfm

 

The “incremental leasing” line for 2015 represents the additional revenues that could be realized from a more aggressive oil & gas leasing program.  Such a program would also increase corporate income tax revenues.   

 

Corporate income tax is one of the most complex areas of the tax law, creating a great opportunity for simplification.  It is also an erratic revenue producer, e.g., yielded only 1.1% of GDP in 2010 vs. 2.7% in 2006 & 2007.  A recap follows:

 

($ in billions)

1990

2000

2010 est.

2015 est.

2015 GOAL

TOTAL

$94

$207

$157

$411

$380

% of GDP

1.6%

2.1%

1.1%

2.1%

2.0%

 

In years past, the revenue from this tax was more significant than it has been lately, e.g., 6.1% of GDP in 1952 vs. 1.1% in 2010. Several factors have contributed to the relative decline.

 

ü      About half of U.S. business income (up from about 20% in 1980) is not taxable at the corporate level, but rather at the individual level via “pass through” entities (S corporations and partnerships).

 

ü      Much of the earnings of U.S.-based corporations is from international business activities, and as such is subject to foreign income taxes – which are creditable against U.S. tax when the earnings are repatriated.  In cases where a substantial net tax would apply on dividends, U.S. companies typically defer repatriation

 

ü      The corporate tax rate is reduced by numerous special tax deductions and credits, with the result that the effective federal tax rate on new investments in the corporate sector is somewhat lower than 35%, e.g., 29% according to a recent Treasury study. Volcker tax study, 8/27/10, pp. 65-66. (For more about this report, see our 9/20/10 entry.)

 

http://www.whitehouse.gov/blog/2010/08/27/perab-tax-task-force-report

 

Realistically, the potential for increasing corporate income tax revenues is limited.  For example, an attempt to tax worldwide earnings while allowing only a deduction for foreign income taxes or force repatriation of low-taxed international earnings would likely boomerang because U.S.-based corporations would be placed at a competitive disadvantage versus international competitors. 

 

The typical legislative response to requests for tax relief has been to enact narrowly defined tax preferences.  Accordingly, as the Volcker study (p. 67) dryly observes, “the current corporate tax system contains numerous provisions that encourage businesses to invest in certain kinds of assets or to engage in certain kinds of activities for tax reasons rather than for reasons of economic efficiency.”

 

The clearest way to improve matters without substantially reducing tax revenue would be to cut the corporate tax rate sharply, say to a top rate of 20%, while eliminating a host of special exemptions, deductions and tax credits (other than the foreign tax credit) that are currently in effect.

 

Don’t make the R&D tax credit permanent, eliminate it – a tax deduction for the expense should be good enough. Say goodbye to energy tax credits, percentage depletion for oil and gas, low-income housing tax credits, and the special domestic production deduction to subsidize US-based manufacturing. Also repeal corporate AMT, which forces many companies to calculate their taxes in two ways without raising much additional tax revenue.

 

Jettisoning tax preferences would offset much of the revenue loss from reducing the corporate income tax rate, and a permanent rate cut should encourage new investment and enhance tax revenue over time.  Nevertheless, we have assumed marginally lower corporate tax revenue in the 2015 GOAL data.

 

*   *   *   *

This discussion of tax simplification was envisioned as a one-entry topic, but the subject is complex and a second entry will be required to do it justice.

 

We started with a goal of identifying ways to raise overall 2015 tax revenues by 1.1% of GDP.  The analysis to this point has increased the apparent shortfall to 1.6% of GDP, and with only the individual income tax left to talk about it appears that many of us would wind up paying higher income taxes under the SimpleTax.

 

Tune in next week for a discussion of what the new income tax system might look like, and some reasons why the likely increase seems reasonable under the circumstances. 


 

11/08/10 – Internal Revenue Code 2.0 – part two

 

SAFE has developed a SimpleTax proposal that would streamline the tax law and also – together with a spending ceiling of 20% of Gross Domestic Product (GDP) – help to balance the budget.  Most revenue components (payroll taxes, corporate income tax, etc.) were discussed last week.  We now turn to the individual income tax, which accounts for 40+% of government revenue.

 

REVENUE GOAL: To bring total revenues up to 20% of GDP in 2015, the individual income tax would be increased as indicated in the following recap.

 

($ in billions)

1990

2000

2005

2010 est.

2015 est.

2015 GOAL

INCOME TAX

$467

$1,004

$927

$936

$1,733

$2,041

% of GDP

8.1%

10.2%

7.5%

6.4%

9.0%

10.6%

% of revenues

45%

50%

43%

43%

48%

53%

 

INCIDENCE: As a result of a graduated tax schedule, plus applicable tax exemptions, deductions and credits, taxpayers in the top half Adjusted Gross Income (AGI) cohorts currently pay nearly all of the income tax.  The following IRS data are based on tax returns (roundly 140 million) for 2008.  

 

Adjusted Gross Income

AGI

Income tax (net)

Avg. tax rate

Top 5% ($160K+)

$2,927B

$606B

20.7%

6-10% ($114K+)

930

116

12.5%

11-25% ($68K+)

1,822

169

9.3%

26-50% ($33K+)

1,674

113

6.8%

51-100% (≤ $33K)

1,074

28

2.6%

TOTAL

$8,427

$1,032

12.2%

           

http://www.taxfoundation.org/taxdata/show/250.html

 

A progressive rate structure for the income tax is generally considered appropriate, and the average tax rates for high-income taxpayers do not appear excessive. The very low average tax-rate for bottom half taxpayers is due in large part to refundable tax credits, which allow some lower income Americans to receive net tax refunds while others are paying substantial income taxes.

 

PROPOSED CHANGES: (a) taxable income; (b) tax exemptions, deductions & credits; (c) Alternative Minimum Tax; and (d) tax rates.

 

a. Taxable income: To prevent duplicative taxation of corporate earnings, we recommend that dividends from standard corporations, and capital gains from investments in their stock, be excluded from the taxable income of shareholders.  Income of “pass through” entities (S corporations and partnerships), and capital gains from investments in such entities, would remain subject to individual income tax. 

 

Net gambling winnings should also be exempted from tax in the interests of simplification.  Since few gamblers come out ahead in the long run, the loss in tax revenue would be minor.

 

Certain employee benefits are deductible by employers, but not taxable to employees.  Such benefits represent economic income, and they should be taxed in the same manner as salaries and wages.  As a result, taxpayers with the same economic income would pay the same income tax without regard to their employment status.  

 

Would taxing the cost of employer-provided healthcare insurance (HCI) coverage disrupt the healthcare system?  Quite the contrary, and we have recommended that this tax preference be eliminated rather than “leveling the playing field” by providing a healthcare tax credit for individuals who do not receive HCI coverage through an employer. In search of real healthcare reform, May 2009, recommendation 2.

 

http://www.s-a-f-e.org/healthcare_reform.htm

 

Gross taxable income after the foregoing changes would be marginally higher than AGI as presently reported.  That is, exempting corporate investment income and net gambling winnings from individual income tax would be more than offset by taxing currently exempt employee benefits. 

 

b. Tax exemptions, deductions and credits – Some tax preferences should be preserved, in our opinion, as follows:

 

* Personal tax exemptions are warranted so that people with de minimis income will not be required to file a return, but the present personal exemptions are too high.  We suggest a personal exemption of $1,000 per person, which once established would be indexed for inflation.

 

* Interest income on state and municipal debt has been held exempt from federal income tax on constitutional grounds; it should continue to be exempt on this basis. (However, the recently instituted program for subsidizing interest payments on taxable municipal bonds has no constitutional foundation; it should be allowed to expire at the end of this year.  “Build America” bonds up in the air after GOP victory, CNBC.com, 11/3/10.)

 

http://www.cnbc.com/id/39990197?par=yahoo

 

* Expenses for taxpayer businesses should continue to be deductible so that tax will be paid on business income rather than gross receipts.

 

* For U.S. taxpayers subject to foreign income taxes, e.g., workers on international assignments, foreign tax credit is appropriate to avoid double taxation of their income.

 

All other income tax exemptions, deductions (mortgage interest, charitable contributions, state and local taxes, childcare, casualty losses, etc.) and tax credits (Earned Income, Child, energy, etc.) would be eliminated.

 

While some of these tax preferences have arguable merit, a case-by-case review would trigger endless debate.  Note: the flat tax or Fairtax would also eliminate them. 

 

c. Alternative Minimum Tax – The AMT is an alternative calculation method for the income tax, not a separate tax. Originally enacted in an attempt to ensure that wealthy taxpayers could not use “loopholes” to avoid all tax liability, the AMT is becoming potentially applicable to more and more taxpayers because the specified income thresholds were not indexed for inflation.  Some 4 million taxpayers are currently subject to AMT, forcing them to calculate their tax liability twice and pay the AMT differential. 

 

But for a perennial AMT patch by Congress, nearly 30 million more taxpayers would be thrown in the same boat.  It is time to end this annual exercise by repealing the AMT for everyone.  Tax cuts to dominate lame-duck Congress, Damian Paletta, Wall Street Journal, 11/2/10.

 

http://bit.ly/aBpIaJ

 

d. Tax rates – There would be a single tax rate schedule with the SimpleTax (versus four schedules under current law: married & filing separately, single, head of household, and married filing jointly).  However, two-earner households would have the option of separate tax calculations for each spouse in order to prevent any “marriage penalty.”

 

With the foregoing pruning of tax preferences, income tax rates at all income levels could be cut by 5+ percentage points.  Here is an example, which compares the proposed SimpleTax rates to the 2009 actual rates for a married couple, filing jointly.

 

SimpleTax

2009 actual

Income bracket

Tax rate

Avg. rate*

Avg. rate*

$0-30K

5%

5.0%

12.2%

31-70K

10%

7.9%

14.0%

71-140K

20%

14.0%

19.6%

140-300K

25%

19.8%

25.7%

300K+

30%

<30%

<35%

                        *Calculated for income at bracket top.

 

Applying these rates to 2008 AGI cohort data (see earlier chart), the SimpleTax would produce marginally higher tax revenue than was paid for that year.

 

2008 Actual Income Tax ($B except in first column)

@ SimpleTax Rates

AGI Cohort

AGI

Inc. Tax

Avg. rate

Inc. Tax

Avg. rate

Top 5% ($160K+)

$2,927

$606

20.7%

$667

22.8%

6-10% ($114K+)

930

116

12.5%

126

13.5%

11-25% ($68K+)

1,822

169

9.3%

186

10.2%

26-50% ($33K+)

1,674

113

6.8%

116

6.9%

51-100% (≤ $33K)

1,074

28

2.6%

54

5.0%

TOTAL

$8,427

$1,032

12.2%

$1,149

13.6%

 

A further tax increase would result from recommended net additions to taxable income, as discussed above, which should bring total revenue to roundly 20% of GDP.  Matters would then stand as shown in the far right column of the following table.

 

Sources of revenue

1990

2000

2010 est.

2015 est.

2015 GOAL

Individual inc. taxes

8.1%

10.2%

6.4%

9.0%

10.6%

Corporate inc. taxes

1.6%

2.1%

1.1%

2.1%

2.0%

Payroll taxes, etc.

6.6%

6.6%

6.0%

6.2%

6.2%

Excise taxes

0.6%

0.7%

0.5%

0.5%

0.6%

Other receipts

1.0%

0.9%

0.8%

1.1%

0.6%

TOTAL REVENUE

18.0%

20.6%

14.8%

18.9%

20.0%

 

ASSESSMENT: In reaction to last week’s entry, which began the rollout of the SimpleTax proposal, a SAFE director suggested more urgent action than we have envisioned.  Here is an extract from his comment.

 

Nibbling away at little features in the tax code does nothing in the medium run. Paying higher taxes is not helpful. The national aggregate budget must be cut more than 15% this next fiscal year to get close to a balanced budget [in all states and the fed] with the enormous tax load we currently carry. Then, taxes must be cut until new revenues come from new business growth in the private sectors.

 

You cannot ignore California, New York, Illinois, New Jersey and some others. They will continue to spend and beg Washington for alms, and sadly Congress is likely to give it to them in return for meaningless promises to do better in the future.

 

In defense of our suggestions (as presented in the 10/25, 11/1 and current entries) for balancing the federal budget by 2015, we would make the following points.

 

First, Congress can only directly control federal spending and taxes; the state and local fiscal situations are a separate matter.  But the proposed 20% of GDP spending ceiling assumes no exceptions for any situation short of a true national emergency.  If California (for example) cannot pay their bills, then let them declare bankruptcy.  (Although there is no formal procedure for this, a state could presumably repudiate selected obligations and defend its position based on inability to pay.) 

 

State and local fiscal problems have been concealed by the availability of federal stimulus funds (which will not continue), creative accounting (raiding trust funds, etc.), and underfunding ($1+ trillion) of pension and healthcare benefit obligations. Some securities analysts expect the municipal bond market to collapse.  States face crisis when fed funds dry up, Washington Examiner, 10/4/10.

 

http://bit.ly/cZK5ZT

 

Would Washington really stand firm in such a situation? With the federal government facing severe fiscal problems of its own, there may be no alternative.  The next big crisis: State bankruptcy, Dick Morris & Ellen McGann, Townhall.com, 6/23/10.

 

 If it is the states and Obama that blink first, we will free our local governments of the grip of municipal unions, their rigid work rules and their unaffordable pensions. If the Republicans blink first, they will forfeit their right to represent the American people, having backed down from the challenge of our times.

 

http://bit.ly/d2cdOs

 

Second, we did not tackle taxes with the idea of raising revenue, the idea was to help restore confidence in the private sector by simplifying the tax system and making it more business friendly.  The budget was to be balanced by cutting spending.

 

A 20% of GDP spending ceiling was selected after reviewing spending levels in past years because the exceptionally low spending level in 2000 did not seem an appropriate ceiling.  Note: the median spending level for 1990-2010 was 20.1% of GDP. 

 

When we got to the tax data, it became obvious that an increase would be needed to hit 20% of GDP (and thereby balance the budget). We incorporated one in the SimpleTax proposal, reasoning that any surplus could be used to reduce debt if Congress spent less.

 

No one wants to pay higher taxes, including us, but a moderate tax increase that affected all income levels (rather than being imposed only on high earners) seems acceptable so long as the accompanying spending ceiling would be strictly enforced.

 

Third, political realities cannot be ignored.  Although the recent elections shifted the balance of power in Washington, with the Republicans regaining a majority in the House, their opponents continue to occupy the White House and control the Senate. If the Republicans moved too aggressively in attempting to restore fiscal responsibility (a goal they have promised to pursue), this could pave the way for a big setback in 2012. 

 

Indeed, some political observers predict political gridlock for the next two years, which would prevent further action on the liberal agenda but also blunt efforts to address the fiscal problem.  Is the Dow right to be in such a celebratory mood?  Methinks not, Jeremy Warner, UK Telegraph, 11/4/10.

 

With the Hill paralyzed, there is now virtually no possibility of a credible deficit reduction plan being agreed at any stage in the next two years – or not unless fiscal crisis before then forces the House to come to its senses.

 

http://bit.ly/cCoswB

 

What strategy should fiscal conservatives (or hopefully visionaries) pursue?  One suggestion is to pursue limited goals, e.g., an earmarks ban, that they have a solid chance of winning. Big win, small opportunity: GOP still needs to win trust of voters for big change, David Mastio, Washington Times, 11/2/10.

 

You can hear it already from The Washington Post's Slate magazine: "If the new leaders make a big deal about banning 'earmarks' - which amount to less than 1 percent of federal spending - count it as a feint. If they propose means-testing Medicare or raising the retirement age, count them as serious." *** Such thinking is a trap.

 

http://bit.ly/d5Mqgv

 

With GOP victory, time for political compromise, Washington Examiner, 11/2/10.

 

Americans want less spending, less regulation, less government, but they also expect their elected leaders to forge ahead in that effort forcefully and with due regard for the difficulties along the way. That means they must compromise. The measure of how they perform will be the degree to which they accomplish what the people expect them to do, which is to send Washington to the fat farm.

 

http://bit.ly/9elW1O

 

Others say the Republicans must seek to defund GovCare and other initiatives because the Administration will be unwilling to rethink its agenda. Employ the power of the purse strings: GOP-led House must restore financial accountability, Tony Blankley, Washington Times, 11/3/10. 

 

Whether the GOP likes it or not, it may have its hand forced. We may well see a season of government shutdowns. And once that gets going, it may well be used to try to block various parts of Obamacare as well. The Tea Partiers may not be denied easily. Nor should we be.

 

http://bit.ly/aD3Vhn

 

Time will tell what happens in the new Congress, but we do not foresee any easy or total victories.  In our opinion, conservatives may do well to use several strategies.

 

If immediate spending cuts can be achieved, great, but we also like the idea of creating a Spending Reduction Commission to review the entire budget and report back before the next election.  There needs to be a specific goal, such as a 20% of GDP spending ceiling, and it would send the wrong message to ask the SRC to also review the tax system.

 

The Bush tax cuts must be extended, another AMT fix is due, and the 1099 reporting requirements in the GovCare bill have to go, but there is also a need for fundamental reform of the tax system.  Since Congress has shown itself incapable of dealing with taxes in a rational manner, a Tax Simplification Commission should do the job for them.  We are ready, willing and able to testify for the SimpleTax.

 

As for what a Regulatory Common Sense Commission might accomplish, stay tuned – we will address this subject in a future entry.

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