It's the Entitlements Stupid

We have heard that the culprit in our rising debt and deficit crisis is the cost of recent wars.  Yet the numbers simply don't support that notion.  It is a popular, but uninformed, myth.  

This week's Barron's features an analysis completed by Martin Murenbeeld, chief economist of Dundee Wealth.  His research is based on numbers reported by the U.S. Bureau of Economic Analysis (BEA).  Since 1970 entitlement spending has grown from approximately 40% of federal spending to over 60%;  defense spending, on the other hand, has shrunk from just under 40% of spending to under 20% of current spending.  Defense isn't the culprit, entitlements are.

The smokescreen argument launched when anyone brings up the notion of cutting entitlements is that we have a moral obligation to help the poor.  Obviously.  It is our responsibility as fellow citizens.  The question in my  mind is not if but who should do it:  the public or the private sector.  My vote is for private sector charities all day long.

Allow me:  the government takes money from Citizen A to fund entitlement programs confiscating money that Citizen A would otherwise use to buy shoes for his kids, a new car maybe, an energy efficient washer or a weekend at Disneyland.  That spending increases sales and potentially creates jobs at the car company or Disneyland whose employees will in turn consume and create growth in other industries.

Poof!  Suddenly the money has been sucked out of the private sector into the vast bureaucratic wasteland.  And it must be factored into our equation that it costs the government money to collect those funds.  According to Jim Payne in his 1991 The Culture of Spending "for each dollar the federal government recycles through the taxation-subsidy system it wastes more than one additional dollar" (51).  He cites detailed government studies that estimate it costs the government 65 cents to collect a dollar and another 50 cents to spend that same dollar.  Dubbed the "bureaucratic rule of two" the conclusion is that "governmental production of the typical good or service costs twice as much as the same thing produced privately"(208).

Now, some twenty plus years later,  the average government worker earns more than the average private sector worker--a dramatic shift since 1991--so it is not difficult to conclude that the governmental cost of collecting $1.00 no longer creates a mere deficit of 15 cents per dollar but some number greater than that.  For sake of argument though we will leave the number where it was in 1991.

If it costs the government $1.15 to collect $1.00 you tell me how long that business model will survive.  Overhead of 115% is not just unsustainable it demonstrates a willful lack of compassion toward those who depend on the aid.

Most of the charities I have worked with and support operate with overhead well under 10%, a far cry from 115%.

It's a simple as that.

In the Words of The Associated Press--September 19, 2012

Tax penalty to hit nearly 6M uninsured people

By RICARDO ALONSO-ZALDIVAR, Associated Press – 24 minutes ago  

WASHINGTON (AP) — Nearly 6 million Americans — significantly more than first estimated— will face a tax penalty under President Barack Obama's health overhaul for not getting insurance, congressional analysts said Wednesday. Most would be in the middle class.

The new estimate amounts to an inconvenient fact for the administration, a reminder of what critics see as broken promises.

The numbers from the nonpartisan Congressional Budget Office are 50 percent higher than a previous projection by the same office in 2010, shortly after the law passed. The earlier estimate found 4 million people would be affected in 2016, when the penalty is fully in effect.

That's still only a sliver of the population, given that more than 150 million people currently are covered by employer plans. Nonetheless, in his first campaign for the White House, Obama pledged not to raise taxes on individuals making less than $200,000 a year and couples making less than $250,000.

And the budget office analysis found that nearly 80 percent of those who'll face the penalty would be making up to or less than five times the federal poverty level. Currently that would work out to $55,850 or less for an individual and $115,250 or less for a family of four.

Average penalty: about $1,200 in 2016.

Beware Unintended Consequences

My old friend, Art Laffer (of Laffer Curve fame) often says if you want less of something--tax it.   Economics, the ancient art of encouraging certain behaviors with incentives and discouraging others with penalties is akin to parenting.  We reward good behaviors in our children and--if we are doing our job--we penalize others.   The end result is, we hope, harmony and productivity.  The body politic functions the same way.

If we follow President Obama's plan we will continue to place an extraordinary penalty on those who produce the most and, by the way, already pay an inordinate percentage of income taxes.  According to the independent National Taxpayer's Union, the top 1% of earners in the U.S. pay 36.73% of the tax bill.  The top 5% pay 58.66%.  President Obama wants them to pay more.  Laffer's view is supported by history--if you want less of something, tax it.  The rich have and always will be able to find ways to minimize income.  Eduardo Saverin, one of Facebook's founders renounced his U.S. citizenship right before the big payday.  Tax it?  You get less of it.

We see how tax policy affects behavior if we examine state population growth relative to state tax policy.  As a native Californian--a native San Franciscan to be precise--I know that it takes a great deal to nudge someone out of that glorious state, yet since 1990 the net migration in California has been a negative 3.6 million people (American Council of Engineering Companies among other studies).  Californians pay the second highest state income tax in the nation second only to Hawaii.

So here we sit, in an election year, hearing that the rich simply aren't paying enough.  That we can engage in profligate and unaccountable spending on the one hand (has anyone figured out where the $870B stimulus went and what exactly we received for it?) and demand that the most productive among us work harder and pay more.

For crying out loud, even the Russians have figured out that a flat tax--a uniform rate of tax on the income of individual--makes sense.  And while our citizens pay income taxes of as much as 50% to federal and state governments, the Russian citizen pays a mere 13%.

Finally, Barron's reported today that tax avoiders owe the IRS an estimated $385 billion.  That is more than one-third of the U.S. budget deficit.  I would support any president who solves that problem before demanding more of the property of hard-working and law-abiding Americans.  

All We Need to Know in Pictures

Our Founders were cognizant of the potential danger that lurked in democracies. History taught them the peril of majority rule particularly when "enlightened statesmen will not always be at the helm" (Federalist 10). That is why they formed a Republic.  And why they did not provide for a direct tax (income tax) in the Constitution.  They spent significant rhetorical capital to warn against the risk of tyranny that could result from the majority having power--and in particular, taxing power--over the minority.  In Federalist 10 James Madison writes:  The apportionment of taxes on the various descriptions of property is an act which seems to require the most exact impartiality; yet there is, perhaps, no legislative act in which greater opportunity and temptation are given to a predominant party to trample on the rules of justice.  Every shilling with which they overburden the inferior numbers, is a shilling saved to their own pockets."  

Today nearly half of Americans do not pay any income tax at all.  Our Founders would consider that a recipe for disaster. They understood one thing.  Over the course of history human nature does not change.  That is why Madison wrote:  But the most common and durable source of factions has been the various and unequal distribution of property.  

Class warfare rhetoric is not how this country became great.  It is how unenlightened leaders hang onto power.

The Debilitating Cost of Government Regulation

Too infrequently when the  political rhetoric flies do we step back and consider the issue dispassionately.  Too often we succumb to emotional appeals without analyzing the matter in a logical, fact-based fashion. 

The August 13th edition of BARRON'S cites an upcoming report by the Competitive Enterprise Institute called Tip of the Costberg.  The study measures the cost to the economy of businesses complying with federal regulations.  During the first half of this year the cost was $1.806 TRILLION.  To put that number into perspective, the federal budget for 2012 is $3.6 trillion which means the cost of regulatory compliance for business is equivalent to 50% of the national budget.  

Imagine how many jobs would be created if that money were invested in the private sector economy instead of fattening the same bureaucracies that snoozed while Bernie Madoff skimmed billions from his clients.  

Crony Capitalism

The following is a direct quote from BARRON'S magazine, July 9, 2012:

Crony Capitalism
Countrywide Financial, now owned by Bank of America, gave discount loans to members of the U.S. Congress and Fannie Mae Executives while it lobbied to combat legislation that would have restricted its sales of subprime mortgages, according to a House committee report based on a three-year inquiry. 

Do we need to know more than that?  Our elected officials accepted preferred terms from an organization that was simultaneously lobbying them to vote against a law that would inhibit their ability to sell subprime mortgages.  The very segment of the market that was at the center of the financial meltdown in 2008.

Private sector employees go to jail for that kind of thing.  Where is the outrage?  Where is the remedy?

Spendorama

After the British won the French and Indian War in 1763 they had a debt problem that needed a solution.  In Washington, a Life, Ron Chernow writes, "The national debt of Great Britain, inflated by military spending, had swollen to a stupendous 130 million pounds, with annual interest payments of 4.5 million pounds engrossing more than half the national budget."(136)

Sound familiar?

The British solution was to institute the highly unpopular Stamp Act which shifted the tax burden of the war to the colonists.  Without their agreement.

Sound familiar?

The only difference is that our deficit does not come entirely from defense spending.  Rather, entitlements are overwhelming federal spending.  Heritage reports--contrary to what the average media report suggests:  "Defense spending has declined significantly over time, even when the wars in Iraq and Afghanistan are included, as spending on the three major entitlements—Social Security, Medicare, and Medicaid—has more than tripled."  


Entitlements are snuffing the life out of our future.