Thursday, May 26, 2011

Anchoring and Personal Finance

We all belong to the species homo sapiens, which has variously been defined as “thinking man” or “wise man” or “knowing man” or sometimes “rational man.” Of these proposals, only thinking man fits the bill—and that only if we include irrational, absurd and incorrect thinking as part of our nature.

In psychology the term “anchoring” refers to the human tendency to rely too heavily on a single piece of information to make a decision. We anchor our choices around this datum. The process itself makes some sense. If asked to answer the question: how many leaves are on an average mature sugar maple tree on June 24th, most of us would have no clue where to start, so we invent our own anchor.

We might think of the pile of leaves we had to rake from beneath a maple tree and use its remembered volume as a start—an anchor from which we then will try to guess how many leaves made up ten cubic meters of leaves. Or we might start with the height of a tree, decide branches Y every two feet, each twig holds twenty leaves and make our guess.

The point is we start with something—and it turns out that when faced with estimating something we have no clue about we will anchor off random numbers. For example, assume you split all the people you know into two random groups. Ask Group 1 whether the tree has more or less than 50,000 leaves. Ask Group 2 whether the tree has more or less than 500,000 leaves. People will make their guesses and don’t tell them if they are right or wrong.

Then ask each person to give you their best guess what the actual number of leaves is. Those in Group 1 will guess a much lower number than those in Group 2. Your first question anchored their response. The final guesses were influenced by the number in your first question.

What does anchoring have to do with personal finance? PLENTY!

Which would you rather buy, something marked 50% off or 30% off or something you need to pay a premium to acquire? We all like a bargain, but here are the actual circumstances:

     Store 1: List price is $100, marked 50% off. Final price $50.
     Store 2: List price is $70, marked 30% off. Final price $49.
     Silent Auction: Donated value $35 (wholesale). Winning bid $45.

When I put it that way, we would all rather buy the item at the silent auction, pay less and at the same time benefit some charity or church. Yet we consistently ignore the bottom line and rely on false anchors to influence our decisions or, more insidiously, how we feel about our decisions.

Let’s say at the beginning of an imaginary year half of us invest $100,000 in Stock A and the other half in Stock B. The Bernie Madoff endorsement from the broker guarantees we will make money. There is a caveat: we can’t sell the stock until the end of the year.

The half who buy Stock A for $100,000 watch as each month it increases $1,000 so at the end of the year the position is worth $112,000. Pretty good investment, right? It earned 12% during the year. They cash out and have $112,000 in the bank.

At the same time the other half buys Stock B for $100,000. In the first four months it increases $25,000 per month. At the end of four months it doubled to $200,000. In the next eight months it loses $11,000 per month. At the end of the year this position is worth $112,000. Pretty good investment, right? It earned 12% during the year. They cash out and have $112,000 in the bank.

How would you feel with each of these investments? You should feel the same, but you probably won’t. Stock A went up and up and up and up. It provided good news twelve months in a row. It is a Snoopy Dance stock.

Stock B doubled in four months and then, while there was nothing to do but watch, month after month after month it gave away your money, until you only had $112,000 at the end of the year. If you are like most of us, you will anchor on the $200,000 you could have had if you sold Stock B at the end of April. You feel miserable as you watch your money shrink.

Oh, but that doesn’t make sense, the rational reader will say. Who said anything about feelings and decision-making being rational?

I know all about anchoring, yet I fall into the trap all the time. I can tell you, for example, that my net worth reached its zenith in October 2007. Three and a half years later it has climbed back to within $10,000 of the all-time high. (Of course that was before this month’s market declines, but I only do my balance sheet at the end of the month.) When I think this way, I feel a bit diminished.

But wait! During those three and a half years I’ve been retired. I’ve removed three and a half years of living expenses from my assets. I’m actually ahead of the game—as long as I set the right anchor to view my finances. In fact, if I compare my current net assets now to those when I retired, I’m up 50%. At the time I retired I figured I had enough to live on, and now I’m way ahead of that with nine fewer years to live. (CPI has only increased 26% in the 9+ years of my retirement.) I should be, and am, delighted with my finances because I choose to compare my actual situation to my original plan and ignore the intervening highs (and lows.)

An acquaintance recently listed his second home for sale at a price that was appropriate when he bought the house at the market peak, but is no longer close to what buyers will pay. His rationale is that he’s in no hurry, but wants to get his investment back. I’ve seen people do this with stocks they hold as well. I’ll sell, they say, when I can make a profit.

The real question in both cases is not what you paid for something, but what its current market value is, and given its current value, whether or not you can apply the proceeds to a better investment? What you paid for something is only interesting when you are looking at the tax ramifications of a sale (which is important to do, but is the tail, not the dog.) If the current stock holding has the best potential, you should hold whether or not it shows a loss or big gain relative to book value. Conversely, if something has better prospects, take your loss and move forward.

We need not beat ourselves up because we are innately irrational. What we need to do is recognize when we are inappropriately anchoring. To do that requires us to remember our goals and objectives and reflect reality.

~ Jim

Friday, May 20, 2011

Solving the Budget Deficit—Step Four: Repairing Social Security and Medicare (Part II)

There is no way to sugar-coat the solution to Medicare, so here’s the brutal truth that no one wants to say or hear: We cannot afford all of the benefits that medical, technological and pharmacological advances can provide. We have learned to delay death, but with a huge economic burden attached.

Yes, the system is inefficient and changes, especially to claims processing, will free up billions of dollars. Yes, doctors perform too many tests because we are a litigious society. Yes, doctors have a tendency to prescribe the latest (and therefore most expensive) drug therapy because some salesman touted a study (paid by drug company dollars) that showed a miniscule improvement over a generic.

Yes, Congress has put fetters on the Medicare system by not allowing it to negotiate drug costs, which any private insurance company can do. We can remove those restraints and save money.

We should make all of those changes, but even if we do, spiraling health care costs that we cannot afford will still confront us.

The conversation that we must have in the United States is this: what level of care shall we provide to all comers regardless of age or income level?
Study after study shows that preventative care for children pays for itself in reduced medical costs as the children become adults. Study after study documents the huge costs we incur extending the life of those who are terminally ill.

Economically, funding life-extending “therapies” but not funding preventative care makes absolutely no sense—there must be some other reason we make these decisions.
In part we make them because no one is paying for them—except future generations through our current borrowing. We make them because we each want the best for our loved ones and when ours are the ones dying, any cost seems justified. We make them because no one has asked us to answer the hard questions with sober minds.

We can either cut benefits or raise taxes to pay for the benefits we currently have. The way to address benefit cuts is not through the false promise of Paul Ryan’s privatization wherein the poor and sick are slowly squeezed out of the marketplace.

We need to be honest and make decisions—tough decisions—about what benefits we will provide our poor and elderly and what benefits we will not provide. If they are rich enough, they can still obtain these benefits privately; taxpayer money is no longer involved.

All the measures we have tried in the past to control medical costs have been like squeezing a balloon at its current bulge. The bulge disappeared from the one spot, but appeared somewhere else. We need to untie the balloon’s knot and let out some air. Late in 2010, Arizona decided AHCCCS (its Medicaid-equivalent program) would no longer fund all lung and some heart and bone-marrow transplants. By April this year the pressure was too much and the new budget restored those cuts.

I don’t know what the right answers are, but as a nation we need to make some really difficult decisions. Should we cover liver and heart and kidney transplants? Should we cover drugs that cost tens of thousands of dollars a year? Should we cover premature babies who cost over a million dollars just to bring to term and who will have increased medical expenses throughout their lives? Should we replace knees and hips and corneas?

Your answers may differ from mine, but if we want to solve the Medicare problem we need to collectively answer those questions, weighing what our hearts and wallets say.

I have great faith in Americans. IF we are asked to make hard decisions we will make them. Now we just need politicians willing to do the same.

~ Jim

Thursday, May 19, 2011

Solving the Budget Deficit—Step Four: Repairing Social Security and Medicare

Social Security and Medicare are funded by what people think of as their FICA taxes. The Social Security portion was intended to be self-sufficient, with benefits “funded” from the taxes without additional income required from general revenues.

More and more of the Medicare benefits have been implemented with the assumption that a substantial portion (75% for much of it) will be funded by general revenues. Because of the different assumptions which birthed these two programs, we’ll address them separately.

Social Security

The biggest problem—perhaps we shouldn’t call it a problem, but an issue—with Social Security is that we are living longer than actuaries originally planned for us. That is not the only issue. We are retiring earlier in larger numbers, which generates fewer years of contributions. As with any program around for three-quarters of a century, some inefficiencies and idiosyncrasies have cropped up. These can be easily resolved if we can get the big fix in place.

Here is an immutable formula that defines financing of retirement plans:

Benefit Payments + Expenses = Contributions + Investment Income

Expenses are not a problem. Social Security is a well-run, efficient operation. Investment income could be enhanced a bit with moderate risk—but that’s a fairly small thing, since the right hand of the general fund of the Federal government has been borrowing from the left hand of the “Social Security Trust Fund.”

To fix Social Security’s problem requires either a cut in benefit payments or an increase in contributions. We can cut benefit payments in three manners: (1) continue to increase the retirement age; (2) reduce benefits the same percentage for everyone across the board to achieve balance; or (3) tweak the benefit formula to minimally affect those beneficiaries who earned the least and significantly cut benefits for maximum wage earners.

It is always easiest for politicians to cut benefits for those far away from retirement. The thinking goes that they have more time to adjust to the changed circumstances. I’m a bit skeptical of the argument. I’d bet most people don’t really know what they’ll get from Social Security—despite Social Security sending annual statements to all workers twenty-five or older since 1999. [Recently the Social Security Administration suspended the statements due to “the current budget situation.”]

One of Social Security’s strengths is that while benefits tilt toward the working poor and away from those better off, they are not so skewed that people consider them unfair. Social Security is widely regarded by all income levels as a good program (which is not to say that people don’t want to make it better, based on their idea of what “better” means.) Changing the current balance by tweaking the formula strikes me as possibly being the straw that breaks the camel’s back.

We should continue to raise the retirement age from its current maximum of 67. The original age 65 normal retirement was adopted at a time when people couldn’t work after 65 because they were physically worn out. Some professions still wear people down to the point they can no longer work. The disability provision must address their situation. For the rest of us, our lifestyle at age 70 today is much more robust than the lifestyle of the 1930s 65-year old. We need to rapidly raise the retirement age and start that process for anyone who has not yet reached their normal retirement age (that includes me).

At the same time the normal retirement age is increased, we should increase the early retirement age. Maintain the current four-year differential for those currently eligible for early benefits. Thus, if someone’s normal retirement age is 70, they could start Social Security as early as 66.
To the extent raising the retirement age does not adequately address the funding shortfall, I suggest cutting benefits in two ways.

First, extend the number of years of averaging from thirty-five to forty in order to receive a full benefit. Start the increase with 2012 retirements and pop it up by one year every other year. For people who work forty years, it will have a very minor effect on their benefits. For those who choose to retire early, it will have a larger effect, eventually reducing benefits by up to 12.5%. Those who are permanently disabled would be unaffected by the change.

Second, provide those who work past the normal retirement age with greater benefits than those who retire earlier, but defer benefit commencement. A simple approach would be to eliminate their future FICA taxes—they have fully paid for their benefit.

If all of those changes are not sufficient to get Social Security back in balance, then cut benefits across the board for everyone: current beneficiaries, those currently working and those not yet born.

Unlike my solution to fix the general fund deficit, I do not think additional taxes are appropriate. One suggestion often touted is to remove the cap on which the OASDI (Old age security and disability income) portion of FICA taxes are paid as was done for the Medicare portion in 1994.

In all my years working with corporate executives I never heard one complain about their personal Social Security taxes. Many looked forward to and celebrated the day when they got their “raise” after they had reached the income threshold and no longer had the FICA tax withheld from their paycheck, but no seemed to think the tax was terribly unfair. If we eliminate the wage limit for FICA taxes, it will drive a wedge between rich and poor in a system that is to the poor’s advantage to maintain.

Congress designed Social Security to be fiscally neutral, and I think that is a good policy to keep. While I believe we should raise taxes on those with higher incomes, income taxes, which benefit the general operating fund, not FICA taxes are the place to raise them.

Next blog for Medicare.

~ Jim

Wednesday, May 18, 2011

Solving the Budget Deficit—Step Three: Paying for Federal Government Services

I favor simplicity and clarity, so lawyers and tax accountants who make their living through tax law ambiguity are not going to like my proposals.

We can consider six general sources of Federal government revenue: personal income taxes, corporate income taxes, taxes on sales (or components of sales price, like value-added-taxes), wealth taxes, fees and social insurance payroll taxes.

Personal Income Taxes

Here is my simplified income-tax form:
Line 1: Income from all sources
Line 2: Expenses directly related to generating income
Line 3: Net income [Line 1 – Line 2]
Line 4: Tax on Line 3.

Schedule A lists all sources and amounts of income.

Schedule B lists all expenses directly related to generating income.

That’s it. All individuals must use a cash basis of accounting. If you don’t have a personal business, line 2 is zero. There are no deductions for mortgage interest, property taxes, state income taxes, state or local sales taxes, charitable contributions, medical expenses, IRAs. None. How you spend your money is immaterial to the income tax you pay.

The tax would be graduated (the rates dependent upon the amount of revenue needed). The minimum rate is 1%. If you only earn $8 an hour and work 1,000 hours a year because the economy sucks, you’ll still pay $80 in income tax. If government needs to support you, that’s an expenditure and shows up on the other side of the ledger.

There are no lower rates for capital gains or dividends. If you suffer capital losses, they offset income only to the extent you do not have unrealized capital gains on other assets. [To be honest, I’d rather mark all assets to market and tax the net increase in unrealized appreciation, but I doubt that would fly for individuals.]

I would allow a five-year transition to ease into the new system (and help the tax accountants and attorneys transition to useful employment). In year one, each of us pays the lesser of the new tax or the sum of 20% of the new tax and 80% of the old. In year two the percentages change to 40% and 60%. In five years the transition is complete. If in any year the new tax is less than the old tax, you are done with your personal transition.

Business Income Taxes

Line 1: Income from all sources
Line 2: Expenses directly related to generating income
Line 3: Net income [Line 1 – Line 2]
Line 4: Tax on Line 3.

Schedule A lists all sources and amounts of income.

Schedule B lists all expenses directly related to generating income.

That’s it. Corporations must also use a cash basis of accounting. Business expenses include bond interest and dividends (since both are taxable to the individuals to whom they are paid). Business expenses do not include charitable contributions, political contributions or any other payments that are not counted as income by a taxable entity. For example, if a gift to an employee isn’t taxable to the employee, it’s not deductible by the corporation.

Yes, I do understand that cash accounting will allow corporations to delay recognition of income to the next accounting period and speed up payment of expenses, but that is offset by other corporations attempting to do the same things.

I recognize that because of parent/subsidiary purchases and sales and foreign corporations that there is a gaping hole in this simplified version. We can solve the subsidiary problem by requiring corporate taxes only at the parent level. For multinational corporations, the rules will necessarily be more complicated and not all tax attorneys and accountants will be out of their jobs. Oh well.

Unlike for individuals, I do not see the necessity of a graduated corporate income tax. The rate should be high enough to reflect that corporations benefit from the government’s existence, but generally should be lower than the upper brackets of individual taxpayers. I’ll offer them the same kind of five-year transition that individuals received.

Sales Taxes & VATs

Although sales and VAT taxes are regressive (those with lower incomes, who must spend all or most of their income each year, pay a disproportionate share of their income on these taxes), I think they have a place in generating government revenue.

Politicians favor them because once approved, individuals perceive them as less objectionable than income taxes since we pay them in little bits and pieces and the total is not as visible as the annual income tax.

Because the government monitors product safety, regulates interstate exchange, etc. I favor a sales-type tax to allow some direct recognition of those Federal government expenses on our behalf. As with the minimal level of individual income tax, if the effect of a Federal sales tax is to take bread out of the mouths of babes, there are other ways to replace the bread.

Wealth Taxes and their kin

Wealth taxes come in two forms: Real estate property taxes are the form most people think of, although strictly speaking that is not a wealth tax since the property owner is taxed on the value of the property, not on the his financial stake in the property. It doesn’t matter whether you own the property or whether you and the bank own the property (or even if the property value is underwater and is worth less than the mortgage), the real estate tax is the same. Real estate taxes are most often local or regional in nature.

Many states use a form of wealth tax as a substitute or auxiliary to income taxes. The tax applies to certain kinds of property: automobiles, boats, stocks and bonds, to name a few.

The second general form of wealth tax is an estate tax. Besides generating income, estate taxes (what Republicans call a “death tax”) also serve the social purpose of redistributing “excess” accumulated wealth to avoid producing a financial aristocracy. Although I personally think that is a good reason for estate taxes, I’ll leave that discussion to the citizen panel I “drafted” in the previous blog.

The other purpose of the estate tax is to capture any deferred income tax—and this is undeniably fair. By not taxing the unrealized appreciation in assets until the assets are sold, it allows individuals to defer income. Death may or may not result in a final reckoning with St. Peter at the Pearly Gates depending on your religious beliefs, but it should result in a final reckoning of your income taxes.

To the extent you have not paid income taxes on any unrealized appreciation, those deferred taxes should be paid in the year of your death. It is a misnomer to call this a death tax; it is actually a deferred income tax. It should apply to anything that has appreciated in value, not just stocks and bonds. That includes the family house or farm or family business. Again, how you choose to spend your money is not the government’s business, but if you invest it in anything and the investment earns money, Uncle Sam should get his cut.


Fees are likely the smallest source of revenue, but not insignificant. If the law requires us to use a government service, there should be no fee. If we choose to use the service for our convenience and receive some benefit from that service, then a fee is appropriate.

For example, I am required to file an income tax. I should not be charged a fee to do so. I am not required to visit Canada, however if I choose to do so, I will need to get a passport. I should pay for the cost of the passport. Yes, I understand that will bar many citizens from leaving the country. Poverty has many prices and this is one of them. We require everyone to have a Social Security card and all males (why not females?) to register for the draft—no fees attached.

Fees make sense as a way for drug companies to pay for testing their products before releasing them to the general public. Similarly when I wanted to be certified as an Enrolled Actuary, I needed to pass a test jointly administered by the IRS and DOL. I should pay for that as well as the periodic costs of documenting that I had met the continuing education requirements.

Social Insurance Payroll Taxes

I put FICA taxes last for a reason. Because they are inextricably linked to Social Security and Medicare benefits, the amount of these taxes must be addressed at the same time the long-term design of Social Security and Medicare are determined.

And that dear reader will be the subject of my next blog.

~ Jim

Tuesday, May 17, 2011

Solving the Budget Deficit—Step Two: Goals and Objectives

I started to write “with the bright light of day shining on all the sausage ingredients…,” but upon reflection, perhaps we need to use ultraviolet light to keep down the bacterial growth when viewing the miasma created by laws midwifed by lobbyists for their clients. In any event, the United States government needs what the corporate world calls a mission statement.

Liberal Democrats and Conservative Republicans have strikingly different philosophies about government’s role. The mass of United States citizens who occupy the middle can agree on many core values, even while disagreeing on some of the details of how to provide the requisite services.

Even pacifists would agree the Federal government, not states, cities or individual citizens, is responsible for national security. The vast majority of us expect the Federal government to keep us safe from faulty products or drugs. We probably expect the Federal government to take care of the interstate highway system, but not the fourteen miles of gravel roads I need to travel from US 141 to my Upper Peninsula homestead. They’re not the responsibility of any government as they are not public thoroughfares and run across private property.

There is a second large group of services where it is not “clearly obvious” the Federal government is the necessary provider. We need to reach agreement about which of these services the Federal government should provide.

What should the Federal role in disaster relief be? Should the Federal government be involved with flood insurance, or insuring mortgages, or pension plans? How about the Federal government’s role in insuring bank deposits? Should the Federal Government provide support for the arts? Each of these programs developed to solve an historical problem. Is each and every one still appropriate?

There are some things that it appears we will not agree on. Republicans have tried in the past to change Social Security from a group benefit to an individual benefit. Bush’s efforts to “privatize” Social Security by requiring individual 401(k)-like accounts failed. Paul Ryan’s proposals regarding Medicare attempt to apply the same “privatization” approach to healthcare.

Social Security and Medicare developed over many years and were passed in bi-partisan votes. To fundamentally change their structure by the unilateral efforts of one party or the other does a real disservice to the citizenship. There is no current consensus that the proposed Republican changes are for the best. We need a bipartisan group to propose how we proceed with these benefits in the future.

I am not suggesting a bi-partisan commission called together by the president with equal representation of both parties, whom everyone can ignore. How about we collect a statistically significant sample of US citizens? Draft them for one year (a judge could determine hardship dismissals just as we do for jury duty). During that one year they are to work full-time (excluding holidays and four-weeks of vacation) to determine what kind of services the Federal government should provide.

We would pay the individuals the same amount as we pay our Congressmen and give them free access to technology to allow virtual meetings to the extent possible. If they need to travel, we’ll pay for that as well. Government agencies could present their case for why what they do is vital and the effects of increasing, decreasing or eliminating the services they provide. Academics could provide information to the group as could lobbyists, citizens and corporations. They could do physical or virtual town halls, have hearings, whatever.

Anyone can try to influence these citizen representatives with information; however, any gifts, promises, or other attempts to influence the group other than through information will be severely punished.

At the end of a year this group of draftees will define the mission of the Federal government. If some worthy service is not within the mission, the Federal government won’t do it. If Congress chooses to expand the mission of the Federal government, they will need to justify that to their constituents and to justify the increase in revenue to fund the service expansion. If it is within the mission, then Congress should legislate its implementation.

This commission won’t be inexpensive, but even if it cost a billion dollars (way more than I would expect) the immediate savings will be manifold times the cost. I am sure a group of citizens could quickly agree to defund $10 billion of pet projects held over from the days of unrestricted earmark programs.

The next step is agreeing how we pay for the services we decide we need. In the next post, I’ll talk about my ideas for a fair taxation system.

~ Jim

Monday, May 16, 2011

Components of Federal Revenue and Expenses

There are only two ways to reduce the US government budget deficit: increase revenues or decrease expenses. Most congressional republicans are posturing that the only acceptable approach is to reduce spending. Democrats have a knee-jerk reaction against cutting spending and therefore favor increased taxes—preferably on the “rich.”

Components of US Government Revenue and Expenses

The following charts on 2010 US Federal Revenue and Expenses were taken from a Wikipedia article:

Individual income taxes are the largest component of federal revenues, followed closely behind by Social Security and Medicare revenues (FICA). These two total 82%. Corporate income tax is another 9%, leaving only 9% for excise taxes, estate taxes, user fees, etc.

It’s useful to remember that FICA taxes are split between employer and employee (with self-employed filling both roles.) Consequently, individual income and FICA taxes account for roughly 62% of revenue; corporate income and FICA account for 29%.

Our income taxes are graduated (also called progressive), which means those with higher incomes (technically higher adjusted gross incomes – “AGI”) pay a higher percentage of their income in taxes. To illustrate, in 2008, the 10% of taxpayers with the highest AGI had 46% of the income and paid 70% of the income tax. The top 1% had about 20% of the total AGI and paid about 38% of total income taxes.

FICA taxes are flat taxes (also called regressive). The portion allocated to Social Security (as opposed to Medicare) and paid by both employees and employers is 6.2% of earnings capped currently at $106,800. The portion allocated to Medicare is 1.45% of all earnings, again paid by both employees and employers.

Consequently, those in the bottom 90% of AGI paid something close to 7.65% of wages in FICA taxes. (The data is hard to extract exactly since AGI includes income other than wages and is also adjusted for deductible expenses. It may be closer to the bottom 80-85% who pay the total 7.65%, but that’s close enough for our general discussion.) Those in the top 10% on average paid something less than 4% and the top 1% paid something around 2%.

Corporate income taxes are also graduated.

What is clear from this quick analysis of revenue is that if part of the solution to addressing the annual deficit is through increased taxes, increases in personal income taxes or FICA taxes must be addressed.

Of course the current Republican stance is that we must solve the deficit through spending cuts alone, so let’s turn to expenses. Here is a chart showing where the money went:

Social Security, Medicare and Medicaid account for 43% of expenditures. Defense is about 20%. Other “mandatory” spending is 12% and so-called discretionary spending accounts for 19%. Interest expense on the accumulated debt currently runs 6%.

Unless we choose to default on our debt (something only the most radical Tea Party proponents think is a reasonable approach) we are stuck with the interest expense, and those costs will only increase each year until we balance the budget. Interest expense will only decrease if we run a budget surplus. Furthermore, interest rates are currently very, very low. If interest rates were at the same level as they were in the late 1970s and early 1980s, our interest expense would be significantly greater. (At one point 3-month treasuries were paying over 12% interest; currently they are paying 0.06%.)

In short, almost regardless of what steps we take to address the budget deficit, net interest expense will likely increase.

Many Democrats appear unwilling to change either Social Security or Medicare and even Paul Ryan's proposals defer any changes for a decade. Taxes generated for these two benefits generated about $965 billion in revenue. Payments (including Medicaid, so it isn’t quite a fair comparison) totaled $1.494 trillion. The difference is $529 billion.

We cannot address the budget deficit without addressing this significant and growing imbalance.

However, given our total deficit is $1.294 trillion, snapping our fingers and “solving” this $529 billion deficit, still leaves us with a $765 billion gap. Eliminate all $660 billion of discretionary spending and we still have $105 billion of deficit.

Defense spending is a sacred cow for many Republicans and a live wire for many Democrats, who fear any vote to decrease defense spending will brand them as “weak on national security.” The United States accounts for about 40% of worldwide arms procurement. Our GDP represents only 23% of the world’s total GDP.

We spend a greater portion of our resources on defense than average. In fact, most of the countries spending a greater percentage of their GDP on “defense” than the US are totalitarian regimes, many of whom get aid from us for their purchases. Great Britain spends 40% less of its GDP than we do; other European allies spend even less.

Reduced defense spending would require the military to innovate and prioritize. If we were to (say) match Great Britain and lop off 40% of our defense spending, we save $267 billion a year – a little over 20% of the current annual deficit.

As you have probably suspected, I favor an approach that addresses both increased revenues and decreased expenditures. In my next post I’ll discuss some approaches we should consider.

~ Jim

Solving the Budget Deficit—Step One: Transparency

From my previous posts you know I favor solving the budget deficit by addressing both taxes and expenses. A couple of days ago House Speaker John Boehner indicated that he was unwilling to raise the debt limit unless trillions were cut from the future deficit and all the cuts must be from spending. He’s drawn his line in the sand: there must be no increase in taxes.

Here is a gift to Speaker Boehner: a rabbit he can pull out of his hat to save his rhetoric while returning to the reality of our situation. Simply identify all tax deductions as spending and shift them from “negative revenue” to “tax expenditures.” Since doing so does not increase any tax rates, Boehner and his knee-jerk no tax increase fanatics can eliminate tax expenditures without raising taxes.

I’ll be surprised if that’s not how some savings comes about. Witness the current attacks on BIG OIL. Eliminating some of their “subsidies” (read tax expenditures) will be a sop to the masses and allow Republicans to avoid using the “T” word.

If it were only John Boehner’s political ass my idea was saving, I couldn’t care a whit. However, the primary purpose of my recommendation to recast the negative revenue of tax deductions into the positive tax expenditures is to help the voting public understand where we currently spend our money—all of our money. To balance our national checkbook we need to understand both direct and indirect expenditures.

By recommending this approach to understanding the Federal Government’s revenue and expenses, I am not adopting the perspective that the nation’s entire GDP belongs to the government. What I am proposing is, given our current tax structure, it is equally important to understand where and how we directly spend money and where and how we implicitly spend money by choosing not to collect it through tax expenditures.

A dollar that we give to farmers to guarantee a minimum price for their crop costs us the same as a dollar we give to a mining corporation when we charge them less than fair market value for claims on Federal government (read OUR) property.

Because not all citizens have mortgages, we must understand how much we collectively spend to subsidize those who do have mortgages. Similarly, we need to recognize the government is subsidizing individuals and corporations when they make “deductible” charitable contributions.

These expenses need to be sitting on the same side of the ledger as the money we spend to provide for those without jobs, to care for the mentally and physically disabled, to wage war in Afghanistan and Iraq.

When I was working, I advocated that my employer should post all salaries so every employee could know who made what. If management couldn’t justify differences between two people then they needed to fix the problem, not hide behind secrecy. So too with our Federal direct and indirect spending. If there is a provision in a law that says it does not apply to any corporation who meets X, Y & Z provisions and it turns out only one corporation meets those provisions, that is a tax expenditure from our pocket to that corporation’s pocket.

We know the Federal government’s finances are so much sausage. It’s time to see all the ingredients.

Only with the bright light of transparency can we engage in an open discussion about what services our federal government should provide, what state and local governments should provide and what remains for individual effort.

~ Jim