Why don’t we Link Spending and Revenue

Google Plus user +Paul Clayton Smith asked a fundamental question yesterday, which I’ll paraphrase here: “Are the dollar figures we see coming out of Washington DC taking into account the nature of the wealthy to avoid taxes, or do the assumptions of revenue gained by tax take into account only present day figures of GDP, incomes, taxes and other inputs into the economy?”

The question is key because to understand the way politicians and the Beltway play with our money is to understand the fundamental disconnect between the amount of that money they take from us and how much they spend on things that benefit only portions of society. For instance, the current “budget” for the Federal Government is over $3.79T, while current revenues only make up around $2.47T. Simple math would indicate the nearly $1.32T in deficit spending the Government takes out of hide based on these numbers. With all the talk in DC about the deficit and how it is a potentially crippling black hole that must be dealt with at some point, one would think that meant there should be a mechanism that would force Congress to keep spending to within a manageable range compared to revenue, but if you take our current “budget” numbers into consideration you’d find there isn’t much in a way of a link between taxes and spending at all.

What is the problem?
Why should there be a correlation between spending and revenue? What difference does it make whether or not the Federal Government balances its budget? Can’t the Treasury just print the money it doesn’t have to make up the difference, or borrow against the credit of the United States in order to keep the bills paid?

Technically, the Federal Government can’t ever “run out of money”. The Treasury can simply print every dollar that is required to fund the Government above and beyond tax revenues, or the Federal Reserve can borrow the money. Many Liberals believe this is acceptable as a course of action, and in fact, a combination of printing and borrowing has been the make-up of over $0.40 of every dollar the US Government has spent for the majority of the last four years.

Printing devalues the currency because it increases supply when there is not a corresponding increase in demand. Demand, in this case, is the productivity of the economy creating money out of products and services. The US Government requiring funding to accomplish its agenda doesn’t constitute demand for the dollar because there is no corresponding product or service created by the Government when the money is created.

Borrowing is expensive, and, if uncontrolled, as it has been for decades, can put the Government in a situation where its interest liability is so high that the revenues brought in by taxes are not enough to cover both spending goals and the mandatory servicing of the debt. Servicing the debt is the primary concern in every budget because to default is to damage the full faith and credit of the US Government on the world stage. If we don’t pay our bills no one will want to continue lending to us. What we’ve done, though, instead of paying our bills, is effectively taking out a loan to pay down only the interest on another loan. This is not a sustainable track.

Whats the solution?
We borrow and print over half the value of revenues into the Treasury every year (in the present budget model, which isn’t actually a budget, but a continuing resolution). In order to solve the fiscal problems the Government has this funding activity must be reversed. Currently the budget is set up so that safety net entitlement programs like Social Security and Medicare/Medicaid, which politicians have convinced voters are the Government’s responsibility, are considered mandatory spending. Items the Federal Government is actually Constitutionally charged with providing for its citizenry, for example, a strong defense, are considered discretionary spending. In order to reverse the overspending we’ve seen over the course of the last several decades there must be a concerted effort by all in Washington DC to stop spending more money than the Government can generate in tax revenue. To do this our politicians must come to terms with what the Government is required to provide for its citizenry and what it can afford to provide for its citizenry.

Why not just raise taxes?
Over the course of our Nation’s history there have been attempts in both local and Federal Government to increase revenues through higher taxation as a means of reducing deficit spending. The idea is that the increased taxes will bring more money into the coffers, and the spending can continue at its present rate, unabated. One major problem with tax rate increases is that the individual is free to make choices that will impact the overall revenue generated by the increased taxes. A prime example of this is the exodus of wealthy individuals from California following the recently passed Proposition 30 tax increases. The State decided to increase income tax rates for individuals with incomes over $250k/yr, up one percent to 10.3% (the increase is retroactive all the way back to January, 2012, due in April, 2013), while those making over $1M/yr will see their tax rates increase to 13.3% (again, retroactive to January 1st, 2012). These tax increases on the wealthiest in the state have made many consider taking action that will reduce or eliminate their tax liability in this regard. There are also considerations that need to be taken into account in terms of property taxes and other, locally generated government revenues, which are not able to be voted on directly by the citizens under the local government.

Human beings will all avoid pain, given the opportunity to do so and no motivations to do otherwise. As noted in the linked article, the financial planner being interviewed commented that until the tax rates reset down in seven years he will make sure his clients incomes are less than $1M/yr. Those who can shelter their incomes from the tax man will do so. Those who cannot may have no choice but to leave the state.

What about at the Federal level? The Federal Government has a captive audience when it comes to tax increases because its much more difficult to simply leave the country to avoid taxes than it is for Californians to go to South Dakota or Texas, right?

Well, when taxes, an inversely proportional input into the overall economy, are increased, overall economic growth decreases. This stems from the fact that when an individual or entity is forced into a liability that is payable before their income is realized that liability is taken into account when the individual or entity budgets their remaining income for a period of spending. For the micro scale, simply put, if the tax man takes X from individual Y based on income Z, net income Zn is the remaining spending power of the entity. If X is increased there is an inversely proportional decrease in Zn.

For the macro scale, when the economy sees a collective decrease in Zn, across all entities and individuals, the entire economy stalls. Since taxes are a function of a percentage of the Nation’s GDP, if GDP growth stalls so does tax revenue.

Conversely, when taxes are decreased, Zn increases, causing entities to purchase more, which causes producers to produce more, sell more, and the engine runs faster. When the engine runs faster tax revenue increases because the overall number of entities with tax liabilities increases along with GDP. As indicated before, tax rates being a function of a percentage of the Nation’s GDP, when GDP grows quickly Federal revenues grow quickly.

Coupling lower taxes with decreased spending will solve our Nation’s fiscal problems. The path to this lies in
the hands of the politicians we vote for. They won’t do it on their own, though. Once most politicians find themselves enjoying life in the Beltway they learn quickly that they need only give their constituents gifts from the public trust in order to continue their employment. Every dollar they earmark or bring home to their district is a dollar spent by the Federal Government on something that benefits a few, but is paid for by everyone.

To claw our way back from the brink of fiscal collapse we Americans must hold our elected officials accountable for not only their responsibilities to their constituents, but also their responsibilities in being proper stewards of the public trust. Until this happens, we’re going to repeat recent history every year until it is no longer sustainable to do so. Once it is no longer sustainable, we will find out very quickly what government services are luxuries and what services are necessary. We’ll also find out very quickly how to live with neither.

The Truth About Taxes

While all the wrangling in Washington about tax rates is important to our wallets, when it comes to government revenues, it is absolutely meaningless.

The fact is, our tax code has become less about raising revenue and more about buying votes, creating class tensions, and control over the lives and behaviors of US citizens.

As far as the federal government is concerned, it doesn’t matter what the tax rates are, nor does it matter how much money comes into the treasury. Congress will spend every single dime of it. And when our tax dollars inevitably run out before the year does, they will borrow or print more money and keep on spending.

Keep that in mind as our fearless leaders debate over the upcoming Fiscal Cliff.

(“Fiscal cliff.” I hate that phrase. This is no cliff…we’ve been flirting with the edge of the abyss for years. We’re just closer to it now, our president says, “Forward,” and the only response from House leadership is, “How fast?”)