Resolving the Federal Fiscal Crisis Requires a Better Understanding of Economic Reality

The graph above was recently created by the Congressional Budget Office to illustrate the size of the US federal debt as a percentage of the country's Gross Domestic Product (GDP) since the founding of our Republic and projected into the future for 30 years or so based on currently planned government policies.

The Washington Post published an editorial today about the CBO report in which this graph appeared and referred to the future projection as a "Matterhorn-like incline of what happens next". As the Post editorial notes, the federal debt has grown very quickly to the present and projected crisis levels shown in the CBO chart.

"The federal debt held by the public -- and, increasingly, "the public" means foreign governments and investors -- has mushroomed from 36 percent of gross domestic product at the end of the 2007 fiscal year to a projected 62 percent of GDP at the end of fiscal 2010. By way of comparison, only during and just after World War II has the federal debt exceeded 50 percent of GDP." http://www.washingtonpost.com/wp-dyn/content/story/2010/07/31/ST2010073100015.html?sid=ST2010073100015

As I have noted in prior posts, one successful approach to reduction of government deficits is to reduce public spending. See my posts about the actions taken by Governor Bob McDonnell in Virginia. The mainstream media (including the Washington Post) and Democratic policy-makers usually say that the solution to our fiscal crisis is to reduce spending and/or to increase taxes. However, it would be more accurate to say that reducing spending and increasing government revenue would help address the problem. Increasing government revenue can actually be accomplished by economic growth without raising taxes. And renewed economic growth can even be stimulated by lowering taxes. These seem to be concepts that are very difficult for the liberal mind to grasp.

Grover Norquist, President of the Americans for Tax Reform, recently presented his recommendations for reducing the federal debt to the National Commission on Fiscal Responsibility and Reform on June 30, 2010. This National Commission is the Presidentially appointed commission (which includes several members of Congress and Senators) that has been asked to make recommendations for solving the debt crisis. President Obama established this commission because our federal officials do not seem to know how to work together effectively in the halls of Congress in accordance with the usual Constitutional procedures to solve the most important problems of the day as we elected them to do.

In his testimony, Norquist stated that the deficit problem is caused by spending:

"100 percent of the fiscal crisis we face is due to an over-spending problem in Washington. Federal tax revenues have averaged approximately 18 percent of GDP since 1970. According to the Congressional Budget Office (CBO), tax revenues over the next decade will climb back to this historical average—even if all expiring tax relief is extended, and the AMT is indexed to inflation. Clearly, taxes are not causing the deficit—spending is.

Since 1970, spending has averaged about 21 percent of GDP (giving a structural budget deficit of 3 percent of GDP). According to CBO, federal spending will exceed this level for the entire decade, averaging 23 percent of GDP."

To reduce spending in the long term, Norquist recommended a Republican proposal offered by Rep. Paul Ryan (R-WI), who is also a member of the National Commission, that Ryan calls a "Roadmap for America's Future". Ryan's proposal can be found at http://www.roadmap.republicans.budget.house.gov/. Liberals would probably be surprised to learn that Republicans actually have ideas for fixing major problems in our country. That is the natural result of believing what the Democrats say about the GOP and only reading the mainstream media or liberal blogs and never watching Fox News.

Here's Norquist's reference to the Ryan plan, as well as another Republican proposal for the short term:

"Given the dual nature of the present overspending problem, leaders must pursue both long and short term solutions. Long-term spending restraint is best achieved by reforming the long-term entitlement programs and enacting meaningful budget constraints as found in Congressman Paul Ryan’s (R-Wis.) “American Roadmap” plan.

In the shorter run, the [Republican Study Committee] balanced budget plan is notable for not raising taxes or letting tax relief expire and returning discretionary spending to the FY 2008 approved level (that is, pre-bailouts)."

The Republican Study Committee recommendation referenced above can be found at http://rsc.tomprice.house.gov/Solutions/RSCFY2011Budget.htm. This recommendation includes the extension of the Bush tax cuts that are scheduled to expire at the end of this year unless extended by Congress.

So how can the extension of tax cuts and the failure to increase taxes cause government revenue to rise? Well, one point often not understood is that for income taxes to bring in more revenue there has to be enough INCOME to tax. When we have high unemployment, increasing bankruptcies and extensive business losses during an economic downturn, there is not as much income to tax. If the economy and hiring increase, there will be more income to tax ... whether taxing at the same rate as today or at lower tax rates that will stimulate more investment and business activity... and, therefore, there will be more government revenue.

Here is Grover Norquist's recommendation on how to raise government revenue:

"Cut marginal tax rates. It is vital to economic growth to cut marginal tax rates on individuals and businesses. In particular, the corporate income tax (the highest in the developed world at 35 percent) should be no higher than Europe’s 25 percent average. The capital gains and dividends tax should be eliminated. The top individual marginal income tax rate (where two-thirds of small business profit taxes are paid) should be reduced from 43.4 percent (after next year’s expiration of the 2001 tax relief and Obamacare’s new 3.8 percent Medicare tax) to 25 percent. This will ensure that the economy will grow faster –and CBO has said that faster economic growth of even one percentage point would lead to $2.5 trillion in new tax revenue.

Lower marginal rates work. They worked in the 1920s when President Coolidge cut rates until President Hoover raised taxes and helped create the Great Depression. They worked in the 1960s when President Kennedy cut rates until Presidents Johnson and Nixon raised taxes to pay for Vietnam abroad and spending at home. They worked in the 1980s when President Reagan cut rates until President George H.W. Bush raised taxes and ended the Reagan boom. They worked in the 2000s when a GOP Congress cut rates in 2001 and 2003 on individuals, businesses, capital gains and dividends until the Democrats took over Congress in 2007 under the promise to let them go up.

Make all expiring tax cuts permanent. Given the positive effects of lower tax rates on growth, economic efficiency, and tax revenues, tax cuts should not be set to sunset when crafting legislative proposals, and those that are scheduled to expire should be made permanent."
http://www.atr.org/grover-norquist-outlines-recommendations-obama-debt-a5252##ixzz0vJ7uwaih

Maybe the wise men and women on the National Commission will see the light and recommend sensible solutions to resolving our fiscal crisis. Sphere: Related Content

More Lessons for Washington from Richmond

When Bob McDonnell was sworn as the new Governor of Virginia in January of 2010, he "inherited" (as President Obama likes to say) a $1.8 billion budget deficit from his predecessor, Tim Kaine, who is now the Chairman of the Democratic National Party. Last week, Governor McDonnell announced that the fiscal year of 2010, which ended on June 30, 2010, would conclude with an estimated $220 million SURPLUS.

The Governor explained this accomplishment as follows:

"Just six months ago we faced a $1.8 billion shortfall in Virginia's budget for the remainder of Fiscal Year 2010. When the General Assembly convened I made it clear that we would not balance Virginia's budget by making it harder for Virginians to balance their own. Through bipartisan cooperation we made tough realistic decisions and closed that shortfall without a tax increase. We continued this work by addressing the unprecedented $4.2 billion shortfall in the Fiscal Year 2011/2012 budget, the spending document that has just gone into effect, in the same manner. We have reduced state spending in this new biennium to 2006 levels. At the same time we put in place funding for a number of job-creating incentives and programs that are already helping us attract new employers to the Commonwealth."

As noted in the Governor's announcement, he also worked with the legislature to close the projected deficit in the next fiscal budget for 2011/2012. All this was done by working cooperatively with both Republicans and Democrats in the legislature to find ways to cut state spending and to adopt job-creating incentives designed to stimulate economic growth without any tax increases!

Governor McDonnell also noted what the surplus would be used for:

"The majority of the surplus is already dedicated within the budget to a number of areas. One of those is to fund a one-time non-recurring 3% December bonus for Virginia's state employees. Our state employees have worked without any increase in pay for nearly four years. This session of the General Assembly, I proposed a plan supported by Democrats and Republicans to incentivize state employees to save state dollars at the fiscal year-end, and receive an incremental bonus of up to 3% if a surplus was achieved. For too long the unfortunate standard procedure in state government has been for agencies to spend down all appropriated funds to zero prior to the ending of the fiscal year. We successfully changed that model by implementing private sector principles of rewarding fiscal discipline and sound management of scarce resources. State employees were successful in identifying more than $28 million in savings..." http://www.governor.virginia.gov/news/viewRelease.cfm?id=238

The "unfortunate standard procedure" of spending all appropriated funds for the fiscal year down to zero is not just a standard practice in state governments. This has been the standard practice in the federal government for many years as well. Governor McDonnell has changed the incentives among state employees from spending money quickly before the end of the fiscal year (so as not to lose it) to looking for ways to SAVE money in order to earn bonuses which he will now use the surplus to pay!

This change in incentives initiated by McDonnell has caused a remarkable shift in the usual manner of bureaucratic behavior. If this approach were to be used in the federal government, it would be very interesting to see what would happen to federal spending.

There is a reference in McDonnell's statement to an action taken by his predecessor in an attempt to control spending that has also not been tried by the federal government: that is that the state employees had not had a pay increase for nearly four years. Imagine how federal spending would be affected if all non-military federal salaries (which now exceed on average private sector compensation levels for comparable jobs) would be frozen for four years!

Private enterprise has built-in incentives to control expenditures in order to help assure a profit for the enterprise's stakeholders. As a result, when economic circumstances make it difficult to maintain the enterprise's revenue streams, it is common practice to adopt incentives to save money, including freezing certain expenditures such as compensation or new hiring.

These types of incentives are, however, not common in the public sector because government employees and their leaders do not have to acquire or maintain customers to earn their revenue. Public employees have operating funds appropriated to them by the legislature, which receives those funds from taxpayers; not customers who must like the organization's products or services before agreeing to pass on their money. Taxes are mandated by the government. Taxpayers must pay taxes or suffer legal penalties, whether they like the government's services or not; or even whether they receive those services or not.

Bob McDonnell had private sector experience before becoming Governor, as have many other Governors. Unfortunately, we now have a federal government run by an Administration that is led by people with no (or very little) private sector experience. The US Congress is led by career politicians who have been on the public payroll so long they do not understand any way of funding the government other than by looking to taxpayers; rather than finding new ways to control spending on their own or to incentivize government employees to reduce spending, as Governor McDonnell has done.

While the federal deficit for fiscal year 2009 was a record $1.41 trillion, the White House just announced a projected deficit for the current fiscal year of 2010 of $1.47 trillion, with the deficit projected for 2011 at $1.42 trillion. Rather than adopting ways to reduce spending, the President has pushed through his Democratic led Congress massive new federal programs from the stimulus bill of last year to health care reform and financial regulatory reform this year.

But Obama does not acknowledge that his new programs have contributed to the lack of any reduction in the deficit. No; he likes to remind everyone that he "inherited" the 2009 deficit and that the economic downturn (that he also "inherited") has made it difficult to cut the deficit. In fact, in today's weekly radio address, the President said that it will take years to significantly cut the federal deficit.

Bob McDonnell also inherited a budget deficit, and Virginia is also impacted by the same economic downturn as the rest of the country (except to the extent that Virginia has a large number of federal facilities and employees that have benefited from the growth of the US government during the Obama presidency). In spite of what he "inherited", Governor McDonnell achieved a budget SURPLUS in six months without raising taxes or blaming his predecessor for the problems he left behind.

How is President Obama addressing the federal deficit? By waiting for a report from his specially appointed budget commission, which will issue its recommendations after the elections in November. I thought we elected Presidents and members of Congress to solve our countries' problems. Why do they have to wait for a group of unelected citizens and a few specially selected members of Congress to come up with solutions?

The Washington Post article on the White House announcement about the revised budget projections describes the Obama approach to the federal deficit this way:

"Economists agree that the most important measure of the deficit is against the size of the economy. Opinions vary, but many economists say a deficit of 3 percent of gross domestic product is sustainable since it would stabilize the overall debt when measured relative to the economy.

The [new White House] report put the deficit at 10 percent of GDP this year and 9.2 percent of GDP next year. It would never reach the 3 percent figure under Obama's predictions - which underestimate war costs and depend on assumptions of tax hikes that may not materialize." http://www.washingtonpost.com/wp-dyn/content/article/2010/07/23/AR2010072303812.html

So it appears that the federal government officials that the American voters elected cannot devise a sustainable budget without seeking advice from a taxpayer funded Presidential commission. As a Virginia voter, I am sure glad we elected a more innovative leader for our Governor. Hopefully, voters in the rest of the country will find better candidates to elect in the future to go to Washington and adopt more creative solutions to our fiscal problems than the unimaginative crew (obssessed with partisan bickering) that we have running the country now.

Sphere: Related Content

From Hope to Lack of Confidence in 18 Months

Newspaper editorial pages, news websites and blogs have been full of reports and commentary lately about the increasing expressions of disagreement between the business community and the Obama Administration. The sad result of this distrust and lack of confidence by business leaders in the direction of the federal government is the continuing high rate of unemployment and the slow recovery of the economy.

I spent over 26 years as a corporate lawyer in a major American corporation. It became very clear to me during that career that business managers do not like uncertainty in the regulatory landscape. They want to know what the rules are in order to be able to make business decisions that comply with the applicable regulations.

Whenever a major new federal law was passed that applied to our business, the lawyers in the company would be expected to give the company's management advice on what the impact of the new legal requirements would be on the company's business and future plans. The company's lawyers were expected to help the managers make decisions on what changes would be required and when the changes would have to be implemented to meet the effective dates of the new law.

In the 18 months of the Obama Administration, the stimulus bill, major health care reform and now significant financial regulatory reform have passed with major changes in laws affecting various types of businesses. There have also been less publicized bills passed that affect business, such as a wage equality law that addresses income disparity between men and women in the workplace and a credit card law that requires new disclosures to cardholders. In addition, of course, the TARP bailout program imposed new requirements on financial institutions, auto companies have faced new federal requirements (including orders to close certain dealerships) and the federal government took over the student loan business that forced Sallie Mae to close its Virginia headquarters. Many of these new legal requirements have caused jobs to shift from the private sector to the government.

The news media has covered well the political arguments and gamesmanship involved in the Democratic party's "strong arm" tactics to pass these laws with very little Republican input or support. However, with each new 2,000 plus page bill passed (basically by only one party), there are numerous changes in business practices required, and, when the bills are so complex and massive in their scope, it takes huge legal staffs at companies and law firms to review and interpret those bills and determine how they will affect their clients. This will, of course, cost quite a bit in legal expenses and take a lot of time during which business people will feel very uncertain about the future. This lack of certainty inhibits the ability of business people to effectively make plans for expansion, investment in new businesses or hiring new employees.

The above discussion only deals with major new laws that have already passed since Obama became President. As each new law passes, the President and the Democratic leaders in Congress start talking about what is next on their agenda. Even as oil gushed out of the Gulf oil spill, the President went on national television and advocated new energy legislation. The Arizona immigration law that is the subject of so much controversy has prompted many Democratic politicians to talk about the need for comprehensive immigration reform legislation at the federal level, which would likely affect company personnel practices. Each of these laws would require "reform" in various aspects of business decisionmaking.

As a result, as profits have started rebounding since the worse of the recession has ended, jobs and other economic benefits have not been growing very quickly. A week ago, Fareed Zakaria described the current business climate as follows:

"The Federal Reserve recently reported that America's 500 largest nonfinancial companies have accumulated an astonishing $1.8 trillion of cash on their balance sheets. By any calculation (for example, as a percentage of assets), this is higher than it has been in almost half a century. Yet most corporations are not spending this money on new plants, equipment or workers. Were they to loosen their purse strings, hundreds of billions of dollars would start pouring through the economy. These investments would probably have greater effect and staying power than a government stimulus....

So why are [business leaders] reluctant [to make investments that could further improve the economy], despite having mounds of cash?.....

Economic uncertainty was [described by business leaders who were interviewed as] the primary cause of their caution. 'We've just been through a tsunami and that produces caution,' one told me. But in addition to economics, they kept talking about politics, about the uncertainty surrounding regulations and taxes.....

One CEO told me, 'Almost every agency we deal with has announced some expansion of its authority, which naturally makes me concerned about what's in store for us for the future.' Another pointed out that between the health-care bill, financial reform and possibly cap-and-trade, his company had lawyers working day and night to figure out the implications of all these new regulations....

Most of the business leaders I spoke to had voted for Barack Obama. They still admire him. Those who had met him thought he was unusually smart. But all think he is, at his core, anti-business. When I asked for specifics, they pointed to the fact that Obama has no business executives in his Cabinet, that he rarely consults with CEOs (except for photo ops), that he has almost no private-sector experience, that he's made clear he thinks government and nonprofit work are superior to the private sector. It all added up to a profound sense of distrust." http://www.washingtonpost.com/wp-dyn/content/article/2010/07/04/AR2010070403856.html

The White House seems confused about the increasing business criticism it has been receiving recently. As Larry Kudlow noted, the President often says the right things:

"After all, as part of his so-called 'business charm offensive,' the president is arguing that 'it’s the private sector that has always been the source of our job creation, our economic growth, and our prosperity; and it’s our businesses and workers who will take the reins of this recovery and lead us forward.'

He also says 'the free market depends on a government that sets clear rules that ensure fair and honest competition,' and that 'too much regulation or too much spending can stifle innovation, can hamper confidence and growth, and hurt business and families'.” http://dailycaller.com/2010/07/15/business-knows-more-than-obama/#ixzz0u58Y1C00

If Obama recognizes that business needs "clear rules", why is there a continuing pipeline of major new rules flowing through Congress that create uncertainty about what those rules will be? And why does the President and his party repeatedly attack business (from AIG to BP) as the cause of almost all of society's problems? The Administration and the Congress have done much to create an uncertain business environment and nothing to help business see the future with any clarity. Sphere: Related Content

US vs. Arizona - What Justifies This Use of Federal Force?

Last week, the US Department of Justice sued the state of Arizona to seek to have that state's controversial immigration law declared invalid under the US Constitution's Supremacy Clause
because "the federal government has preeminent authority to regulate immigration matters". The US complaint, which was filed in the federal district court for the District of Arizona, starts with the allegation that:

"S.B. 1070 [i.e. the Arizona immigration law under attack] pursues only one goal – 'attrition' [in order to discourage and deter the unlawful entry and presence of aliens in the state through law enforcement] – and ignores the many other objectives that Congress has established for the federal immigration system."

This statement ignores the Arizona statute's first sentence, which is:

"The legislature finds that there is a compelling interest in the cooperative enforcement of federal immigration laws throughout all of Arizona."

Throughout the state law there are repeated references to Arizona law enforcement authorities contacting and working with federal authorities in order to verify a detainee's immigration status and to transport illegal aliens to the custody of federal law enforcement agencies. The clear purpose of the law is to work in concert with the federal government in enforcing federal immigration law.

The US complaint even acknowledges that the federal government looks favorably on states assisting with the enforcement of federal immigration laws:

"The federal government, moreover, welcomes cooperative efforts by states and localities to aid in the enforcement of the nation’s immigration laws. But the United States Constitution forbids Arizona from supplanting the federal government’s immigration regime with its own state-specific immigration policy – a policy that, in purpose and effect, interferes with the numerous interests the federal government must balance when enforcing and administering the immigration laws and disrupts the balance actually established by the federal government."

There are a range of programs offered by US Immigration and Customs Enforcement (ICE) that are designed to engage local and state law enforcement agencies in cooperative efforts to enforce the federal immigration laws. Most of these are provided pursuant to ICE Agreements of Cooperation in Communities to Enhance Safety and Security (ACCESS) that provide state and local law enforcement agencies an opportunity to team with ICE in addressing immigration problems in their communities.

A list of the programs provided under ACCESS can be found at
http://www.ice.gov/pi/news/factsheets/access.htm. At least, seven state, county and municipal law enforcement agencies in Arizona have signed ACCESS agreements with ICE.

The Justice Department's objection, as expressed in its complaint, is that Arizona is trying to "supplant" federal immigration laws. However, there is no intent in the Arizona law to supplant or replace federal law with another type of immigration program. All through the state law, it refers to using federal legal requirements and law enforcement resources to assure that persons detained, held or arrested by Arizona authorities are legally present in the country before they are released from local custody. This state purpose appears very consistent with the purpose of the ICE programs offered under the ACCESS agreements. The Arizona law is not setting up a new immigration program to supplant the the federal laws.

The US complaint acknowledges that the federal government has resources that are made available to state authorities to help determine the status of foreign nationals. However, DOJ is concerned about the burden that helpful cooperative Arizona police officers may impose on those federal resources:

"Mandatory state alien inspection schemes and attendant federal verification requirements will impermissibly impair and burden the federal resources and activities of DHS. S.B. 1070’s mandate for verification of alien status will necessarily result in a dramatic increase in the number of verification requests being issued to DHS, and will thereby place a tremendous burden on DHS resources, necessitating a reallocation of DHS resources away from its policy priorities. As such, the federal government will be required to divert resources from its own, carefully considered enforcement priorities – dangerous aliens who pose a threat to national security and public safety – to address the work that Arizona will now create for it."

So the federal government is concerned that Arizona will increase its workload in verifying the immigration status of foreign nationals who are detained by state and local law enforcement agencies because it will divert the DHS resources from seeking out "dangerous aliens". It would seem reasonable to assume that aliens detained by police officers in Arizona may include some who are dangerous. If so, it would seem that Arizona would be assisting the federal government in carrying out its priorities, not just interfering with its goals.

Based on the President's speech at American University the week before this lawsuit was filed, it appears that the federal government could use the assistance of Arizona police and others in enforcing immigration laws. Here is some of what the President said:

"To begin with, our borders have been porous for decades. Obviously, the problem is greatest along our Southern border, but it’s not restricted to that part of the country. In fact, because we don’t do a very good job of tracking who comes in and out of the country as visitors, large numbers avoid immigration laws simply by overstaying their visas....

More fundamentally, the presence of so many illegal immigrants makes a mockery of all those who are going through the process of immigrating legally. Indeed, after years of patchwork fixes and ill-conceived revisions, the legal immigration system is as broken as the borders....

The result is an estimated 11 million undocumented immigrants in the United States....

In sum, the system is broken. And everybody knows it......

But our borders are just too vast for us to be able to solve the problem only with fences and border patrols. It won’t work. Our borders will not be secure as long as our limited resources are devoted to not only stopping gangs and potential terrorists, but also the hundreds of thousands who attempt to cross each year simply to find work."

If the federal immigration legal scheme is so broken, as President Obama put it, why would the federal government not want the assistance of Arizona in stopping the flow of illegal immigrants through that border state? The existing programs offered by ICE appear to suggest that the cooperation and assistance of state agencies is very well accepted as an important part of the federal law enforcement system established under the US immigration laws.

Maybe the answer can be found in this statement in the US complaint against Arizona:

"The [federal immigration law] also vests the executive branch with considerable discretion in enforcing the provisions of the federal immigration laws, generally allowing federal agencies to ultimately decide whether particular immigration remedies are appropriate in individual cases."

In other words, the US government wants to decide, based on its own discretion, whether to always enforce the laws intended to keep foreign nationals from illegally entering the country. If the US goal is not to keep all illegal aliens out of the country, of course, they would not want Arizona or any other state to help it stop every alien from illegally crossing the borders into the US. That must be why DOJ sees the Arizona law as interfering with federal law.

This would mean, of course, that a discretionary amnesty program is already in effect, operating under the radar and out of sight of most American citizens, which apparently includes state governors and legislatures. If this is the case, why would there be a need for a new comprehensive reform of federal law at all? The President and his Administration can already enforce the immigration laws at their discretion. And it is that discretion that the Obama Administration does not want Arizona to interfere with or supplant. Sphere: Related Content