Saturday, May 22, 2010

Bruce Krasting: If we fail to grow, we die.

The Commission on Fiscal Responsibility and Reform held their first meeting recently. These chitchats will continue on a regular basis until December when their thoughts will be made public. Former Sen. Alan Simpson, R-Wyo., the panel’s co-chair, summed up the difficulty the commission faces:
“It's going to be like giving dry birth to a porcupine.”

While Senator Simpson has provided a colorful description of what lies ahead I think he (and most others in D.C.) are doing us a disservice. As it turns out a significant portion of the revenue problems can be fixed. All that Congress and the President have to do to right the revenue ship is: Do Nothing.

Consider this first graph of the CBO projected budget deficits through 2020. The graph measures the size of the annual deficits. These very big deficits assume that various tax credit/deductions are eliminated and taxes on income are increased.

This second graph shows what would happen if Congress and the President were to extend existing tax breaks. The three big areas of tax increases come to $3 trillion over the ten-year period.

Our tax code is littered with provisions and temporary “fixes” that have the affect of reducing tax revenues. Each of these provisions has a drop-dead date attached to it. If Congress were to just say “no” to extending any of this we would generate $5.3 trillion over the next decade. That much money would go a long way toward addressing our fiscal imbalances.

The CBO has a list (Expiring Tax Credits) of the nasty tax breaks that could fall prey to the setting sun. The list is three pages long. Many are important incentives for alternate energy. There are some that smell like pork. For example the Depreciation Classification for Certain Race Horses could be eliminated. That would save us $500 million. But these categories don’t amount to much. We need to go after the big bucks. We need trillions, not billions.

Our politicians will be faced with two difficult choices. Either they can go to their constituents and corporate contributors and say with glee:

“I voted to raise taxes on every damn think we could think of!”

Or they could do it the easy way and say:

“I did not vote for any tax increases. My record is clear. I did the responsible thing. I did nothing”.

Given how things work in D.C. and that a fair swath of the population hates everyone (red or blue) at the moment it would seem reasonable that our leaders will do what is necessary (and expedient) and do nothing at all. With that in mind it is worth taking a look at the CBO list to see what big-ticket tax increases are in store between now and 2020.

-EGGTDDC (AKA- The Bush Tax Cuts) Letting this roll off into the sunset on 12/31/2010 will result in a $1.6 Trillion tax increase. Big money and it would result in an immediate increase in revenue. This increase will come from those making over $200k. On average this will mean about 2% off the bottom line of 5-10mm households. A substantial hit.

-Raise long term capital gain to 28%. This comes to $350b over the ten-year horizon. It is not a big category but a politically important one. This is going to happen.

-Estate and Gift taxes will add $570b. I think this one is a layup. Sorry trust funders.

-Expensing of Investment Property will save $300b. Your incentive to own any real property will be diminished.

-Eliminating the deferral on AMT will generate $530b. This is an ugly tax. I have been subject to it for years. I think of it as a 28% flat tax. But it really is a bastard of a flat tax because certain deductions are still permitted, while others are not. Here is how the IRS describes the AMT:

The AMT is a separately figured tax that eliminates many deductions and credits, thus increasing tax liability for an individual who would otherwise pay less tax.

What are those deductions/credits that you might lose? (1) Child-care, (2) State taxes, (3) local property taxes, (4) medical expense and (4) charitable contributions. Basically if you live in NY or California (or state with high income tax), own a home where property taxes are high and have three kids and support your church; bend over. This tax is going to hit between 10 and 20mm people. If your individual or combined income is ~$125,000 look out.

Something along these lines is coming. We have survived high tax burdens in the past and will likely do so this time. The most critical factor in the CBO analysis of the future deficit is not expenses or taxes. It is the growth in the GDP of our economy.

In a utopian world we would have tax receipts of 15% and expenditures of 18%. We are far from utopia. In 2010 we are looking at tax receipts of 10% and expenses of 25%.

Consider this graph of the CBO’s projected growth of GDP. They assume an average growth rate of 4.38%. I think it is going to be closer to 2%.

The difference between the CBO estimate and the more realistic 2% comes to a whopping $22.5T over the ten years. Apply a 15% tax rate to that missing growth and you end up with $3.3trillion of less revenue. That is equal to all the tax income that will be created by the big rate increases that are coming. In other words, nothing will have been accomplished.

If we fail to grow, we die. The deficits will overwhelm us. It is very difficult for me to imagine how we can grow if we implement these (or similar) tax increases. We will bump back and forth from good years to bad and the average growth will be closer to 1% versus the 4% we need. That said, I still think we will do “Nothing”.

(from Bruce Krasting's blog, May 18, 2010)

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