The two leaders of U.S. President Barack Obama's Deficit Commission Wednesday produced a proposal for deficit cuts that slaughtered a lot of budgetary "sacred cows" and cut $3.8 trillion off the deficit over the next 10 years.
And the cuts were even made in just the right ratio – with $3 of spending cuts for every $1 of tax increases.
But if there was ever a proposal that exemplified that saying "the devil is in the details," this surely is it – for everyone will find something in here that they hate.
Let's take a look at the bits that I hate – after which I'll point out the proposal's strong points, before giving the commission leaders my final grade for their work.
The Good, the Bad and the Ugly
Known officially as the National Commission on Fiscal Responsibility and Reform, the Deficit Commission was formed by President Obama early this year to identify "policies to improve the fiscal situation in the medium term and to achieve fiscal sustainability over the long run." It first met in late April.
The proposal released Wednesday was crafted by the commission's two co-chairmen, and is now slated for review by the rest of the members of the panel.
They've been given a daunting assignment. In the wake of the biggest financial crisis since the Great Depression, the U.S. federal government is looking at running $8 trillion in deficits over the next 10 years. If that forecast becomes a reality, the already-onerous national debt would soar to more than $20 trillion. And even if the panel's proposals were adopted without change, the United States would still be looking at deficits of $350 billion a year.
The $3.8 trillion deficit-cutting plan the commission unveiled this week would pare Social Security and Medicare, would eliminate tax breaks (including the popular mortgage-interest deduction), and would cut income-tax rates.
As proposed, the Deficit Commission proposal would slash the annual U.S. budget deficit from $1.3 trillion this year to roughly $400 billion by 2015 and would start reducing the $13.7 trillion national debt, according to a Bloomberg News report.
The plan only reduces spending to 22% of gross domestic product (GDP), which means that federal outlays will remain substantially higher than the historical norm of 20%. At the same time, the plan calls for taxes to increase to 21% of GDP, significantly higher than their historical level of around 18%.
Thus, the bad behavior that's been a hallmark of the White House and Congress of the last decade is to some extent set in stone, even if some of the excesses of the last couple of years are removed. That's partly because the proposal does nothing about the "Obamacare" healthcare legislation, which very clearly will add an amount equal to at least 1%-2% of GDP to federal spending by 2020.
I can understand why the panel didn't touch Obamacare: It's too much of a political hot potato, and Obamacare does provide some clear benefits in terms of increased coverage. However, there's no question that big savings could be achieved by bringing the free market more fully into healthcare, and that hasn't been done.
Conversely, the Deficit Commission's work on taxes is almost wholly admirable. It gives three options, each of which has the effect of reducing both tax rates and deductions. That would push the current U.S. tax system back towards what we had immediately after the sweeping Tax Reform Act of 1986 – which I still believe was the single-best piece of tax legislation that I've seen in my lifetime.
The home-mortgage-interest deduction is economically very damaging – as we more or less proved in 2002-06 – since it diverts capital artificially away from productive enterprise and into unproductive housing.
The employer deduction for health insurance premiums is also damaging from an economic standpoint. But if you're going to abolish it, which increases costs, you need to make major changes in the healthcare system to remove the cross-subsidization, restrictive practices and legal leeching that makes this country's healthcare the most expensive in the world.
The Deficit Commission's proposals on the capital-gains tax and the dividend tax are just plain wrong.
The proposal calls for the capital-gains levy to be increased to 28% and dividends to be taxed as ordinary income. Since dividends are paid out of income that has already been taxed at the corporate level, their tax should be reduced to zero – or, better, dividends should be made tax-deductible from corporate income. As for the capital-gains tax, 40 years of experience has demonstrated conclusively that the revenue-maximizing level for this is 20% – and no higher.
The commission makes proposals that would cut spending by $200 billion by 2015. Cuts to achieve this would include a 10% cut in the federal work force and a $3 billion cut in farm subsidies.
That's fine, but it's only a down payment on what's really needed.
The Road We Need to Travel
There is no earthly reason why the federal government should not be expected to live on the 18.2% of GDP that it absorbed in 2000, at the end of a two-term Democrat presidency. Therefore, getting the federal expenditure down to 22% of GDP – as the Deficit Commission proposes – is a hopelessly un-ambitious target.
To get that additional, needed 3.8% of GDP – we're talking about roughly $550 billion annually – all we should have to do is apply good management and be willing to excise some of the foolish excesses of the past decade.
With Social Security, the commission proposes two changes:
- To increase the retirement age to 68 in 2050 and 69 in 2075.
- And to fiddle – yet again – with the consumer price index (CPI), using a "chained" index to adjust Social Security payments.
That last gimmick is just that – and it's flat out just a plain rip-off that, far from overstating inflation, actually understates it.
Since 1980, the CPI has not accounted properly for housing costs. Since 1996, it has included a "hedonic" adjustment that accounts for the (overstated) consumer benefits from increases in computer processing power, but not for the consumer costs of automated-telephone-answering systems, misguided computerized billing processes and similar price offsets.
Using a chained index for Social Security adjustments consistently underestimates the impact of inflation – which over time will put the country's senior citizens in a financial squeeze.
At the same time, however, since we are raising the retirement age by a month a year currently, getting to 67 by 2026, why not continue doing so, making the retirement age 68 in 2038, 69 in 2050 and 70 in 2062? Doing this would solve Social Security's funding crisis in perpetuity, rather than just over the artificial 75-year accounting period used by the government actuaries.
If we grade the area of Medicare/Medicaid, the Deficit Commission clearly and completely flunks. It proposes setting cost goals for those programs to kick in after 2020, and then sets price goals to meet those cost goals. That won't work, because it will move the medical system further towards government micromanagement and further from the market.
A complete review and retooling is needed on the U.S. healthcare system, but that's very unlikely to occur under the present political configuration.
So where does that leave us?
The Deficit Commission's proposals don't solve the U.S. budget problem entirely, but they do make considerable progress towards solving it. The concern here is that Congress – in its usual fashion – will take only the commission's bad ideas and neglect the good ones.
For example, I'd be willing to wager that we don't get lower marginal tax rates out of all this.
But overall it is a start.
So let's give it our final grade – a solid "B-minus."
[Editor's Note: If you have any doubts at all about Martin Hutchinson's market calls, take a moment to consider this story.
Three years ago – late October 2007, to be exact – Hutchinson told Money Morning readers to buy gold. At the time, it was trading at less than $770 an ounce. Gold zoomed up to $1,000 an ounce – creating a nice little profit for readers who heeded the columnist's advice.
But Hutchinson wasn't done.
Just a few months later – we're now talking about April 2008 – with gold having dropped back to the $900 level, he reiterated his call. Those who already owned gold should hold on, or buy more, he said. And those who failed to listen to him the first time around should take this opportunity to remedy their oversight, he urged.
Well, we all know where gold is trading at today – at about $1,410 an ounce.
For investors who heeded Hutchinson's advice, that's a pretty nice neighborhood.
Investors who bought in after his first market call are sitting on a profit of as much as 83%. Even those who waited, and bought in at the $900 level, have a gain of about 60%.
But perhaps you don't want just "one" recommendation. Indeed, smart investors will want an ongoing access to Hutchinson's expertise. If that's the case, then The Merchant Banker Alert, Hutchinson's private advisory service, is worth your consideration.
For more information on The Merchant Banker Alert, please click here. For information about Hutchinson's new book, "Alchemists of Loss: How Modern Finance and Government Intervention Crashed the Financial System," including how to purchase the book at a 34% discount, please click here.]
News and Related Story Links:
- Merchant Banker Alert:
Official Website. - Bloomberg News:
Deficit Plan Matches $3.8 Trillion Math With Tough Politics. - Money Morning News Archives:
Obamacare News Stories. - FiscalCommission.gov:
Official Website of the National Commission on Fiscal Responsibility and Reform. - Wikipedia:
Perceived Underestimates of Inflation. - Money Morning Investment Research:
When Investing in Latin America, Politics Point the Way to Profits. - Wikipedia:
National Commission on Fiscal Responsibility and Reform. - Wikipedia:
Tax Reform Act of 1986. - Money Morning:
Author Chat: Money Morning's Martin Hutchinson Talks About "Alchemists of Loss"
Healthcare – at least emergency care cannot really be a free market option. If you are in an accident, are barely conscience and have internal bleeding; how are you to reseach the available hospitals and doctors in this situation?
I disagree with your thoughts on medical. The private sector has shown what iut can do and that is to charge whatever the traffic will bear. Even to the point of self extinction. We have seen how good the banking sector is , and in the medical area of pharmaceuticals, aren't they great? When the citizens of this country are forced to pay many times more than whaty is charged in other countries, you know something is wrong.
It would appear that the customers in the U.S. are expected to cover the R & D costs for new drugs. The funny thing is that many of the pharmaceuticals are foreign companies. With the drug insurance at least most people are sheltered to enough of a degree that the high prices are not important to them.
All in all, I have lost faith in large corporations to do what is best for the U.S.A. The ones that were thought to be too big to fail, failed. Who bails them out? If it wasn't for the outrage, who would have been paid performance bonuses out of bailout money? I am sick of the corporations being allowed to rape and pillage.
On the other hand, I am against differentiation of income sources for tax purposes. Why should income I EARN investing be taxed any different than income I earn sweeping the factory floor? Why force corporations to pay income tax? Where does the money go if a corporation does not pay income taxes? Income taxes should at least try and be honest, but tax should only apply to the end of the line. Corporations will either reinvest the cash (a good thing) or increase dividends (also a good thing) , raise the pay to employees, not bad, or even reduce consumer pricing. (Wanna bet?) But in any case, a tax will be paid somewhere along the line and there will be no reason for corporations to worry about tax dodges except at the executive levels where their personal income tax bill would probably go up.
As you stated, we all will find items in here that we do not like. That is why it will fail miserably. Congress is utterly incapable of solving this issue — they cannot even agree on a simple thing like raising the retirement age. How will they make any of the really hard decisions.. especially considering the disparate views of the two parties on everything… and the tendency to worry more about elections than solving important issues. The only way to solve this is to put teeth in it — force it through law. Either through a deficit reduction commission that congress has to vote up and down in its entirety (ie… closing military bases type commission – which worked brilliantly).. or a balanced budget amendment – which although extremely difficult, is probably where we are heading. We will have to drop off a cliff first, and then the will to put some kind of controls in place that protect congress from itself will finally be put into place. Unfortunately, we have to go through a lot of pain first.
Martin
The housing implosion was mostly caused by government mandates via CRA, Freddie and Fannie to lenders to approve mortgages up to 120% LTV despite the borrower having no demonstrable source of repayment, no established history of a willingness to repay their debts (no credit or poor credit history), and zero down payment. That irrational loosening of credit standards for housing is completely ignored by you as you claim the "home-mortgage-interest deduction is economically very damaging-as we more or less proved in 2002-2006 since it diverts capital artificially away from productive enterprises and into unproductive housing."
How convenient for you, a marketer of supposedly "productive enterprises" to disfavor "unproductive housing." Clearly, your bias has you either unaware or unconcerned that for the vast majority of non-investor class Americans, their investment in their home is the only significant investment they have. Your instinctive and self-serving summary approval of the proposed elimination of the home mortgage deduction is bad enough but when you attribute justification for supporting this financial rape of the non-investor class to something supposedly "proved" that was in fact, not proved at all, you lose all credibility.
Hasn't the private market had every chance to lower healthcare costs with no success? How can the private market lower costs when its prime objectives are profit and unduly high compensation for its executives ? Also where is your support for the statement that the recently enacted health legislation will increase costs? You will have to provide more details to convince me.
I would be hard-pressed to give it a grade above a 'C.' For starters, one major flaw is that it sets the propsed level of confiscation by the Federal government at 23% of GDP. This is too high; we should look at spending reforms first. After all, if you know you are spending more than you earn, which do you do: Increase your income, or reduce your outflow? Since we cannot, as a nation, immediately increase our income, we need to start on the other side of the program: Reduce outflow. A more correct amount of reduction would be the elimination of most of the executive-branch departments, the organized sale of ALL federal lands to the highest bidder, elimination of restrictions on land ownership, and a reduction of 95% (yes…95%) of the Federal civilian workforce. And this is just part one.
Notice that the National Defense Budget is one of the sacred cows that wasn't touched.
Why we still need troops in Germany, Japan, and South Korea is beyond me not to mention all the US military bases across the globe.
How about the $3 Billion which we send to Israel year in year out?
Retirement increased to 66 years causes Medicare to begin earlier at 65 years. I found this to be a knightmare that Social Security is not properly prepared for. I believe Medicare should also be increased with the retirement age which is now 66. Wouldn't this save government money and make the process a smooth one. I don't plan on using Medicare anyway, it is my domation to those who need it.
WE THE PEOPLE just ran over the Dumbocrats like a freight train hitting a pop can. If the Repubelicrats raise the age to collect SS we will do EXACTLY the same to them in 2012.
It is time for our elected representatives and ALL employees of goobermint at every level from the local dog catcher to the president to get EXACTLY the same retirement plan as every other American: Social Security and a 401k with 3% match. Nothing else. When that happens those pitiful sacks of excrement will create a system that works. Ditto medical benefits, vacation, etc, etc, etc.
This is at best a weak plan and falls far short of the mark. Our nation is in grave danger.
The home interest deduction did not cause the housing crisis. Outrageously irresponsible gov't policies (aka Barney Frank) managed to cause that single handed..
The elimination of the home interest deduction should only be entertained with the implementation of a lower, fairer flat tax. In that case. homeowners would not need an interest deduction ( or any deduction) if the tax rate were 10-15%.
This deficit reduction program smells, looks and feels like a tax increase!!!
Freeze current spending. Eliminate all deductions and set a flat rate starting at $30,000. Reduce spending 2% every six months until the deficit is eliminated then maintain until debt is eliminated.
Privatize SS. Raise retirement age to 70 for those born after 1965; same for Medicare. A portion of the Medicare tax goes into an HSA. Those with private accounts and HSAs can retire at any point the account has a value of $1,000,000 or more.
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[…] taxes to 21% of GDP, significantly higher than their historical level of around 18%," Hutchinson wrote in a column that appears elsewhere in today's issue of Money Morning. "Thus the Presidential and Congressional bad behavior of the last decade is to some extent set in […]