"A Focus on Growth - The Best Way to Rid the Deficits"

Sydney M. Williams

Thought of the Day

“A Focus on Growth - The Best Way to Rid the Deficits”

December 14, 2010

It is remarkable, in the quest by both political parties for reducing budget imbalances and lowering the deficit, how little emphasis has been spent on increasing economic growth. Even the current tax deal – should it pass – is only temporary. Businesses cannot invest based on a tax policy that expires in two years. The deficit commission and most Republicans emphasize spending reductions and tax cuts. Democrats want to raise taxes and increase entitlements. A focus on sustainable, long term growth – the real generator of both income and tax receipts – has been largely missing. In addition, the rapid expansion in entitlement spending, which comprises almost 60% of the federal budget, must be addressed before we are smothered.

Inhibitors to growth over the past few years include the explosion in both public and private debt and the recent (financial crisis induced) extraordinary increase in government spending, with a corresponding decline in federal receipts, due the recession. The latter should be a temporary phenomenon; it is the former that risks becoming part of the fabric, especially that part of it related to entitlements.

Total debt – household, corporate and public – approximates $45 trillion, or more than three times GDP. Corporate debt, ex financial companies, is not the problem. As the Wall Street Journal reported on Friday, December 10, non financial U.S. corporations were sitting on $1.93 trillion in cash, or 7.4% of corporate assets, a 51 year high. The consumer is improving his/her balance sheet. Household net worth, at the end of the third quarter, was $54.9 trillion, up almost $10 trillion from the first quarter of 2009, but still below the $65.7 trillion reached in the second quarter of 2007. Consumer debt peaked in the third quarter of 2008 and has modestly declined, principally led by reductions in credit card debt. The problems are two-fold: First, financial institutions need to continue the process of deleveraging – a natural inhibitor to growth; second, government spending has reached its highest level relative to GDP since World War II and must be curtailed. There is little question that the severity of the recession, brought on by the financial crisis, necessitated a pick up in temporary government spending. However, Congress, contrary to their natural instincts, will have to undergo a fiscal detoxification program.

There is no disputing that the country is on an unsustainable course. Most in Washington fail to acknowledge the tough choices that will have to be made. The role of middle-of-the-road politicians is, too often, to perpetuate the status quo, or to move in incremental steps. These people are invested in the “system.” They live off of it. These times call for radical change. What will be required are politicians from both parties who are willing to sacrifice their careers for the sake of the country – not a high probability given the narcissism that runs rampant in the halls of Congress and behind the gates of the White House.

The globalization of the economy requires recognition that emerging economies represent both potential customers and competition. Nevertheless, the U.S. has several unique advantages, which managed correctly should serve it well: it comprises a land mass third behind only Russia and Canada; it is rich in a multitude of natural resources; it has a the most diverse population of any country on earth and, singular to developed countries, its population continues to expand; it sits between the world’s two great oceans; it is the world’s oldest democracy, and it has never been occupied by a foreign country.

Mayor Bloomberg’s “withering critique” (as described by the New York Times in last Thursday’s issue) on how Congress and the White House have managed the economic recovery was on target, in my opinion. Economic recovery means encouraging entrepreneurship; it means incenting investing by lowering taxes on capital; it means encouraging corporate spending on R&D; it means encouraging trade and immigration; it means accelerating depreciation, or expensing certain capital expenditures. As Minnesota Governor Tim Pawlenty expressed in yesterday’s Wall Street Journal, it means confronting public unions who stand to serve themselves at the expense of the public. Perhaps most importantly, it means confronting the growing problems of our addiction to ever-expanding entitlement spending. Social Security, Welfare, Medicare and Medicaid consume nearly 60% of the federal budget. The healthcare plan just passed will only serve to aggravate that spending. It is inconceivable, given the size of our debt and its foreign ownership that interest rates will not be rising over the next few years, placing additional pressure on the budget.

What both parties should be looking to do is light a fire under the economy. Instead of pursuing a political agenda, fiscal policy should be directed toward impelling economic progress. Making the argument that “wealthy” Americans can afford to pay more in taxes is simply a statement of the obvious, but that does not make it right. The “equality” embedded in American Democracy is not about outcomes; it is about opportunities. There will always be those that are richer. They may work harder, or be smarter. They may be better educated, or simply have been in the right place at the right time. Importantly, they are the progenitors of jobs. Government’s role should be to ensure that all people have the opportunity to move up and down the economic and social ladder, according to their inherent abilities and work ethic. Taxes should not be about punishing one group, or a means of redistribution. Such actions encourage class warfare, a path fraught with risk. If “rich” people feel they should pay more in taxes, there is nothing to prevent them from doing so, any more than there is anything to prevent them from giving their money to charity, buying a sports franchise or building a mansion.

When considering the effect of tax cuts or increases, federal budget projections rely on static accounting; so that President Obama can stand before the people and claim with certainty that extending the Bush tax cuts for the “rich” means a cost of X billions of dollars over Y years. It’s poppycock. Static accounting does not exist in the real world. People and businesses respond to incentives. Carrots and sticks impact behavior. One of the more encouraging recent signs is the President’s apparent willingness to overhaul and simplify the tax code, a code that currently encompasses 10,000 pages and nine million words. The Code’s very cumbersomeness and complexity aids the wealthy who can afford high priced accountants to search out loopholes, but hurts the middle classes who must try to understand its ramifications on their own.

Investment is the engine of economic growth; it must be encouraged. Punitive taxes on capital returns are a disincentive to investment. Faster growth means higher tax revenues for the government. Increased tax revenues – aided by a simpler tax code with lower rates and fewer exemptions – coupled with reining in entitlement spending will put this “ship of state” on a course toward prosperity and will allow the U.S. to respond more fully to the welfare of its people and to the needs of the international community.