A serious response to the S&P downgrade

The Unablogger

The Standard & Poor’s downgrade of U.S. debt is a genuine wake-up call. The country is in deep financial dodo. We need to get serious about enacting government policies that will right the ship.

S&P stated that the downgrade was issued, even after the much ballyhooed deal to raise the debt ceiling and reduce the deficit, because of (1)  the nation’s continuing budget deficits and climbing debt burden and (2) the political gridlock in Washington.

The first problem, of course, is that the government is spending more than it takes in. A lot more. In order to reduce the deficit (and ultimately, the debt), the U.S. must either increase revenue, reduce spending, or do some of both. President Obama and Democrats in Congress (notably in the Senate where they hold the majority) propose to increase revenue via tax increases. while Republicans in Congress (notably in the House where they hold the majority) propose to reduce government spending. Their disagreement produces the second problem – the gridlock.

The Democrat policy is flawed because it is based on the fallacious assumption that higher taxation automatically generates a proportionate increase in revenue. The problem is, higher tax rates act as a disincentive for business expansion, consumer spending and job creation. Those in turn result in less income subject to the higher rates, reducing or even eliminating the assumed gains in government revenue. The Heritage Foundation points out that tax revenues correlate with economic growth, not tax rates. Since 1952, the highest marginal income tax rate has dropped from 92% to 35%, and tax revenues have grown in inflation-adjusted terms while remaining constant as a percent of GDP. Democrats temper their tax increases by proposing to increase taxes only on “the rich.” Unfortunately, “the rich” includes most of the employers whose employment decisions are impacted by tax rates. Heritage notes that tax changes favoring “the rich” create growth better than tax cuts favoring low- and middle-income taxpayers. The other side of that coin dictates than tax changes targeting “the rich” will harm economic growth more than tax increases targeting low- and middle-income taxpayers.

Democrats in the debt debate have tiptoed around actual tax rate increases by proposing the elimination of certain deductions (e.g., the President’s rhetoric about corporate jets). But, as with tax rates, that policy’s  impact on related employment and other tax-generating activities needs to be considered carefully. For example, the 1993 tax increases included an excise tax on yachts that sharply reduced yacht sales and led to loss of jobs in the yacht building industry. Current Democrat proposals to cap itemized deductions for the wealthy would effectively eliminate deductions for home mortgage interest and charitable donations by the very people who can afford to make such personal expenditures. That in turn would further harm a housing industry whose slide helped precipitate the Great Recession, and reduce the resources available to charities at the very time they are needed most.

The Republican strategy of cutting government spending is more sound. Eliminating the trillion dollar Obamacare boondoggle (which a clear majority want Congress to do) would be an excellent first step. While Obamacare repeal wouldn’t save its entire trillion dollar cost because of the need to restore the Medicare cuts that Obamacare imposed, the net savings would be significant. A smaller but symbolically important gesture by the President would be to reduce expenditures on his personal staff. Former Clinton adviser Dick Morris notes that pay increases to the President’s top 20 employees increased this year by an average of 48%. That’s unconscionable in these perilous economic times. And, of course, cut the pork.

Keynesian Democrats, flashing back to the 1960s, argue that reduced government spending adversely impacts government revenues in the same way as tax increases. Democrats liken increased government spending to tax cuts, claiming that both strategies utilize a “multiplier effect” by putting  money in people’s pockets that they spend on other goods and services. But government spending doesn’t really pump any new money into the economy, because, as the Heritage Foundation notes, government must first tax or borrow that money out of the economy. In contrast, pro-growth tax cuts support incentives for economically productive behavior. The right tax cuts help the economy by reducing government’s influence on economic decisions and allowing people to respond more to market mechanisms. Most tax increases do exactly the opposite.

Unfortunately, principled but simplistic solutions like “raise taxes” and “cut spending” are not sufficient by themselves to solve a problem as complex and as federal debt accumulated over a number of years. While cutting federal spending is a much better solution than raising taxes, spending cuts alone many not be enough. But revenue sources should be chosen that don’t negatively impact economic growth and job creation. The government can raise some revenue without taxing anybody at all by simply selling off unused or underutilized government assets, like certain office buildings and other real estate. Reducing or eliminating deductions for state and local taxes should be considered because such a policy wouldn’t really provide a disincentive for anything within a taxpayer’s control (other than the extreme step of moving to a lower taxed state or locality). The so-called “sin taxes” on cigarettes, alcohol and similar products whose consumption has not historically been adversely affected by higher cost are another avenue to explore. Another realistic conservative sacrifice could be reinstating pre-Bush levels of estate and inheritance taxation. Conservatives recently reduced these taxes on the basis of fairness, but can we legitimately argue that higher death taxes will be a disincentive to death? If so, bring it on!

The “political gridlock”part of the problem must be solved by voters in 2012. We need to turn the presidency and control of both houses of Congress over to a single political party. If a constitutional amendment (like the Balanced Budget Amendment) is part of the solution, the straight-party vote should also extend to members of state legislatures, where constitutional amendments are ratified. The personal popularity of politicians from the other party must be disregarded in this time of crisis. In order to get a government that is decisive, the voters must be decisive. One way or the other, full bore.