Face the Music

James Macdonald

Feb. 21, 9:31 a.m.

One aspect of the US debt problem is that Congress has strong positive feed backs for spending, and little negative feedback.  Making little changes around the margins will not correct the tendency of Congress to spend more and more. We must change the motivations that drive congressional spending. 

The current tax and budget system rewards high spending members of the legislature that vote for more spending than low spenders.  The high spending members achieve positive press by supporting new spending, the approval of their political contributors, and “bring home the bacon”.  This increase in spending is paid for with increased taxes by all citizens, not just the local district and contributors that put the representative in office.  This lack of linkage between spending by a representative and the district tax rate rewards high spending representative’s districts, and other representative’s districts unfairly suffer the high tax rate with less of the high spending benefits.

This imbalance could be corrected with a tax system in which the personal and corporate tax rates would adjust such that districts of high spender representatives would pay a higher rate than an average district.

The legislative record of votes on spending bills would provide the required spending information.  This would require that all spending bills be passed by recorded vote, not with a voice vote.  It would also require that the all of the government spending be subjected to an annual vote, or at least every two years so as to match the election cycle. To fully capture spending, votes to approve tax deductions, refunds or any other changes to the tax code resulting in a reduced tax due to the treasury should also be included in the representatives total spending. The sum of each representatives voting would provide their total spending, and the average of all the members numbers would provide an average spend per representative. 

If a member’s vote record matched the average, the tax rate for the district would remain unchanged at 100% of the stated tax rate.  If a member voted for 50% more spending than average, the district tax rate would be changed from 100% of the stated rate to 150% of the stated rate. With the US Congress, the district rate would need to reflect the House representative and both senators.  Districts that value high government spending would be willing to pay a higher tax rate and send high spending members to Congress.  Districts that value lower tax rates over higher government spending could send members that reflect their wishes.

The district representative adjustments would reset each tax year, and the adjustment for each House and Senate member would be clear and separate line in the tax form.  The rate would be based on the average for the representative for the years from the last election cycle. The tax rates would be computed on the votes for spending from October to the next years September, and announced on the second week of October, so as to be known to the voters prior to the elections. 

This proposal if adopted should change the motivations of our representatives, making them more sensitive to high levels of spending.

I am just trying to get what I think is a valuable alternative idea injected into the mix as the discussion of how to balance the budget evolves.  The question is would taxing districts of higher spending representatives at a higher rate have the effect of reducing spending? If it would work, what advantages would it have over other policies? The US constitution has been amended many times. It is not easy, but can be done.  A balanced budget amendment is what some see as a solution. Would this be a superior alternative?  I do not know, but if the concept is made public, considered, challenged, and compared to other plans in open debate, we will know. If this idea of proportional taxation never sees the light of day, it will have no impact.
I took a look at the US constitution. The sections on tax and equal protection are

Article 1, Section. 8. Powers of Congress
The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States;

Hum, they forgot to say tax in the second half.  Does that mean that taxes do not have to be uniform?  If taxes have to be uniform, then our current income tax with multiple rates and deductions would clearly be in violation. Is the current federal income tax unconstitutional?

Amendment 14 Equal protection
1. All persons born or naturalized in the United States, and subject to the jurisdiction thereof, are citizens of the United States and of the State wherein they reside. No State shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States; nor shall any State deprive any person of life, liberty, or property, without due process of law; nor deny to any person within its jurisdiction the equal protection of the laws.
The states have to allow equal protection to every citizen.  But the states already have tax codes that tax incomes at different rates, and deductions for some activities and not others. Are the current state taxes unconstitutional?
Amendment 16 Income tax
The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration

So, incomes can be taxed.  We have to avoid apportionment or the use of census counts.  To my non-lawyer eye, it does not say everyone has to pay the same rate.  But wait, ever one already does not pay the same rate. We charge higher rates at higher incomes, deduct home mortgage interest but not other interest, and so on. Why not set rates based on districts representatives spending votes?

This is written from the perspective of US national government.  It could also be applied to state government, or any governmental unit worldwide with local district representation.

Bernardus Pottker

Feb. 15, 3:27 p.m.

Indeed a very interesting article.  Mentioning all these great economists of the past brought back good memories. The souvereign debt crisis in Europe and the US will indeed more-or-less bancrupt us, as the article seems to imply. I agree with most of the analysis/conclusion but I have only one problem and that is with the end, where Ms. Hunt predicts continued low interest rates. It may be that she means in “real terms” and then I will agree.  However, with the continued increase of money created by the FED and a basically stagnating economy, you rightfully predict a decrease in the velocity of monney.  However, it could well be that inflation is on its way as well. If more and more money decends on an essentially constant GDP and the velocity doesn’t fall proportionally, then there is only one way for prices to go: up which means “inflation”. 
Also, if you take a closer look at the Long T-Bond interest rate (the table at the end of the article), there could be another interpretation. From 1929-1979 interest rates wemt from a “top” in 1929 and again to a “top” in 1979.  This is exactly the length of the Kondratieff Cycle. Threfore, it could well be that we are reaching the bottom of this cycle again about now—-it may actually be that this time the cycle may be a little longer because “too many problems have occurred” in the last 15 years (tech-collapse 2000/1; financial mortage and derivatives crisis here in the uS in 2007/8 and now the European Souvereign debt crisis 2009/12?). “Fiancial Innovation” may have helped to stretchthe cycle a bit.  So, while I agree that we may have a little longer the low rates that we see now, we may have a “jump” in 2013/14 when we come at the end of the trough..
The enormous inflation of the 1968-1979 period wiped out a lot of debt (I remember borrowing 12 times my salary in 1972, to buy a house of $130,000, when the “average” house cost $30,000.  My house was worth >$1 million in 1990. I sold in 1993 for $850,000) This period laid a base for future growth in the period 1983-2000—-particularly helped by the disastrous “financial innovation” which has created several booms/busts. In my opinion we are at the frontdoor of inflation and high interest rates again.
Bernardus H. Pottker,
Scottsdale, AZ

Nick Jacobs

Feb. 15, 11:09 a.m.

Dr Hunt said:
“...that’s why you hear it said often that one of the solutions is to inflate our way out….
But I don’t think you can do that because your debt is 350% of GDP. If you get an inflationary process going, interest rates will rise proportionately with inflation. So, if inflation goes up 1%, in time, interest rates will go up 1%.... your interest expense is going to rise proportionately with inflation.”

I don’t understand this at all, because if the government is willing to “inflate our way out”, it can simply create enough dollars to pay off its debt entirely. Government debt is then zero. Its interest expense on the debt is then also zero, regardless of what interest rates might be.

Private debt is slightly different - it cannot just be set to zero by government fiat - but in an inflationary environment, everything (wages, prices) tends to go up in nominal terms, remaining the same in real terms. The practical effect is to reduce consumer debt in real terms. Think of somebody who bought a luxury house in 1970 for $20,000 with the help of a $15,000 mortgage at 5%. The 1970s were years of high inflation. By 1980, the same house would be priced at probably $100,000 to $150,000, the owner’s salary would have gone up from $5,000/year to $40,000/year,  and mortgage interest rates had certainly gone up - to about 11% if I remember correctly. But the real value of the principal, $15,000, had been inflated away, so that the impact of the mortgage payments would be much less, not more, than when the house was bought. High inflation is, on balance, very good for people who have a lot of debt.

Gerald Ferguson

Feb. 14, 3:57 p.m.

I agree with Bob Salsa comments. He understands the difference between Euro users, American states with money beyond their individual control, vs. the fiat system of the US, Japan, Canada and China, for example. Private debt in our low employment climate is the real problem, not the federal debt (actually a construct of Congress, left over from the Gold standard), something our politicians do not seem to know.

Willis Smith

Feb. 14, 11:19 a.m.

There will be great misery and suffering in the years ahead, because the American people will not support doing what needs to be done until the crisis is overwhelming.  Greece is a microcosm of what is in store for all of us.  During the depression a lot of people still lived or near a farm where they could get sustenance.  That is no longer the case.  Expect massive civil unrest.

Paul Innes

Feb. 14, 10:42 a.m.

It is great to read this.  But ... Are our Congressmen also getting it?  I hope you are sending your eletters to them. 

Thanks for yourwork, John.

Bob Salsa

Feb. 14, 10:14 a.m.

Going even further than Craig’s recognition that it is private debt as the problem –

It is clear the author is living in pre-1971 and doesn’t understand the difference between non-federal debt (private sector plus state/local govt) and the “debt” of a monetarily-sovereign entity like the US govt that owes it debt entirely in the currency that it has a monopoly to issue. Like with Japan (but not like Euro-nations), monetarily-sovereign nations do not pay off their debt, they roll it over. The US rolls over its entire “debt” 4-5 times each year to more than willing buyers - with the exception of the idiocy of Andrew Jackson, the US always has and always will.

The only concern for federal deficit spending is the degree it adds aggregate demand to the economy - too much, you get inflation; but too little, you get deflation. That is true today and that will be true tomorrow. The legacy of the ongoing federal debt is the interest payments - in the future, that can be a problem if it adds sufficient demand to cause inflation - the solution to that is to increase taxation to destroy money circulating in the economy until inflation is mitigated.

However, interest payments on the federal debt may be a godsend in a future where deflation is a problem (such as now). If one knows what the economy needs (further federal spending or further federal taxing) in 20 to 30 years from now, then one shouldn’t be wasting their time on speculating about the distant future, but becoming super rich by just pinning down where the markets will close tomorrow.

It is all well and good to study and apply Fisher, Minsky and other great minds to non-Federal debt that was the cause of Great Recession and Financial Meltdown of 2008; we are still living with the aftermath of household deleveraging that debt and businesses sitting on cash rather than investing in supply because of decreased demand.

However, it is extremely damaging to our economy and society to pursue policies that treat the federal govt as a household or a business. It is not. This is not rocket science. It does not require a huge intellect to “get it.” It requires an emotional ability to challenge and rise above a nearly-genetic, but still false and harmful, belief that all debt is the same.

Craig Cheatum

Feb. 14, 7:54 a.m.

Looking at Chart 1 it seems that the private sector debt has been the driving force since 1940-1950, with a significant acceleration since about 1980.  The government is just along for the ride and not a controlling factor in debt or GDP growth.  Government debt as a percent of GDP has been relatively stable since 1960, except in the last few years where the emergency stimulus has been applied to soften declines in the private sector.  Private sector debt passed 100% of GDP around 1960 (now over 300%), whereas the government is just now approaching 100%.  The problem has been in the private sector since 1960, but I guess it’s easier to blame our problems on the government beacause of the last few years.  Any analysis on the smallest part of the problem (government) is going to give miss-leading results because of the low cause and effect relationship.  I don’t like the government debt at all, but that’t not where the big problem is, and I’m not aware of any reason why the governemnt is stalling the recovery by diverting available funds from the corporate sector.  The financial sector has become too large for our economy and needs to be reduced in size significantly. How do we do that?  I don’t know.  We could probably start with reversing mark-to-model FASB accounting back to mark-to-market (which was in effect prior to April, 2009) to force financial institutions to properly account for their “bad or risky” assets by pricing them at market prices (probably some extensive liquidation).  We could come up with a way to determine the market value of outstanding derivatives.  We could also follow some of Lacy Hunts tax ideas, like eliminating homeowners interest deductions.

Craig Cheatum