CPA Blog

What the Tea Party has achieved that the Axis Powers couldn’t …

In 1941, the US was put on a watch for a credit downgrade.  The obvious reason being a world war and the need to determine how it would progress.  Despite having debt grow to 110% of GDP, rampant inflation, huge government expenditures on the war, the US wasn’t downgraded. 

Over the last few years, I have become increasingly annoyed with the Tea Party, Conservatives, and the Republican Party in general.  Over the last three years we have seen a political party that is more concerned with bringing down a president than doing what is right for the country.  Some may dismiss me as a partisan hack, but the facts are facts. Simply look at how many filibusters have occurred since 2009.  Listen to the Republican leaders who talked about their first priority is defeating Obama in 2012.  If it means they have to destroy the economy in the process, what do they care?

 The fact of the matter is that the downgrade on Friday by S&P is a direct result of the Tea Party Republicans to work with the President and the Democrats.

Read the report here:

http://www.standardandpoors.com/servlet/BlobServer?blobheadername3=MDT-Type&blobcol=urldata&blobtable=MungoBlobs&blobheadervalue2=inline%3B+filename%3DUS_Downgraded_AA%2B.pdf&blobheadername2=Content-Disposition&blobheadervalue1=application%2Fpdf&blobkey=id&blobheadername1=content-type&blobwhere=1243942957443&blobheadervalue3=UTF-8

While there is a discussion about the medium and long term debt situation, the credit downgrade and the potential future downgrade in the next two years is related specifically to the inability of the government to develop a workable solution.  They also cite specifically the use of the debt ceiling as a “bargaining chip” and the “brinkmanship” we saw last month during the debt ceiling debate.  Obviously, when you have congressional leaders holding press conferences talking about a default wouldn’t be a big deal or in some cases actually hoping for a default that does nothing to inspire confidence in bond holders.

The whole reason for the downgrade is because the Tea Party and Republicans live under the delusion that we have to keep lowering taxes and that we cannot increase taxes on anyone.  Had the Republicans voted for the so-called “grand bargain” that would have reduced the long term deficit by $4 trillion dollars.  It would also have given the markets the confidence that the government has the capacity to deal with the long term debt issues and this first ever downgrade in US credit would not have happen.

A revenue number that we thought we could reach based on a flatter tax code with lower rates and a broader base.  That would produce more economic growth, more employees and more taxpayers. 

John Boehner July 22, 2011

At the press conference on yesterday Speaker John Boehner made this comment when discussing his reasons for “walking out” on the debt ceiling negotiations.  I bring this up because I found it particularly interesting.  It reminds me of a comment by an Economics professor that I have never forgotten:  he stated that the purpose of political parties was to redistribute wealth to its constituents.   It didn’t matter if it what they called it, but the bottom line is both parties redistribute wealth to their constituents.

Take a look at what Boehner is saying:  he may claim he doesn’t want to increase taxes, but that is only partially true, what he doesn’t want is to increase taxes on his constituents the wealthiest households in the nation.

In 2007, 97.1% of taxes were paid by the wealthiest 50% of the nation.  That is people making over roughly $32,000 per year.  According to the Tax Policy center approximately 45% of households paid no income taxes.

http://www.taxpolicycenter.org/publications/url.cfm?ID=901335

However, they do pay other taxes (Social Security and Medicare pay roll taxes).    The reason I mention this is because look at what Boehner is saying, he wants “flatter” taxes with a “broader base.”

So let’s see what would happen with a flat tax system.  The taxes on the lower income households would have to go up and the higher income households would go down.  In a perfectly flat tax system households making less than $32,000 that comprise 50% of households would have pay their “fair share” of 50% of the tax burden up from 3% under the current system.  While, I don’t think Boehner would propose a perfectly flat tax system, any “flattening” of the current system will necessarily mean that taxes for the wealthy will go down and for the middle class and poor will go up.

As a CPA, I will tell you that the tax code is in need of reform and cleaning up.  We haven’t had a major reform of the tax code in 25 years and it is about time; however, one constant of the tax code since its inception in 1913 was its progressive nature in that those people with the higher incomes paid a higher percentage on their marginal income. Currently, the highest marginal rate is 35% that doesn’t mean people pay a 35% tax on all their income, but they pay 35% on their last taxable dollar earned.

Make no mistake, the Republicans are about reducing the income taxes and steering government benefits to their constituents just like Democrats are about steering lower taxes and government benefits to their constituents.  The only real question is what benefits the US economy the most.

I am hoping that the grownups will actually prevail in Washington and that the Debt Ceiling will be raised and avoid the calamity of a first ever default on the US Debt.  Having seen the Republicans travel this partisan obstructionist road during the 1990’s and the last two years, I am not so sure.

Recently, Obama is quoted as saying that Social Security checks are in danger.  Many are claiming it is a scare tactic, and perhaps they are correct, but it is a scare tactic based on reality.  On Aug 3 the government is projecting to bring in $12B in revenues and Social Security payments for that day are projected to be $23B.  So if you can’t borrow where do you get the money from?

The Bipartisan Policy Center and PBS Newshour have put together a day by day analysis of the month of August that is rather interesting

http://www.pbs.org/newshour/rundown/2011/07/the-debt-ceiling-crisis-day-by-day-blow-by-blow.html

So tell the Government to cut back like we all did during the Great Recession

Even if we ignore the day to day consequences, the simple fact is that 44% of the government spending is financed (not paid for with tax revenues).  According to a CitiBank analysis a 44% cut in government spending could result in an almost immediate GDP loss of 8-9%

http://www.huffingtonpost.com/2011/07/13/wall-streets-warns-congress-debt_n_897472.html?1310586684?igoogle=1. 

To give you a little scale the worse the economy did during the Great Recession was -4.1% during the Q2 2009.  We saw close to 10% unemployment at that time.

http://www.data360.org/dsg.aspx?Data_Set_Group_Id=274

The economic contraction will cost us and the federal government much more than the additional interest on a couple trillion more in debt.

So what happens if the government defaults:

US Treasuries are supposed to be the safest investment on the planet and if the US defaults that means EVERYBODY’s interest rates will increase.  It means that credit will dry up again. 

Without credit a modern economy stops functioning.  In the fall of 2008 GE couldn’t get overnight financing, and there were rumors that McDonald’s was having a hard time securing financing.  We will have a worldwide financial crisis the likes of which have never been seen in our lifetimes, if ever.   The result will be a massive Depression that will take decades to recover from.  This is what the Republicans, or more specifically the Teaparty Republicans, are trying to do.

Imagine and 8-9% contraction of the economy during the next 3 to 6 month period.  The pitiful recovery that we have now sputtering along would stop immediately.  Just as in 2008 the collapse of Bear Sterns brought down Lehman Brothers and then Wall Street, we would see other countries default and then banks.  If CitiBank or Bank of America had a bank run there would nothing the Federal Reserve or the FDIC could do to save them.  Remember the scene from It’s a Wonderful Life where George Bailey has to rescue his Savings & Loan with his honeymoon money?  Imagine that repeated in every state and every city, but with no Mary Bailey offering $2000 in cash to help everyone get by until the bank reopens.

You may say that I am using “scare tactics” or exaggerating, but this actually did happen in the 1930’s resulting in Banks being completely shut down for 10 days. 

So what is the solution?

Beats Me.

I think that in the long run (5 or more years) we need to have the government do more to help control the costs of healthcare.  It has a powerful leverage in the form of Medicare.  I also believe that by making Medicare available to everyone (not just the over 65 crowd) we could offer effective competition to the major insurance companies to help reduce costs.

We (the 40 somethings and younger) are going to have to accept that we need to work a few years longer and have a little less social security to help pay back the Bush spending spree.

Personally, I think eventually you will see the social security tax extended to all wages, not just the first $106k in wages.  I also think ALL the Bush tax cuts should expire.

We need to reduce our military spending.  The Soviet Empire is gone and the Cold War is over.  We need to get out of Iraq and let the Afghans take responsibility for their own country.  I am not suggesting we abandon Afghanistan, but certainly there are better ways to spend $200 million per day than on a large military footprint.  Historically, the US has always demobilized after a war, which allowed us to focus on industry and technological development.

Right now we need to try some good old fashion Keynesian economics.  The problem with the economy is that nobody wants to spend.  So we need the government to step in as a spender of last resort.  Right now the government should be rebuilding the roads and energy infrastructure with all the cheap labor and low interest money that the government has available to it. 

Think about this:  the government interest rate is nearly 0 despite having the highest debt to GDP ratio since WWII, and now some in Congress want to trash it’s credit rating.