DEFICITS, TAXES, AND GOVERNMENT SPENDING

by Richard "Chip" Peterson, PhD, April 8 ,2010

Budget Deficit Concerns

    There is much concern about the growing U.S. budget deficit. There are reasons to be concerned since, as our indebtedness to other countries grows, we become more dependent upon them to provide us with future financing. This means that they may be able to hold our international and domestic policies hostage to their willingness to provide us with future financing (for instance, China may ultimately demand that we discontinue our supportive relationship with Taiwan as a condition for continuing to buy our government debt). It also means that, at some point, foreign nations may decide our government debt is too risky to buy unless it carries a very high interest rate--which in itself will help increase our budget deficit and increase the probability that we may default upon some of our governmental debt obligations--including, perhaps, promised social security payments. 

    As we continue to increase our budget deficits and our total government debt outstanding, pressures will grow for the Federal government to effectively "default" upon its debts. It can do so in any of several ways. First, if the government allows the currency to inflate, it will increase its tax revenues and reduce the real burden of fixed-rate debt repayments. That is the most common way that governments reduce the burden of their indebtedness, but inflation sorely hurts people who have not anticipated it, and also causes the price of imported goods to increase. Second, the government may change the terms on debts that are not formally guaranteed. Since social security is adjusted for inflation, social security obligations can only be reduced by reducing the real amount that the government is willing to pay. This can be done by raising the retirement age so people will receive less social security before they die, or by reducing promised payments relative to the amount that people have paid  in social security taxes (already, high income earners receive benefits that increase only by 10% of the amount that their social security average annual contributions increase), or by taxing more social security payments (already, the highest income earners pay taxes on 85% of the social security payments they receive, even though their previous contributions to the social security fund were made on an after tax basis--in the future, either the income level required to pay tax on social security benefits could be decreased or taxes could be applied to up to 100% of social security benefits), or by means testing social security so only tne poorest people would receive social security benefits. Similar cuts could be made in other non-guaranteed government obligations--for instance, deductibles could be increased for higher income earners under Medicare and their premiums (which already may equal several times the premiums paid by lower income earners) could be increased still more. Third, as a last resort, the government might formally default and refuse to pay interest and principal on its formal debt obligations as scheduled. While government debt defaults have primarily been used by smaller countries, the U.S could ultimately be forced to default on some of its debts--possibly by stretching out scheduled payments or reducing interest payments on its debt--a practice that would be particularly easy to do with the large quantities of government debt held by government controlled institutions--such as the Federal Reserve, or with social security funds or other funds held by government controlled pension funds. The U.S. could also refuse to pay some foreign lenders, or stretch out or reduce the interest payments it was willing to give them (this is what many Latin American countries have previously done by issuing "Brady Bonds" to refinance their government debts). While the face amount of the debt appeared to be the same, the present value of the debt would be reduced substantially.

    In order to reduce the threats of inflation or of defaults, in one form or another, caused by excessive government debts, it is desirable to reduce our budget deficits and our total government debt outstanding. Deficits can be reduced either by reining in government spending or by raising government revenues and taxes. In that way, current government spending will not exceed current revenues so it will not be necessary to borrow in order to spend more. 

Tax Increase Proposals

    People who are "liberal" or "progressive" in their orientation have a strong preference for how they think the government should reduce its deficit. They think the government should increase taxes. In fact, they often propose government spending increases first, then, when the bill comes due, loudly proclaim that taxes must be raised to pay for the new spending lest the government deficit explode. Their mantra is to "Spend and spend; then Tax and tax." By so doing they can achieve their goal of expanding governmental influence over the economy and its people. They also can often argue that the hated "rich" should pay most of the new taxes, which is a policy consistent with their desire to redistribute income from the "rich" to the rest of society.

    Most recently we have seen the "progressive liberal" approach play out with the health care debate. First they forced the health care bill through Congress--including, along the way, new Medicare taxes on the "rich" and new taxes on "rich" people who received too much in the form of interest or dividends. Now their minions are appearing on Capitol Hill (starting April 7) to testify that the government deficit will explode because of the impending growth in the Federal deficit so we MUST impose new taxes. They are suggesting that not only could tax rates be raised, but also, that new taxes could be added --such as a national VAT sales tax or a carbon tax, etc. What the progressives seem incapable of considering is that another way that federal deficits can be cut is by cutting federal spending. 

Spending Cut Proposals

    My purpose in this statement is to propose ways in which the federal deficit could be reduced by reducing spending. There are several ways that can be done. First, government employees are paid much more than private sector employees. There is a reason for this bias and it can be corrected by cutting government pay or, at least, preventing government employee salaries from rising until the disparity in private and government salaries and in their relative riskiness is rectified. At present, the median federal worker salary is, I believe, approximately $108,000. The median private worker salary is approximately $50,000. It appears that the government employees' salaries are biased upward. The reason for the bias is that government pay scales are determined by government employees who try to determine what comparable pay would be for particular jobs in the private sector of the economy. Even though many government employees may be college graduates, there is no guarantee that they are the most productive graduates since truly ambitious graduates are more likely to seek employment in private industry. I doubt that the government employees make any quality based or ambition based adjustments to salaries in the private sector when comparing them to salaries in the government sector. Also, they probably do not take into account that private sector employees often work much longer hours than government employees because they are ambitious to succeed based upon their individual accomplishments--while government employee salary increases often occur along a fixed salary scale automatically. In addition, private sector employees may work hard just to avoid being laid off--which is often a real risk if their company fails or downsizes. Government employees have a great deal of job security and government agencies, in contrast with private companies, rarely shrink or lay off people--and even if they do, the former employees are often first in line to obtain other government jobs.  Thus,  private sector employees should be paid a risk premium in their salaries to compensate for the greater riskiness and uncertainties in their job tenure and rewards. As far as I know, there is no risk adjustment made when computing comparable wages, and, given their greater certainty of government salaries, the risk adjustment should be substantial. Thus, better estimates of comparable wages and working conditions would probably justify significant cuts in Federal employee salaries relative to private sector employees. 

    Second, the government does not regularly assess the usefulness or value of what it is doing. That should be rectified by imposing zero-based budgeting for all government operations, at least every few years, and using sunset legislation to mandate a review of all government operations and activities periodically to see if the resources devoted to them are still appropriate. In that way, every government activity would be reviewed to ensure that it was effectively accomplishing a useful goal. 

     Third, Congress should be prohibited from adding pork barrel requests, called earmarks, to legislation if the requests are not fully reviewed and authorized by the legislature as a whole. At present, favored Congressmen are allowed to slip pet projects through Congress by adding them to bills without overall review by other members of Congress. This can sometimes occur  in the middle of the night.

     Fourth, the Congress should try to implement all cost cutting proposals made by the Citizens Against Government Waste organization, the previous Grace Commission Report and other studies that have tried to eliminate wasteful or unnecessary government spending. Often those groups and commissions find egregious examples of wasteful spending and Congress does nothing to rectify them. 

    Fifth, the U.S. should not try to be the world policeman. While it needs to retain a strong national defense, it does not need to have numerous troops stationed in front lines around the world defending (often rich ) countries such as Germany and Korea, and it should not get involved in or have good people die in wars (such as  Bosnia) in which the U.S. has no substantial national interest. 

Email Chip with any questions., Chippete@aol.com

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