Time to Prove Sobriety Over Changes Needed to Federal Budget

by: Karl Denninger

Let's start a real discussion on this issue. As said on CNBC this morning, our government continues to play "powder puff" instead of dealing with the issue:

We'll start with what we know to be facts and then attempt to develop a policy prescription:

  • The Federal Government has never in the history of the nation managed to collect more than 20% of GDP in taxes. This has been true in times of peace, war, Democrats, Republicans, deficit hawks and doves. It has been the case with a top marginal tax rate from 90% all the way down to today's rates. The reasons for this are complex, but the primary one is that people don't have to work, and there is a pain threshold beyond which they simply work and get paid less, or at least "paid less" in terms that can be taxed.
  • The Federal and State Governments cannot have in its budget, for a sustainable spending plan, items that increase in price faster than the productive output of the economy. That is, GDP growth from actual organic growth, not from debt. That in turn means that the Federal Budget cannot fund medical care as it is currently constituted in the United States. This doesn't mean we can't have social assistance for medical care in some form, but what we have right now for a medical system precludes government involvement. This is a fact and the medical industry either has to deal with it (meaning getting rid of the elements that cause this distortion) or get thrown out of the government spending bucket - in its entirety.
  • We cannot generate a nation of people who vote for a living. That is, if you receive benefits from the government and have income you must in some form pay for that government. You don't necessarily have to pay a lot, but you do have to pay. Everyone needs "skin in the game" so that their voting and political involvement, to whatever degree they are involved, reflects in some form and fashion of self-interest. Altruism is a great idea but never works in the real world.
  • Taxation must be a means of raising revenue and be entirely transparent, rather than a means of attempting to direct social policy. If you wish to direct social policy that's fine - do it with legislation. Attempting to use the tax code for this purpose is evil, especially when you hide those benefits and costs in federal law and administrative code books at the IRS that take up linear feet of space.

With these facts in place let's deal with taxes first, then spedning.

There are two outcomes for taxation that will work. The first is The Fair Tax, otherwise known as HR-25. This has been filed in the last several Congressional sessions. The broad outline is:

  • It replaces all federal income taxes (including FICA, Medicare, Unemployment, personal and corporate Income tax and similar) with one consumption tax on the first retail sale of any new product or service. Transactions in used goods are exempt. The 16th Amendment is effectively repealed on an interim basis by de-funding the IRS and deleting the entire Internal Revenue Code (the authorizing law for all those other taxes) and a formal repeal of the 16th Amendment is part of the process. There are no exemptions of any sort from taxation in consumption of new products and services. The "tax inclusive" rate is set at 23% (tax "inclusive" is how federal income taxes are set now.)
  • A "prebate" is sent by Treasury to all households in the United States of US Citizens. This "prebate" contains the amount of tax that is due on poverty-level spending for that household size, in advance, on a monthly basis. This results in a household that lives at the poverty line paying no federal tax at all. Those who live at two times the Federal Poverty Line would pay an effective tax rate of 1/2 the Fair Tax rate (or about 11.5%), tapering off until at approximately 10x the Federal Poverty Line (roughly $108,000 for a single person and $223,000 for a family of four) you would be exposed to the full level of taxation (that is, 23% inclusive.) As an example a family of four that spends $44,700 a year would pay an effective tax rate of 11.5%.

If you wish to criticize or debate this option you have an obligation to read the proposed statute first. That's the only warning I'll give those who intend to comment on this thread.

The second option would be to shred the entire existing tax code and replace it as well, but with a simple bracketed flat tax. Shredding the existing code means getting rid of the fiction of FICA and Medicare taxes as "separate items"; they are in fact not, and are insanely regressive as currently constituted, as in point of fact the poor pay about 15% of their incomes in this tax from the first dollar.

An acceptable replacement would be something similar to this for single people (add 50% for a married couple filing jointly):

  • $0 - $10,000: 10% (much lower than is paid now via Social Security and Medicare)
  • 10,000 - $50,000: 15% (note this and beyond is a marginal rate)
  • $50,000 - $100,000: 25%
  • $100,000 - $250,000 : 35%
  • $250,000+: 45%

Before you howl that this is a "huge tax increase" please read the above. It is not a tax increase; it is in fact a flatting of the code. For those without tricky tax returns and deductions it is moderate tax decrease as FICA and Medicare, along with unemployment, are included in this tax. Some of these taxes are currently hidden from you, but they are in fact deducted from your pay either directly or by reduction in what your employer is willing to offer in wages.

Second, everyone must have skin in the game who earns an income. Creating a nation of people who can (and do) vote for a living will eventually, when that percentage reaches a plurality, destroy the nation. This is not conjecture, it is certainty. We're damn close to this point today, and we must avoid it.

All dividends, interest (including carried interest) and short-term capital gains are taxable at the same rate for individuals. There are no deductions of any sort and no credits, refundable or otherwise. EITC, mortgage interest and similar all go away. The 1040 tax form fits on one piece of paper.

Corporations are taxed at a flat 20% of net income. Any corporation doing business in the United States is taxed on their worldwide income subject to a set-aside for taxes paid in other jurisdictions up to but not beyond the U.S. rate. This instantly stops the "tax shifting" game that GE and others play. There are no deductions permitted for interest expense but dividends are deductible dollar-for-dollar against net income (since they will be taxed at the individual level.) We must stop the unfair competitive advantage that large multi-national corporations have against small, home-grown entrepreneurs in the current tax code. Small business is what creates jobs and they must have a level playing field to do so.

Again, the corporate 1120 tax form fits on one piece of paper.

Long-term capital gains (defined as investments held for more than one year) are taxed at 20% or your base bracket, whichever is lower. Very long-term capital gains held by individuals only (defined as held for more than five years) are taxed at 10% or your base bracket, whichever is lower.

This change in corporate tax policy would provide incentives for corporations to do what they're allegedly supposed to do - pay out their net income to the owners. Doing so is not a taxable event, but it is taxed when the owner gets the money. Retained earnings that are actually spent on development are business expenses and do not get taxed; this allows investment in R&D and similar without penalty.

Debt has no offset in the tax code, so there is no incentive to take debt. Interest is not deductible for anyone - not people or corporations. There is no reason for the government to provide an incentive for people take on additional leverage. If you wish to do it you should pay the entire cost of doing so without tax offset.

Now, on to spending.

We currently have five entitlement programs that consume the entire Federal income stream. Those are Social Security, Medicare, Medicaid, Unemployment and Welfare.

Unemployment is an insurance program for the first 26 weeks and should be maintained. All other unemployment provided by the government must be dropped. Persons should be free to contract privately for unemployment insurance beyond 26 weeks, but they should also pay for it. If a company wishes to offer this as a benefit and deduct from paychecks for it (or absorb it) that's up to them.

General Welfare payments, whether in the form of Section 8, SNAP or similar, must be time-limited and conditioned on job training and/or educational enrollment and progress. Offering people a "hand up" seems to be mandatory on a social basis. My Libertarian view (note the big "L") is that these programs should not exist at all, but the nation's population disagrees with me on this. What I believe the vast majority of people can agree on, whether liberal, conservative or libertarian (note small letters!) is that Welfare in all of its forms cannot be a means to sit on one's butt and do nothing.

Social Security is next. The program is not sustainable as currently operated. However, it is reasonably easy to fix. The existing step-functions are fine, as they cap off at a modest amount in benefits. The inflation escalator must be redefined to use headline CPI, not wages and allow negative adjustments. In addition the CPI calculation must be made for two points; the highest Social Security payment (approximately the existing CPI number) and the base payment. This prevents the screwing that lower-income retirees take from food and energy price escalations in Social Security. At the same time the full retirement age must be indexed to longevity and re-based to where it was when Social Security was introduced. These changes must be made now, not on a sliding scale.

Medicaid and Medicare are another matter. There is no rational adjustment to these programs as currently constituted that is going to work. I wish there was, but there isn't. We can write checks with our medical technology that we simply cannot cash as a society when applied to the whole. Dialysis is an example; it is extremely expensive (thousands a month) but is not sustainable permanently and invariably leads to a transplant which costs tens of thousands of dollars to perform. The patient then requires thousands a month indefinitely in the form of anti-rejection drugs. We cannot fund, as a matter of public policy, dialysis and transplants for everyone who might need one. The same applies to treatments like Provenge or heart bypass operations.

Before the advent of EMTALA (the 1980s law that required treatment irrespective of ability of pay) we had a network of charity hospitals and clinics that provided medical care on a purely-private charitable basis. They did not provide everyone's needs, but they served those who had no resources. Churches and other similar institutions provided most of their funding. Today, there remain few of these charitable medical operations. This must change, for the simple reason that we cannot provide what is being demanded by our citizens.

It is time for us to have an adult conversation about these matters. We will all die some day. That is a matter of fact and no amount of whining will change the final outcome. We are scientifically capable of extending life in many cases, but the cost of doing so is another matter entirely. Every person in our nation should have the ability to pay for as much life extension as they have the funds to cover, and the above tax policy, coupled with a monetary policy that results in actual zero inflation, will mean that you can save a large enough "nut" to have a shot at providing what you wish to have, whether through private insurance or private savings.

We cannot, however, tolerate the existing medical system. It is not possible for us to provide everyone who needs it a heart bypass operation. Nor can we give every man with metastatic prostate cancer another four months of life for $100,000 each. If you wish to buy that time with your own effort, that's fine. But nobody has the right to demand that others pay the bill so you can draw even one more breath. That responsibility is yours.

Our current medical system is distorted by allowing anyone, including illegal immigrants, to show up at a hospital in labor (or with a nail through their foot) and bill "someone else" (the taxpayer) for their medical care. This must end, especially for those who are not citizens of the United States. If our government is incapable of negotiating with those nations who's nationals are in our country, legally or not, to provide payment for these services then services must be refused except for voluntarily-provided charity care or that which the patient is willing and able to fund themselves. This is the case in virtually every other nation on the planet. It must become true in the United States now.

In addition we must end all "shadow payments" and protection for foreign price-fixing. If I buy a drug or device I must be free to resell that drug or device as I see fit. I own it, I have a right to dispose of it as I direct at any mutually-agreed price point. Ending protectionism of this sort will put an immediate stop to the practice of pharmaceutical makers pricing drugs at or near reproduction cost in other countries and forcing the United States to effectively bear the entire development cost of these drugs and devices. This sort of restraint of trade is supposed to be unlawful and yet it is protected in the medical field by current "re-importation bans."

In the realm of services it must become unlawful to cross-subsidize treatment. All providers must bill and accept payment in full in identical amount for an identical service. Medical providers claim that Medicare and Medicaid (in particular) pay below their cost of providing the service. This claim, if true, is an admission that they are shifting part of the expense of that service to the privately insured or uninsured private customer. This practice must be made explicitly criminal and expose the provider involved to not only criminal sanction but treble-damage racketeering suit as well.

"Prepaid, no bill seen" claims of "insurance" must go away. Every person must be presented the actual bill for their services and products in the medical realm. If you have an insurance policy that will pay that bill, that's fine - but the exact amount must be shown to you and you must accept it with a signature. That amount must match that billed and paid by any other party, irrespective of how the party pays, subject only to a reasonable discount related to the actual cost of processing the payment.

At the same time the tort system must be completely overhauled. It is very common for a person to present to a doctor with symptoms that could be caused by four different conditions. One condition might have an 80% probability and require a short-term medication (e.g. a course of antibiotics) for treatment. The second might have a 10% probability and require a $500 test to rule out, but if it is present, it is dangerous to the person's long-term health. The third might have a 7% probability but require a $3,000 MRI to rule out, and the fourth might have a 3% probability and require a $5,000 CAT scan with contrast to rule out. The latter two, if either is the condition involved, could be fatal if not caught in time.

The problem with today's medical tort system is that you, as the patient, will demand $8,500 worth of tests because you don't see the cost of those tests, and if they're not done and you're in the unlucky 7% or 3% bucket and don't get them, you (or your next of kin) will sue (and win.) This is unacceptable, especially when the government is providing the care through Medicare and Medicaid. What must happen instead is for the provider of medical care to present you with the possibilities and the cost of the procedures to rule out each of those possibilities. You then decide, after consulting with your insurance carrier (who may or may not pay for each of them) what you wish to do, and you accept the risks associated with each choice.

We cannot resolve the medical crisis in this nation, with costs that are doubling every ten years or less, unless we take the above steps. This is not about compassion, it is about mathematics. We can provide excellent medical care in this country but we cannot subsidize the world's medical development, nor can we allow one group of people to forcibly bill another for their treatment.

We must become adults instead of screaming toddlers. We must make choices, and decide how we wish to spend our individual funds in the investigation and treatment of our individual conditions. If we run out of the ability to pay, we must accept that while we can ask others for help we do not have the right to stick a gun up the nation's nose and demand that others pay bills we either refuse to or are unable to cover ourselves.

Next, our military. We currently spend about 3/4 of a trillion dollars a year on military "adventures." Roughly half of this is spent protecting our access to foreign energy sources. This must end, but it doesn't end via just pulling troops home. Instead, it must end by instead getting rid our need for those foreign oil sources. This goal is achievable - the impediments are political, not technological. I have long been an advocate for nuclear power in all of its forms, and we have the ability to exploit it not only for electrical generation but also to get rid of the need for foreign oil.

That path forward is not without risk. But there is no human endeavor that is without risk. We are choosing between risks in this and every other circumstance, and it's a choice we both should and must make. The current cost of a barrel of imported oil, when one includes the back-door subsidy of our military protection, exceeds $200/bbl. This cannot be sustained - our economy simply cannot afford it, and more to the point, we can replace that oil for far less than $200. This can be done right here, right now, today. We know how to do it, we simply must decide we're going to.

Finally, those programs that have proved to be worthless or worse, and are properly the function of the States, not the Federal Government, must disappear. The Department of Education is one these. Homeland Security is properly a function of the FBI, not a separate agency. That the CIA and FBI were consumed with internecine BS prior to 9/11 doesn't justify adding another boondoggle to the budget - it justifies knocking heads together in those agencies, publicly exposing who did and didn't do what, shaming the people responsible and tossing them out of Langley and the FBI building on their ass! In short, solve the problem instead of introducing new ones.

Finally, cut all other programs back to 2000 levels. That's a rough halving.

If we take these steps we can:

  • Stabilize tax revenues and rationalize them.
  • Stabilize Social Security and stop its growth.
  • Cut Medicare and Medicaid spending in half and stop its growth.
  • Cut half of Defense spending.
  • Eliminate the Department of Education and Homeland Security.

Does this get us all the way there? Probably not, but it gets us damn close. We're talking about well over a trillion dollars in savings on the spending side immediately, and a complete halt to the spending escalation on social programs. At the same time tax revenues would stabilize and grow with economic output.

Such a plan is credible. It can be done. It will raise much howling from the various constituencies, but this sort of plan is the only option other than a forced set of conditions and spending cuts when our Federal Government credit card gets cut up.

It will get cut up folks. We are only arguing over when, not what. If we refuse to take these steps then either The Federal Reserve will continue monetizing debt, in which case energy and other commodities will keep climbing in price (effectively stealing the same money you think the government is giving you) or we will be forced into a much worse set of austerity programs when bond buyers throw up their hands and say "no more until you cut this crap out."

The time is now to have this debate and resolve what we're going to do. If legislators refuse, then we must throw them all out on their ear - right here, right now, today.

All these claims about "2020" projections are nonsense. They will never happen. The time to prove sobriety on this issue and that you're serious about addressing it must come in the form of changes to these programs and their funding levels today, in both the 2011 and 2012 budgets.