The basic issue that first comes to mind is whether the size of US Debt creates a solvability issue. After all, the real issue when purchasing someone else’s liability is to assess his creditworthiness. What can be said of the above total other than it is huge and not rounded just for the fun and ridicule of its size? Not much, unless they are looked relative to the size of something. In this case that something is also huge, it’s the US economy. The US economy as of the same date is 14.46 trillion as per the latest BEA release and so the Debt to GDP ratio is 93% based on my adjusted total.
It is widely accepted that a ratio of 60% or below for debt to GDP is sustainable over the long term. However, most fears concerning the government debt level are likely to start abating as soon as the budget is trending towards a surplus and even more so when confirmed by the first surplus budget year. The reason no one appears to be considering that possibility at this time is because the Congressional Budget Office does not project any surplus, ever again. As I mentioned previously I don’t believe these projections are of any help to determining the actual path of the fiscal accounts. The assumptions and extrapolations performed have never ever provided the correct path in the medium term. In the short term however they offer some guidance. The CBO estimates in “The Budget and Economic Outlook: Fiscal Years 2010-2020” published in January 2010 are the following:
Fiscal year Deficit % of GDP
2009 1.414 trillion (actual) 9.9%
2010 1.349 trillion 9.2%
2011 980 billion 6.5%
2012 650 billion 4.1%
2010-2020 6.047 trillion 3.2% on average
In the ten year outlook, 2009 had the worst nominal deficit with 1.4 trillion gradually improving to 475 billion in 2014 and then worsening consistently until 2020 at 687 billion. These numbers are constantly growing and the 2010 deficit is now expected to be 143 billion more than that of 2009. So basically, the outlook contains two frightening components; all years are deficit years and the trend after 2014 accelerates again. No wonder we hear about sovereign default!
With that kind of data the doomsayers are partying. Why question this path? There are a number of reasons.
First of all, as hinted in last month’s letter, I believe we may be entering a period of contracting wealth disparity. The current fiscal situation may very well be the catalyst for a significant change in the rapid pace of wealth disparity witnessed over the past few decades. The pendulum could well be swinging back. As per last month’s letter “An increase in the tax rate imposed to the top 5 percentile has an impact on over half of income taxes collected. Talk about a small change, which impacts very few voters but makes a big difference to the fiscal situation.” Other than the super-wealthy, the upper middle class has historically been the most affected by a change in taxation. The perceived origin of this crisis (a crisis which actually originated from incredibly low long term rates due to global structural imbalances) is only likely to add fuel to this reversion. Put simply, when the time comes to pay, you go knocking on the doors of those who have the money. In a democracy where each individual has one vote, income disparity is elastic and we may be reaching the limits of this elasticity. But individual income taxes are not the only target for higher taxes. Of the 2.1 trillion in budget revenues for 2009, 915 billion were individual income taxes but only 138 billion were corporate income taxes. The 30% corporate tax rate is a myth for most large international corporations. As an extreme example consider Goldman Sachs who generated a 2.3 billion profit in 2008 but paid only 14 million dollars in taxes and this after distributing close to 11 billion in employee compensation and benefits. When facing the risk of social unrest and a loss of confidence in fiscal solvency the changes that appear unthinkable today may very well take place at lightning speed tomorrow. You may be thinking I have just taken an extreme example.
You are probably right, but consider this: since 1960 individual income taxes have grown from 40 billion to about 1.1 trillion pre-crisis (28x) whilst corporate taxes have grown from 20 billion to 300 billion (15x) pre-crisis.
Considering that this slow rise has taken place during one of the longest bull markets in history where multinational companies have become giants, one has to wonder why taxes have grown by only half that of individuals. Don’t misunderstand this statement; I am in no way suggesting that the corporate tax rate should be higher, only that it appears that many of the largest corporations have simply found a way to avoid paying their share. Basically, the US has the means to increase its receipts when it has to do so.
Disclosure: No positions