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Posted by on Aug 6, 2011 in At TMV | 30 comments

S&P Report: A Moderate’s Manifesto

I have no idea if a math error is to explain S&P’s decision to downgrade the US government credit rating. And I’m quite aware of S&P’s dubious record in helping to create the very credit bubble that got us into this mess; remember those “AAA” bonds insured by credit default swaps?

But I think, as Ezra Klein argues, this downgrade is real and is justifiable.

So what is the rationale for this? Logan Penza accurately holds both sides accountable. The text of the report is clear enough that blame goes around everywhere.

But I think this is more than just an assignment of blame on our broken political process and unwillingness to deal with the debt crisis seriously. I see it as a manifesto for moderate politics of the sort that will get our fiscal house in order and grow the economy again.

The non-moderate way to look at the debt crisis is to focus on only one side of the politico-fiscal ledger. Liberals say there aren’t enough taxes and there is too much defense spending. Conservatives say there is too much entitlement spending and that tax increases on the rich will do virtually nothing to lower the debt (and will stifle private investment).

The moderate accepts the basic truth of both sides here

Entitlements have not only grown, but will expand enormously as Baby Boomers face retirement.

Defense spending, after falling during the Peace Dividend days of the 1990s, was ratcheted back up again in the post-9/11 era to fight two long, draining wars that serve little national interest.

Taxes, which were raised in the early 1990s by Bush I and Clinton, were irresponsibly lowered during the early Bush II years, contributing more to the debt than any other single item. Refusal of Republicans to raise them – and Democratic cowardice to press the point – is at the heart of the debate.

But Democrats – including moderate Democrats – must accept the fact that if the Bush tax cuts are going to be repealed, they must not be limited to the wealthy. In fact, most of the tax cuts from 2001 and 2003 went to those making less than $250,000 a year. Coupled with various child tax credits, the middle class ends up paying virtually nothing in Federal income taxes. Yes, there are other tax burdens the middle class must shoulder – payroll taxes, state and local taxes, etc. – but the virtual zeroing out of Federal income taxes from the middle class was every bit as irresponsible as cutting taxes on the wealthy. And, yes, any tax increase will negatively affect consumer spending and business investment. But the alternative is more delusion, making decisions far harder in the future.

Finally, there is the matter of our political system itself. One of the elements cited in the report is clear on this: “The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed.”

It doesn’t take a rocket scientist to figure out who was playing “brinksmanship” in the recent debt ceiling debate. The Tea Party, far from bringing sanity and solution to our national debt woes, has only made things worse. They have utterly refused any tax increases, which the report says is necessary to any solution, and have shown utter reckless disregard for global market considerations of short-term political action.

But the left, while far weaker in this debate than the Tea Party right, was able to hold its line on entitlements. And that is just as much a part of the problem. Social Security and Medicare were created at a time when life expectancies were much lower than today. The cuts and reforms don’t have to hit the folks coming into retirement right now. But for those in their late 40s and younger, there should be an expectation that retirement benefits (health care and Social Security) will not come into effect until at least the age of 67, if not 70. Those are the sorts of concessions the left must make, and they were as far from the recent debt deal as were responsible tax increases.

The answer to our debt woes will not come from the current crop of politicians in Washington. The right wing of the Republican Party is flagrantly irresponsible, both in method and in goal. The recent debate sapped much public support for the Tea Party; one can only hope that continues.

But Democrats – Obama especially – must give up the fiction that we can raise taxes on the wealthy alone. If Obama is going to be the transformational leader he promised in 2008, he has one more chance to deliver: call for a true grand bargain that raises taxes across the board and cuts spending across the board. Start with the Simpson-Bowles commission report if necessary. But stop shirking on this in hopes the Tea Party right will implode in a fit of arrogance and ignorance. Leadership is necessary to steer the course back to the center; inertia will not do it.

A grand bargain on tax increases would let ALL of Bush’s tax cuts expire, including those for the middle class. Anything short of this would be grossly insufficient.

On entitlement reform, the Republicans will have to give up their voucher fantasies – Medicare’s single payer is far more efficient and cheaper than what Paul Ryan offered – and then Democrats will have to accept real but incremental changes in the retirement age.

Ironically enough, both parties may agree on defense cuts, as there is little stomach left in either party for more military spending or adventures.

The big question, then, is the current economy itself. A major – perhaps THE major – driver of the deficit’s growth since Obama took office was not the stimulus bill. It was lost revenue in the recession. No debt measure will work if it doesn’t boost the economy.

Neither Keynesian nor supply-side solutions will work at this time. Nor can quantitative easing. All will aggravate the debt situation.

Sadly, the only answer is time. The business cycle must run its course. Housing prices must bottom out. Consumers must finish the de-leveraging process and pay off their personal debts.

But if we build in the other structural changes to the way we fund and benefit from our government – higher taxes and lower entitlement spending – then we can make the other kinds of private and public investments – including education and infrastructure – that will form the basis for real, long-term growth. There is no free lunch. But a modestly priced lunch – offered by moderates – may be the best deal for all Americans.

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  • SteveinCH

    Good post Aaron. I was sad to see you quote Chait. That chart from the WH is so biased that’s it’s ridiculous.

    I’d also question whether lack of funding is really the issue on either education or infrastructure or alternatively as you why you think it is.

  • AARON ASTOR

    Lack of funding is only part of the issue with education and infrastructure – especially education. In my neck of the woods – East Tennessee – there is a lingering cultural distrust of education and acceptance of academic mediocrity much like you see in inner city communities. And quality teacher placements are hindered by nepotism and cronyism as much as they are by central office buffoonery and out-of-control unionism in big cities. That said, the money helps. Gifted students are completely under-served here (mostly because NCLB forced all “special ed” funding to go to the struggling/LD kids, creating the sort of lowered expectations that NCLB was designed to fight). Textbooks are out of date and shabby. Science labs are fit to respond to Sputnik – and not much else. And teachers are paid as if they were mere child-care providers and not educators for our future workforce.

    Infrastructure is more complicated because it depends on what sort of infrastructure is at issue. In my area, the biggest issue is out-of-date TVA power plants. In others, it’s crumbling roads. Elsewhere it’s poorly maintained public transit.

    As for the Chait piece, I think the essential point is accurate. Drop in tax revenues with the recession is the greatest driver to deficits in the last couple of years. That does not, in any way, absolve the Obama Administration of responsibility, however. It just adds an important part of the context, which is that “the economy” is a major determinant in deficit calculations.

  • DLS

    Note that education and education funding properly are state and local, never federal, issues. (I doubt we’ve reached the point yet where many want the feds to engage in Canadian-style “equalization” [redistribution] payments among the states, and besides, we’ve started to run out of money for all the feds already do, anyway, and it’s ludicrous to expect such a large program.)

    Aaron, the problem with the federal government (and state and local governments) is spending — it’s not “equal” or “balanced” [sic]. The only additional thing that can be said that’s major is that too many expect or want too much from (each) government. Taxes will have to be increased to pay for (someday reformed) entitlement growth, and the tax freezes and cuts after 2008 as part of “stimulative” measures did cost revenue (and it was very irresponsible to cut FICA taxes and make the Social Security and Medicare programs even worse and more unsustainable). The main part of resolving the fiscal issue will be the reducing and controlling of spending. The Economist was correct when it said the ratio of spending cuts to tax increases should be about three to one — and that’s interestingly what Obama apparently sought.

  • merchan5967

    Wow very good post. And you’re absolutely right; both sides and their partisan bickering are to blame for this mess.

  • SteveinCH

    Aaron, two things.

    First, per child education spending in real dollars is up more than 100 percent over the last 30 years. I’m sorry, there’s no way spending is the issue. The allocation of spending may well be but that’s a different thing.

    As to the Chait chart, the CBO did an assessment of the same issue and concluded that the “Bush tax cuts” accounted for about 15% of the total shortfall if one compares the actual fiscal outcomes with what the CBO projected from FY2002 to FY2011.

    The CBO data is tabular but I’ve put it on a spreadsheet and graphed it.

    Chait’s chart (which is from the White House)asserts that nearly $7 trillion in changes were due to tax shortfalls. This is off by nearly a trillion dollars and the Bush tax cuts number is off also by more than a trillion.

    If that constitutes essentially accurate in your opinion, I’d have to say that seems a relatively biased point of view.

  • AARON ASTOR

    I may have my charts mixed up, but I believe the Chait chart – or maybe it’s the “ThinkProgress” chart cited by Andrew Sullivan – gives $3.7 trillion to the Bush tax cuts. I thought that the recession accounted for $4 trillion, not $7 trillion of the debts. Either way, the larger point is that a recession-based fall in tax revenue is a major player in present and future deficit considerations. That’s what I meant by “essentially accurate.”

    DLS, the 3-to-1 ratio is exactly the ratio we should be aiming for. It depends on the timing of tax increases and spending cuts, of course.

  • cg

    I don’t believe raising taxes on the middle class is the right answer. Rising health care costs are eating up whatever savings were had with the cuts, and now, with paying down our personal debts, the economy would suffer with a further bite from personal income of its broadest consumer base.

    HOWEVER, I find it really frustrating that NO ONE is talking seriously about restructuring the tax code so that income derived from capital gains (such as what’s received by hedge fund managers, the independently wealthy, and real estate developers) is reclassified as income tax subject to the regular taxes imposed on WORKING, WAGE EARNING Americans.

    That’s the major inequity that isn’t even addressed by Democrats or Republicans… that the truly wealthy are taxed at only 15%, while small business owners with pass-through income have their growth consistently hampered via the 35% + alternative minimum tax structuring they endure. Democrats spouting off about taxing people earning more than $250k are talking about taxing the WORKING and SMALL BUSINESSES, not the very wealthy they seem to suggest (millionaires and billionaires!) Its disingenuous at best, and aimed at the working public who is largely unfamiliar with the larger framework of taxes.

    I am a believer in keeping capital gains low for business investment. I am not a believer in it when that money is withdrawn and deposited into a checking account for personal spending for people under retirement age. I believe that if we raised the taxes on that income, more money would stay in the businesses to grow the economy. Likewise, if we limited it to retirement age withdrawals, we could then shove those very wealthy retirees out of the social security/medicare entitlements (afterall, they probably paid very little into those accounts, anyway.)

    Charles Schumer, Democrat, blocked legislation raising the taxes on hedge fund managers on behalf of his Wall Street constituents. It’s time to just restructure that tax so that those millionaires and billionaires actually *are* paying their fair share… 35% like the high earning workers, not the 15% that puts them on par with those earning $34k or less!!

  • Allen

    Yes the Republicans irresponsibly lowered taxes under Bush and as you can see it did no good what-so-ever for our economy. We just simply didn’t pay our bills while George Bush borrowed even more!

    Just raise taxes and all this will go away.

  • LOGAN PENZA

    Getting rid of the tax benefit for capital gains is one of those things that sounds really good until you consider what it would actually do to economic growth to discourage investment that way.

    A better approach to restructuring would be to eliminate harmful loopholes, like the mortgage interest tax deduction (especially the portion for home equity loans), which both cost billions and which help fuel dysfunctional economic engines like the housing bubble.

  • cg

    Pardon me, I meant that if we limited the increase in capital gains tax (calling it something else for personal income) to pre-retirement spending, and then allowed the distributions to happen as tax-advantaged capital gains or something like it at retirement age, most independently wealthy would then take their dividends at retirement. Tracking that could trigger a negation of social security and medicare allowances, kicking them off of entitlements they don’t really need. In reality, since they probably earned very little as w2 wages, anyway, these people likely have paid scant amounts into the entitlements in the first place.

  • cg

    Logan,
    Why couldn’t you classify capital gains for individuals as taxable like W2 wage income? It seems to me that capital gains need to be kept low for the vast sums of business capital that need to exit and enter various funds. Individuals removing it from the “pool of investment,” so to speak, have nowhere else to grow their money, so they’ll still keep it invested. They’ll likely just withdraw less.

    BTW, I believe in zero taxation for businesses, unless they are conducting business that has some kind of social/civil/environmental impact, which could then be structured as “pay for service” fees. All government revenue should be generated from individuals.

    Would appreciate your thoughts.

  • SteveinCH

    Wow Aaron. That’s a new low in essentially correct…off by a factor of 2. The Bush tax cuts according to the CBO were $1.7 trillion. That’s a lot but it’s a heck of a lot less than the $3 trillion in the WH chart or wherever you got the $3.7 trillion from.

    All I’d suggest is that you actually look at the CBO report…it’s more likely to be unbiased than anything from the White House or ThinkProgress (which is just a front for the CBPP on matter economic).

  • LOGAN PENZA

    The reason capital gains are given a lower tax rate is to convince people to invest in the first place and to reinvest gains. Investing is risky but good for the overall economy if people take that risk, thus allowing businesses to expand and hire more people.

    Also, capital gains are a huge part of what supplements millions of retirees through their participation in mutual funds and money markets. A tax increase on them under the guise of going after “the rich” would actually increase taxes on tens of millions of middle class people.

  • Allen

    What Capital Gains?

    Stock market investors are not needed now. Money in corporations accounts, investment firms, and, bank capital has never been this high before. They are just sitting on the money. Giving them more means jack if they are not going to USE it. There is no need for capital gains tax cut because it does nothing. What is needed is raising taxes.

  • cg

    Not a capital gains cut, Allen. An increase. And not on “capital gains” per se, but in the form of a reclassification of gains distributed as *income* (not reinvestment… this would be similar to the mortgage capital gains… if reinvested in the market, it could remain subject to regular capital gains rate at 15%)– this is what I’m arguing for. Simply, a reclassification of capital gains distributed as personal income becoming subject to the regular income tax brackets.

    It would not limit reinvestment b/c it would keep reinvestment very incentivized. And it wouldn’t hurt the “middle class” because it would be subject to the same income tax structure as W2 wages.

    Can you really argue against this?

    To me, raising taxes on the same old income tax structure is like trying to make more pie by slicing a small pie in ever smaller pieces. Meanwhile, there’s a gigantic pie down the counter that remains untouched because it falls under this “holy grail” of a blanket capital gains rate. We need to cut that pie up a little… invested capital gains can remain low. Distributed capital gains… let’s slice that up a little.

  • DLS

    We need to get rid of all the tax-law special favors, including the home mortgage interest deduction (which I’m surprised the Dems didn’t extend in better times to interest for all, including credit card, debt, after automobile and large appliance debt), the sacred cow of the tax laws (not limited to the self-serving realtors).

    Admittedly, tax reductions are in order for stimulating the economy, but as with additional government spending, we’re hitting the wall.

    Tax reform is imperative, dwarfing the superficial desire (or worse, with “soak-the-rich”) for tax increases.

    C.G.: Yes, capital gains are income and should be taxable, but no differently than any other income, and of course only realized capital gains are truly income and taxable. The worst want to tax unrealized capital gains (but not permit any kind of deduction for realized or unrealized capital losses.)

  • DLS

    Steve in Chicago wrote:

    Chait’s chart (which is from the White House)asserts that nearly $7 trillion in changes were due to tax shortfalls. This is off by nearly a trillion dollars and the Bush tax cuts number is off also by more than a trillion.

    HA! Maybe that’s the motive behind the anti-S&P crowing now!

  • LOGAN PENZA

    Capital gains covers more than just the stock market.

    And we definitely DO need people invested in the stock market.

  • DLS

    C.G.: FYI, I’ve been on record as stating that all forms of income should be subject to the income tax (intuitively!), and that all forms of compensation, including things like grants of stock or stock options (or re-pricing them to ensure they’ll profit the management holders of these if the market changes unprofitably), to FICA taxes.

    (The income “cap” should be raised or abolished. This is a trivial thing in and of itself, only postponing the original 2016 deficits of Social Security for 6-7 years, but it’s meaningful and eliminates what is an arbitrary or illogical feature. Note that to be moral, benefits for those subject to new, higher taxes, must be increased, but we already have a benefit formula favoring the lower-income people and a modern FICA and Social Security setup would at least raise the cap to around $250,000 and have a new benefit structure with “bend points” that include $250,000 anyway, at which point the increase in benefits would not be much, would appear almost or essentially flat on a graph of it.)

    (Without changing anything, FICA taxes in the current system would have to be raised to around 25 per cent to make those parts of Social Security and Medicare financed by FICA solvent.)

  • DLS

    C.G.: Any seriously reformed federal individual income tax (and the corporate income tax, too, if retained) would eliminate the need for the alternative minimum tax, as a consequence.

  • cg

    Argh, my terrible terminology. I meant “similar to the capital gains on the sale of a home” as opposed to “mortgage capital gains.” IN other words, just as their are parameters around how the profit from the sale of a home are classified as subject to capital gains, we could create parameters around what can be classified as capital gains (reinvested income) and what must be subject to income tax (distributed gains.)

  • DLS

    I’ll leave others to carry on, but before going, here’s the latest of such lessons that tax fiends need to be taught.

    In addition to the moral defect, “tax the rich” fails because THERE AREN’T ENOUGH RICH and NOT ENOUGH INCOME OF THEIRS TO TAX and expect to pay for much, if anything at all, any more, people. (And note the fraction of those paying no income taxes!)

    [IRS 2009 tax year]

    The number of Americans reporting incomes of $10 million or more also plunged even more than the steep drop in income for the population as a whole.

    Just 8,274 taxpayers reported income of $10 million or more in 2009, down 55 percent from 18,394 in 2007. Compared with 2007, total real income of these top earners in 2009 fell 58.6 percent to $240.1 billion, but average income slipped just 8.1 percent to $29 million.

    While the number of people who earned enough income to file a tax return fell, the share of those filing who paid no income tax rose to 41.7 percent of tax returns in 2009, up from 36.4 percent in 2008.

    http://www.reuters.com/article/2011/08/04/us-usa-economy-incomes-idUSTRE77302W20110804

    Tax those $10M+ people at 100%, and how many days of federal government operations are paid? Just over twenty or so?

  • cg

    Realized capital gains can and often are *reinvested* however, and I’m for keeping those at 15%. I’m talking about people living off the proceeds of their capital gains. And I’m not talking “soak the rich”– I’m talking parity between the working Americans and those who are able to live off the proceeds of already accumulated wealth and experience taxation that is similar to those earning $34K or less. That’s a huge inequality/unfairness. Working high earners are carrying a very unfair burden for the American economy.

    BTW, I would have to argue against the entitlements extending into the upper income brackets. Since the program is so mismanaged as it is, we should keep upper incomes free to use their retirement funds to stimulate the economy. Our ill-managed public retirement funds can/should only preserve the lowish-income elderly from penury. Our track record with these funds is too terrible to make it an even larger part of the pie we’re working with; frankly, the rich can manage their own retirements better. SS and medicare are a necessary evil because we’d otherwise have no safety net for low-income elderly.

  • cg

    Ah, yes, DLS. I agree. The state of California experienced a massive loss of revenue b/c “the rich” is such a slippery subset of society and highly subject to economic winds– much more so than “wage earners.” So “the filthy rich” are not necessarily a sustainable source for large revenue (at least not during an economic downturn.)

    See these articles and note how things swung for CA in a mere 2 months!
    http://online.wsj.com/article/SB10001424052748704604704576220491592684626.html

    http://www.huffingtonpost.com/2011/05/16/california-budget-unexpected-state-revenue_n_862656.html

    But since the argument on the Democratic, 1 to 3 revenue increase tends to mean “raise income taxes on the already 35% + amt + FICA” taxed middle class that we mistakenly call “millionaires and billionaires,” there’s some argument to be made for the unfairness of this rhetoric.

  • DLS

    C.G., that’s a novel way to re-express a desire for means testing that is so common now. [grin]

    I always play devil’s advocate and remind everyone of the case that liberals make for universality. Not “social solidarity” Euro-language nonsense, but rather, preventing our entitlements (SS, Medicare) from being seen as poor-oriented welfare programs, with the likely big loss in taxpayer support for the programs (and beneficiaries).

    A reasonable compromise can be found effectively on this graph:

    http://upload.wikimedia.org/wikipedia/commons/thumb/4/43/Hyperbola_one_over_x.svg/300px-Hyperbola_one_over_x.svg.png

    On both halves of the graph, income increases from left to right.

    Liberals envision a Social Security benefit structure like the left part of the graph, where the horizontal axis is the maximum. Reality would be like the right part of the graph, where the horizontal axis is the minimum. That (the “reality” part) is what I would foresee happening to the benefit structure if we kept Social Security (and Medicare) universal.

  • Yes, capital gains should be taxed as any other income, with two caveats:
    1. Index it for inflation. We have enough incentives to think short term.
    2. Venture capital should be treated differently than buying stock. The stock market is now little more than a gambling arena.

  • mrmarket

    The rating agencies were either negligent or co-conspirators in the last financial crisis. Are they being over protective here because of their past? Are they just going to further the crisis or are they actually doing their job this time

    I am in agreement we need to do something to address entitlements and speeding. It seems from an Washington outsider standpoint everyone is more interested in assigning blame versus solving the problem.

  • CStanley

    I agree it’s a good post, Aaron. Just to add one more thought- if moderates are to rise up in the current situation, one thing they’ll have to overcome is the complete lack of trust in politics. Our politicians of both parties have so badly eroded the public trust that virtually no one believes that serious issues will be addressed. They’ve all become much too good at the posturing and most legislation is more about the pretense of doing something rather than actually doing substantive things.

    The use of budgetary accounting tricks (a cut in the rate of increase is called a cut, for instance) and the time shifting by use of a promise to cut spending or raise taxes later are all too frequent. One problem with the latter is that sometimes it really IS appropriate to time shift these things (eg, raising SS and Medicare eligibility ages gradually, so that people have time to prepare for the effects of it, or laying out a longer term budget that shows spending cuts or tax hikes after a recovery instead of making the changes immediately when those might be detrimental.)

    If moderates are to get serious about making substantive changes, they’ll need to overcome the public’s (justified) cynicism and address these issues both in reality and in rhetoric, in order to get popular support behind them.

  • SteveinCH

    If I could, it’s worth knowing to Christine’s point, that if the Federal government reduced the rate of spending growth to equal the rate of growth of inflation plus population (about 2.8% projected) for the balance of the decade, the deficit issue would be solved (under 1% of GDP) leaving taxes as they stand today by 2021.

    The notion that we are gutting something when total spending under any foreseeable deal will continue to grow faster than the rate of inflation plus population is really quite striking.

  • DLS

    Just slow the growth to equal population growth.

    Incidentally, inflation is wrong, but if we were to have it, anyway, then limiting inflation also to population growth would be better than so many other alternatives.

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