January 28, 2009

Finding The Money -- Paying For Government (draft update)

People reasonably get caught up in all the details of the current debates on federal spending and taxes, and we seldom really step back for a long term view. Let's look at what should be reduced and what new taxes should be enacted.

What to Cut

Let's look at the estimated 2008 Federal Spending. The Census Bureau gives the 2008 estimated Federal Outlays by category, showing among notable large categories.

Estimate of 2008 Federal Outlays ---$2,931B ($2.93T)

Social Security ----------------21% ($615B)
National Defense -------------21% ($607B)
Medicare -----------------------10% ($396B)
Interest on Federal Debt ----8.3% ($244B)

We all know that Social Security as structured will eventually run into a squeeze decades from now, Medicare is expected to balloon much sooner, and interest on the Federal Debt will go up within years (despite the current low rates at which the US can borrow).

Can we really expect to pay for our increased healthcare standards and longevity of today while retiring at the retirement age of yesteryear?

The obvious reality we face is that if people live longer than they did 40 or 70 years ago, then we have to work longer than the traditional social security retirement age. If your life expectancy rises to 78, you need to work longer to than you would if your life expectancy were 72.

In this example, would you need to work six years longer? Probably less than a full 6 years would be required, but....we need to face the reality that living longer means we have to build up a higher level of retirement funds. Living longer means working longer. It's just that simple....

This is just common sense.

It is not a difficult political sale. Many already plan to work longer than they had thought to years ago, due to simply looking over the math.

It's not even really a hard choice.

Most people will accept this readily. Especially since it can be entirely voluntary.

The adjustments is simple and straightforward -- updating the expected payout levels for different retirement ages to be accurate (to reflect what Social Security taxes can sustain).

Just as before, you get a higher payout level if you retire later.

If the accurate math says there is less available for those retiring early (at 62 for instance), then update the expected payout level for age 62 retirement to reflect that fact.

One extra age-of-retirement option could be added for instance at 72, so that those choosing to work even longer have a choice without penalty.

This whole adjustment could be just updates with one extra option for even later retirement.


The next big picture issue is whether we need to police the world, really, in order to be safe at home.

Why don't we face up to reality and admit that we can't afford to police the world?

Let's bring our troops home sooner rather than later, and assume a posture of defense only.

Our ability to defend ourselves at home through security isn't weak (we have several instances of intercepting and preventing attacks since 2001), and it can be made stronger, and it doesn't cost much compared to the overseas military activity.

We could accomplish more by subsidizing charities overseas than by trying to control the chaos with force of arms. We can adequately defend ourselves here at home with half the ships, troops, and aircraft. We could cut back over the next two years our orders for new aircraft and weapons to levels adequate to maintain modest productions lines for selected key systems so that a more gradual turnover of equipment would be established. We'd still maintain weapons manufacturing expertise and an ability to ramp up production in need.

We could stop spending so much on military power, and begin diverting more of our labor (troops, scientists, engineers, technicians) and funds into creating more economic power here at home in the form of *all* the necessary components of energy independence. Progressively, over time, we would lower our oil import needs more and more.

Whenever anyone objects to our vast military spending -- far more than any other nation, by any measure of any kind -- they are met by comparisons of current military spending to current GDP.

The argument is that current spending isn't so high by standards of the last century, compared to GDP, only 4.2%. Well, significant military spending (such as 4.2% of our previously larger GDP) makes sense if we face a current threat of proportional magnitude.

Currently, the U.S. faces no sizable threat from any group or nation. Russia does not threaten to overrun France or Germany. China is not threatening to take over Australia. Al Qaeda is not threatening to take over Iran or Egypt. In fact, the Muslim Brotherhood in Egypt is a greater power by far, cannot be overrun by Al Qaeda, and does not threaten other nations.

As we withdraw from Iraq, stabilize Afghanistan and begin to wind down, we should not plan anymore to fight two medium sized wars simultaneously. We can begin scaling back some future equipment plans today.

Overseas aggression is better handled by the UN and by sanctions, and in the worst case, finally by coordinated effort of an alliance of nations. The U.S. does not need to patrol the world, or feel it has to contribute most of the world's security.

Defense means to protect oneself or one's allies from aggression. It does not include preemptive wars on the possibility a nation could threaten us.

National Defense ultimately requires far more than only military might. It requires economic strength and also the morale that comes from being on the principled side of conflicts. The American presence in Iraq (and even Afghanistan) is lessening our long term security by inspiring new hatreds through appearing imperialistic. Even if Iraq becomes successfully independent and stable this doesn't change the fact that being in other peoples' business inspires hatred. Being involved in other peoples' wars is not a safe way to live. In contrast, participating in United Nation police actions as only another equal participant can accomplish the same goals many would have us fight alone for.

By now the fallacy of holding down oil prices by protecting the Middle East should be exposed for the pipe dream it was. Oil prices rose even as we dominated the region. And oil will rise again, sooner or later. Real oil security would come from increasing energy independence. Even better, building energy independence creates American jobs.


New Revenue

Obama proposals on the tax side already have some good ideas: reducing taxes on the middle class, which needs it, and increasing taxes on the top earners and on capital gains such as on stocks, one of the forms of income of Warren Buffett, who advocates higher taxes on the wealthy. The capital gains tax increase should have at least one step in relation to income, as it would if the rates simply reverted back to the pre-2003 levels. In fact, this can be achieved simply by allowing the capital gains rates to revert to the pre-Bush-tax-cut levels without any new legislation.

Are there other tax adjustments that would be beneficial? Many favor a targeted investment tax credit that would encourage more manufacturing here in the U.S.

On the increasing revenue side there is one less talked of tax increase that makes great economic sense.

One tax that ought to appeal to everyone is for the fuel (gasoline and diesel) tax levels to be set to include all the expenses of fuel use we are already are paying through other taxes and indirect costs.

Cost we are already paying.

But not in proportion to our fuel use.

Most people would prefer that everyone pay their own way. None of us want to pay the extra costs for others' driving, in addition to our own costs.

Neither would we want to give special favors to certain businesses by forcing other businesses that choose more efficient vehicles to subsidize the businesses that choose less efficient vehicles.

In short, we want the complete costs of fuel use to be paid by those using the fuel.

This would not increase overall fuel costs -- it would simply stop robbing Peter to subsidize Paul through national defense taxes and other costs elsewhere.

Currently the Highway Trust Fund year end balances are projected to go negative sometimes near early 2010, though many factors could change the timing (some info here). At the pump fuel taxes are not covering Highway Trust Fund expenses for roadwork, right now.

Under the stimulus package much new money for roadwork will be allocated, and aid to state budgets will also be included. So the "robbing Peter to pay Paul" effect would be increased.

But if we set fuel taxes to equal all the costs of fuel use, businesses and consumers could adjust and also plan for the future in their vehicle purchases. The real complete costs could be phased in over 8-10 years.

Giving new car and truck buyers a more visibility of at least part of future gasoline prices allows them to choose vehicles more effectively and gauge how much to pay for higher fuel efficiency.

Among the actual real costs of vehicle fuel use are costs of national defense expenses protecting Persian Gulf shipping lanes (perhaps $70B/yr), increased national health costs due to ozone and other vehicle exhaust (taking a middle value of many studies, perhaps 7 cents per car mile, and 40cent/gal).

And then of course we have road and bridge construction and maintenance.

100% of all of these costs should be in the fuel taxes.

Since the stimulus package includes the middle class tax cut of $400/year per person, it makes very good sense to consider raising the gasoline tax now, especially now while fuel prices are low (under $3/gal). As an offsetting extra stimulus, we could include a temporary $70/household fuel-tax rebate for instance, which could be mailed to households in a similar manner as the 2008 tax rebate.

It's important to allow people to plan ahead for their vehicle purchases and use, so the fuel taxes must be phased in over time.

I think we could try to get close to either a sum of costs as above or alternatively to the European levels of fuel tax over about 8-10 years, in a transparent way that allows everyone to plan ahead.

As a preliminary example of the correct way to phase in fuel taxes, consider if we expected to eventually have a federal gasoline tax of about $2.50/gal 10 years from now.

One way would be to simply add 25 cents/gal each year, after immediately setting the federal tax from the current level near 18 cent up to 25 cents for 2009.

Even better I think is to allow more consumer planning, by delaying most of the increase until later years after an initial step up, so that recent buyers of autos will not be penalized so much after 3 or 4 years.

For example, the federal gasoline tax could be set to 50 cents now, in 2009, and then be left at 50 cent for 5 years, scheduled to rise again by 40 cents/yr from 2015 until it hits the target in 2019. This kind of sequence is much fairer to auto manufacturers and recent purchasers.

Everyone could see the increases eventually coming, and plan ahead.

The conventional wisdom that fuel tax increases aren't politically possible I think is a red herring, and not realistic anymore. If an presented as paying our own way, and with an offsetting rebate, and a gradual phase-in removed to the future 5 years down the line, this kind of program would gather popular support as a way to help move the nation towards energy independence.


So, simple common sense could go a long way to ending America's budget problems.

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