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New Budget, Death Spiral by John Dalt 2/01/10 The White House sent its 2011 budget proposal to Capitol Hill this morning; it weighs in at $3.83 trillion dollars, the largest ever. Luckily, we are only going to borrow $1.27 trillion of that amount, or 33%. That is down from borrowing $1.56 trillion in this fiscal year. Whew, that was a close one! We are making headway… Reuters has the story, “Obama’s 2010 budget Soars to Record $1.56 Trillion.” The President’s Budget raises total government expenditures to over 26% of GDP, the highest rate since the depths of WWII. This puts the U.S. budget into a death spiral, more spending, more taxes, and more deficits. With no end in sight. The president asked for a $100 billion jobs program this year, with more to come on next year’s budget. The President is going sign an executive order to create a deficit commission. This commission will recommend ways to cut the deficit now, and in the future when baby boomers drive Social Security and Medicare costs higher. We can expect a new budget Czar soon. Accelerating retirements and claims for aged benefits will widen the deficit as the unified budget does not set aside funds for Social Security and Medicare; instead they are included in the federal budget. As more citizens collect retirement benefits, the budget will explode higher. They are the original unfunded mandate. Subscriber J.P. wrote in last week “is there any correlation to the history of our national debt and tax rates. It seems to me that as tax rates have come down, our national debt has increased. At the same time our GDP has continued to rise. Tie that in with the fact that companies like IBM, while being a US corporation, has about 20% of its work force based in the US. The balance scattered all over the world. Can you help me make some sense of all this?” A great book that addresses taxes and economic growth is "The End of Prosperity" by Laffer, Moore, and Tanous. It has been some time since I read it (need to do that again) so my observations may not agree with said book. The other danger is that I know of at least three economics professors that read MarketToday. Whatever I say is subject to grading; let’s hope I don’t get an ‘F’. Remember, I am a Journalism major, not business. My business education has come in the school of hard knocks. Come to think of it, I remember the hard knocks better than most of my college lessons. The U.S. Constitution forbade the taxation of productivity under Article 1, Section 9. Taxes could only be collected on an equal basis. Abraham Lincoln instituted an income tax during the Civil War but it was unpopular and discontinued. The Supreme Court ruled the income tax to be unconstitutional in 1895, when it was revived. This was changed with the Sixteen Amendment that was ratified under Woodrow Wilson in 1913 The first levy under this amendment was 1% on individual income over $3000, with a surcharge on incomes over $10,000 per year. With this history, and knowledge that income tax rates rose as high as 90% after WWII, we can see that taxes once enacted, rarely go down. The chairs may be rearranged to look different, but they are all still on the deck. The challenge for congress is to collect ever increasing amounts to fund the promises they make, without destroying the golden goose. From an accounting standpoint, it does not matter how you collect the money, it is the amount of money. The Federal Tax Receipts have averaged 17.9 percent of GDP over the last sixty years. These numbers are from the Government Printing Office. You can access them here. Click on the tax receipts and outlays as a percentage of GDP.
YEAR
GDP TAX REC Outlays
Surplus
Remember the proposed 2011 budget exceeds 26% of GDP! Even John M. Keynes wrote in 1931, “Taxation may be so high as to defeat its object, and…given sufficient time…a reduction of taxation will run a better chance than an increase of balancing the budget.” Keynes who advocated a larger and activist government understood that low taxes would result in higher productivity and higher tax collections. The U.S. went through an unprecedented economic expansion after WWII. We were coming out of a war, depression and had the industrial revolution to power the world’s leading economy. Our infrastructure had not been damaged by the war; in fact our industrial capacity was expanded to meet the demands of war material production. The world was hungry for raw materials, goods and services that we could produce. U.S. marginal tax rates were high, but there were many deductions that allowed taxpayers to manage their taxable income. GDP grows when the economy increases productivity. Productivity is driven by creative destruction and capital investment. The efficiency of the economy is not enhanced by propping up business that should have failed. Capital investment is made in anticipation of demand. Businesses buy equipment to increase productivity if they predict a reward of higher sales or wider margins. The availability of capital for capital purchases is hampered by competition from government borrowing. Government deficits must be financed by selling debt; this increases the cost of business to raise capital as the fixed asset market becomes more crowded. Simply put, the more to be borrowed the more it costs. In 2005, Jeffrey Frankel, the Harpel Professor of Capital Formation and Growth at Harvard University wrote, “if budget deficits remain large in the long run they can be harmful to the economy, because they soak up available saving… the budget deficits produced by the low-tax policies of 1981, 1989 and 2001 were accompanied by increased spending, not reduced spending. The fact is that Congress can spend money it does not have, and does so gleefully.” While we criticize the President for proposing large budgets, and painting dreams as big as the Montana sky, the congress only uses these budgets as a road map to even greater spending. All spending bills originate in the House of Representatives. IBM having workforce overseas may not be a direct result of tax rates in the U.S., it may be a simple business decision. They are a multinational corporation with operations that must be supported and expanded by a foreign work force. Our tax rates can drive business out of the U.S., but I would tend to believe in IBM’s need for foreign employees. Their success contributes to our GDP, and their manufacture of hardware cheaper overseas forces prices lower to increase the standard of living of all citizens, here and abroad. The answer to this question would be if their employees are spread around the world in a sales related function to serve different areas, or are their foreign workers congregated on low tax counties that produce products at lower cost. J.P., I hope this has addressed your questions. Friday’s MarketToday article on Pair Trading did not include the chart that showed the extreme swings in the relative value of oil and gold. We apologize for the breakdown in technology. We are constantly amazed at the communications available to us, but frustrated when all does not go as expected. You can view the complete article with the chart here. "In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the "hidden" confiscation of wealth. Gold stands in the way of this insidious process." ---Alan Greenspan, 1966 Funny how truths are forgotten, and time changes attitudes. The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions. It may contain errors and you should not make investment decisions based solely on what you believe you have read here. Do your own research, it is your money. If you lose it, it is your responsibility, not ours or your grandmothers! The editor may or may not have a position in any securities discussed. The editor may have held a position in a security earlier, or in the future. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Copyright © 2010 Freedom Development, Inc., 1377 N. Clearwater Rd. Clearwater, KS 67026 All rights reserved. The above message may be republished, retransmitted or forwarded with attribution to John Dalt of www.galtstock.com. We ask you to make us aware of any reproduction of our material at john@galtstock.com We may be able to return the favor. |
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