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Budget, Taxes & Jobs

The US national debt is dangerously high, our tax structure encourages this, and technology and outsourcing are eliminating jobs.  There is a surprisingly simple single solution to all three of these problems.

Table of Contents

Lack of Fiscal Responsibility
For decades, year after year, the federal national debt has grown, with the administrations of every president from Kennedy onward increasing it significantly1.  During that time, years with a federal surplus were extremely rare, with only Bill Clinton having two or more such years in a row.  The deficits run by George W. Bush and Barack Obama are staggering compared to those of Kennedy and Johnson, even when taking inflation into account.  The average deficits during the administrations of Ronald Reagan and George H.W. Bush were roughly $375 billion per year in 2013 dollars.  In contrast, Barack Obama has averaged a $1277 billion deficit for the first four years of his presidency.  As of this writing, the US budget deficit stands at $16.7 trillion2.  That corresponds to a debt of over $50,000 for every man, woman, and child in the country.

It this trend does not stop, the United States will face a financial fate similar to the one that recently befell Greece.  However, unlike Greece, the US is the largest economy in the world, and when our country goes bankrupt, the world economy is likely to experience an unprecedented contraction.  Unfortunately, the budget is going to be extremely difficult to balance.  Mandatory spending (mostly entitlements like Medicare, Social Security, and Welfare), defense spending, and interest payments on the national debt constitute 84% of the 2013 federal budget3.  However, total federal government revenues are only 76% percent of total spending4.  So even if the government was to eliminate all non-defense discretionary spending, it would still run a deficit.  A realistic plan for balancing the budget, assuming that the existing revenue and spending structure were unchanged, would require at minimum a tax increase, substantial defense spending cuts, and significant cuts in entitlements.  Doing so would cause the economy to take a big and sustained hit.  The country has been getting high for so long on deficit spending, cutting back is going to be very painful.

Loss of Jobs
From December, 2006 to December, 2009, the US unemployment rate more than doubled from 4.4% to 9.9%, and in the 3+ years since then has not dropped below 7.3%5.  Likely causes for this drop in employment are automation and outsourcing.  Between 1978 and 2007, there was a net 29% loss in manufacturing jobs in the US6.  This job loss was compensated in part by an increase in service and construction jobs; for example, over 500,000 construction jobs were added in 2004 and 20057.  However, these high construction employment rates were caused by the “housing bubble”, and when it burst from the Great Recession (about 200,000 construction jobs were lost in 2007-2009), there was no other boom industry to make up the difference.

Employment rates are likely to continue to be driven down by automation and outsourcing.  Independent studies have found that approximately 30 million US jobs, or 20% of the working population, are vulnerable to loss due to outsourcing8.  However, automation may actually represent the greater threat to jobs.  Jeremy Rifkin argues in his book The End of Work that we have finally reached the point where new job creation through innovation and entrepreneurship cannot compensate for the rate at which new technology eliminates jobs9.  MIT professors Erik Byrnjolsson and Andrew McAfee have argued that this trend will accelerate as advances in computer technology grow exponentially10.

Taxes, Subsidies, and the EPA
The US tax structure and federal subsidies are an integral part of the short-sighted culture in the US that has contributed to our staggering budget deficits.  Indeed, an income tax by definition promotes spending and borrowing (if interest payments are deductible), rather than savings and investment.  Both spending and borrowing create short-term prosperity, at the expense of the long term.  Returning to the drug analogy that I used above, spending and borrowing bring a temporary high, but to retain that high and avoid withdrawal symptoms, the spending and borrow must continue indefinitely, and even increase with time.

Federal subsidies have a similar affect.  They tend to produce immediate gains in the economy by stimulating investment and therefore production.  However, the subsidized industry quickly becomes dependent on the government to survive, and often subsidies stimulate an overuse of resources, putting the industry into worse shape than it was before the subsidies started.  For example, the US subsidizes the domestic fishing industry11.  This subsidy has contributed to overfishing in our territorial waters, especially in the North Atlantic.  The fishing industry is now suffering immensely, and would be worse off still if the subsidies were ended.

The EPA is one of the most complex regulatory bodies in the world.  While it has been largely effective, it has not been effective enough to regulate the thousands of new chemicals that are released into the environment every year, most likely contributing to the steady rise in cancer rates in the US12.  Furthermore, the EPA has declined to regulate carbon dioxide (CO2) emissions, a major cause of global warming.  This is most likely because CO2 is not considered a pollutant, and because decreasing CO2 emissions from any specific process would be extremely difficult, given that this cannot be done through modifications to the process as with other pollutants.

Subsidies for “green” initiatives often backfire, because of the law of unintended consequences, and the biases that are invariably introduced by the political process.  Here are two examples of “green” initiatives gone awry:

  • Production of ethanol from corn was subsidized until recently.  The idea was to use corn to produce a petroleum substitute, ethanol, that is clean burning, renewable, and in theory, CO2-neutral.  However, the subsidy turned out to be a disaster.  The green benefits of corn ethanol were almost nil, due to the very large energy requirements to ferment and distill the ethanol in the first place.  In addition, the diversion of a large portion of the corn crop to fuel rather than food severely changed the world food markets for the worse, resulting in famines in poverty-stricken countries like Haiti13.
  • Use of wind to generate electricity is currently subsidized in the US, and regulations require US electrical utilities to distribute wind power on the electrical grid whenever it is being generated.  However, environmentalist are concerned about the danger that large windmills present to migratory birds14.  Furthermore, since wind speed usually does not correlate with electricity demand, electrical utilities are forced to cycle coal-fired power plants, which were not designed for frequent start-ups and shut-downs, introducing significant costs to the electricity-generation process15.  There is also speculation that this cycling of coal plants could significantly offset the reduction in CO2 emissions caused by the use of wind power, although environment groups have disputed this claim16.

A Solution
What do these three apparently disparate subjects have in common?  All of these problems could be greatly alleviated by a radical change to our federal tax code.  Specifically, all sources of federal revenue, including income, Social Security, and Medicare taxes should be replace by a single consumption tax.  An average tax rate of 25% on the expected 2013 GDP of $15.7 trillion would provide revenue of $3.9 trillion.  This is slightly more than the 2013 US federal budget of $3.8 trillion, and would far exceed the $1.5 trillion spent on discretionary spending.

My plan would have the government eliminate all entitlement programs such as Social Security, Medicare, Medicaid, and Welfare.  This would restrict federal spending levels roughly to the level of discretionary spending.  The difference between federal revenues and expenditures would then be rebated each year back to the people on a per-household basis.  Since consumption from this rebate would also be taxed, revenues would rise to $4.75 trillion, so the rebated amount would be $4.75 trillion minus $1.5 trillion in discretionary spending, or $3.25 trillion.  In 2013 there were approximately 135 million households in the US17, so the rebate amount would be $24,000 per household.

This plan would have four very important benefits:

  1. It would provide an automatic safety net.  Whether or not you were poor, old, sick, disabled and/or unemployed, you would know that your family would be guaranteed a minimum income each year of $24,000.  Furthermore, these funds would not be restricted to your needy years, but would arrive year after year, returning some responsibility for planning your own life back to you and other Americans.  In other words, what you did with this money would be your own business.  Most people would use at least some of their income (from the rebate or employment) to buy health insurance and save for old age.
  2. In the long run, it would be a huge boost to the economy by encouraging savings and investment rather than consumption.  Indeed, any savings would be like a modern IRA or 401K, in that all of it would be tax-deferred.
  3. It would automatically balance the budget.  The idea would be that the amount that was rebated each year would be equal to revenue minus discretionary spending.  So, politicians could squabble over what the tax rate should be and how much money to spend on discretionary programs, but this would all be done against the background knowledge that adjusting either of these numbers would affect how much money would flow directly back to the people’s pockets.  There would actually be a popular incentive to raise taxes, since consumption taxes, in absolute amounts, would be born disproportionately by the rich.  Poorer citizens would actually see their income increased by an increase in taxes.
  4. A significant consumption tax rate and sizable rebate would make the effective tax rate against income highly progressive.  This would alleviate one of the big criticisms raised against a consumption tax; i.e., that such a tax would be regressive in that tax rate vs. income would presumably decrease with greater income, since the rich would be able to save more.  The next paragraph provides some detail in this regard.

Let I represent a household’s total income from all sources other than the rebate, R be the rebate amount per household, and t be consumption tax rate.  Then assuming that all income is spent and thus taxed, the formula for the effective tax rate is [t*(I+R) – R]/I.  With R = $24,000 per year and t = 0.25, the following table shows the effective tax rate against income for various income levels:

Table 1: Effective Income Tax Rate from a 25% Consumption Tax

Non-Rebate Income $1000/yr
Effective Income Tax Rate = 0.25 – R/I
0 -Infinity
20 -65%
40 -20%
80  3%
160  14%
320  19%
640  22%

Notice that the effective tax rate does not turn positive until a household income of $72,000 per year.  The assumption that all income is immediately spent is not realistic, so the effective tax rates, especially for the higher income brackets, would be lower.  However, taking savings into account still does not change the fact that this tax structure would be highly progressive.

A flat consumption tax would address several of the problems described above, namely the government’s lack of fiscal responsibility, the loss of jobs in the face of outsourcing and automation18, and the current emphasis on spending and borrowing rather than savings and investment.  But what about green subsidies and the EPA?  To make environmental policy in the US more effective, regulations for all but the most toxic pollutants could be eliminated.  Instead, the consumption tax described above would be variable by product, and based on the past and expected net environmental impact of the product.  Thus, for example, when a new automobile was purchased, the amount of tax would depend on the environmental impact created by its manufacturing process and the expected impact of its disposal (it would not include the impact of it’s operation, as that would be taken into account in the taxes on fuel and other fluids and replacement parts when purchased).

An environmentally-based consumption tax could easily be extended to greenhouse gases such as methane and carbon dioxide.  It would be much more effective than EPA-style regulations and green subsidies, since such a tax would avoid the law of unintended consequences19.  A high enough carbon tax would provide a strong incentive to find alternative energy sources, unleashing the innovative energies of the free market.  Any bad ideas, such as ethanol from corn, would be quickly killed by the market.

Such a tax would have two problems of its own, but both could be overcome.  The first is that figuring and administering the tax amounts would be a complex process.  However, it would be very straightforward.  The EPA would need to come up with a comprehensive toxicity or pollution index for all of the myriad compounds, ingredients, and emissions that make up the modern economy, certainly a daunting task.  However, once that was done, it would be a straightforward if cumbersome calculation to calculate the net index value for any product.  Tax rates would be tracked with each product along with the its wholesale price.

The second problem would be that environmental taxes would provide an incentive to reduce toxic emissions.  Doing so would then lower the tax base, and would require a corresponding increase in the tax rate to keep revenue constant.  This in turn would provide an additional incentive to reduce emissions, and the process would continue until it converged to an equilibrium.  This would put the US at a disadvantage economically compared to countries with more lax regulations or without an environmental consumption tax.  However, this situation would not be much different than the current situation with our complex environmental regulations.  In addition, it would be in the interest of all countries to adopt an environmental consumption tax, and doing so would level the playing field.

Conclusion
A consumption tax is not a new idea.  Taxes in the US were originally based on consumption20, and the ability to levy an income tax was not granted to the federal government until the sixteenth amendment to the constitution was ratified in 1913.  The income tax was adopted to encourage consumption and to promote a progressive tax structure, but as we have seen, the former is short-sighted and the latter can be overcome.  Returning to a consumption tax would solve many of the most difficult problems facing the country today.  Furthermore, an environmental consumption tax would be an ideal way to promote environmental health.

Unfortunately, the powers that be are dead set against such radical change.  They are correct in that a cold-turkey shift from an income to consumption tax would cause a great deal of pain and economic disruption, and for this reason such a switch would have to be phased in, over a period on the order of 10 years.  Even so, I fear that such a significant change is beyond the capabilities of our modern political process.  The only possibility of making it happen and saving ourselves is to educate the public on the benefits of an environmental consumption tax, such that they demand this reform from their elected lawmakers.  The time to start this process is right now.

End Notes

  1. Manuel, Dave, “A History of Surpluses and Deficits in the United States”, URL=<http://www.davemanuel.com/history-of-deficits-and-surpluses-in-the-united-states.php>.
  2. Hall, E., “U.S. National Debt Clock”, URL=<http://www.brillig.com/debt_clock/>.
  3. “2013 United States federal budget”, Wikipedia, URL=<http://en.wikipedia.org/wiki/2013_United_States_federal_budget>.
  4. Ibid.
  5. “Databases, Tables & Calculators by Subject”, Bureau of Labor Statictics, URL=<http://data.bls.gov/timeseries/LNS14000000>.
  6. Morss, Elliot R., “The Loss of American Manufacturing Jobs: What Are The Facts?”, URL=<http://www.morssglobalfinance.com/the-loss-of-american-manufacturing-jobs-what-are-the-facts/>.
  7. “Current Employment Statistics – CES (National)”, Bureau of Labor Statistics, URL=<http://www.bls.gov/ces/ceshilightsarch.htm>.
  8. Levine, Linda, “Offshoring (or Offshore Outsourcing) and Job Loss Among U.S. Workers”, Congressional Research Service, December 17, 2012, URL=<http://www.fas.org/sgp/crs/misc/RL32292.pdf>.
  9. Rifkin, Jeremy, The End of Work, Tarcher/Putnam Books, New York, 1995.
  10. Byrnjolfsson, E, and McAfee, A, Race Against the Machine, Digital Frontier Press, Lexington, MA, 2011.
  11. Knight, Jo, “New Study Shows Eliminating Harmful Subsidies Could Improve Health of U.S. Fisheries”, The Pew Charitable Trusts, March, 3, 2009, URL=<http://www.pewtrusts.org/news_room_detail.aspx?id=49752>.
  12. Barron, Jon, “Growth of Cancer”, The Baseline of Health Foundation, February 21, 2011, URL=<http://www.jonbarron.org/article/growth-cancer>.
  13. Miller, Henry I., “Ethanol Subsidies: Dumping Corn In The Ocean Would Be A Better Idea”, Forbes, June 7, 2011, URL=<http://www.forbes.com/sites/henrymiller/2011/06/07/ethanol-subsidies-dumping-corn-in-the-ocean-would-be-a-better-idea/>.
  14. Taylor, James M., “U.S. Wind Turbines Kill 1.4 Million Birds and Bats Every Year”, Heartland Institute, July 24, 2013, URL=<http://news.heartland.org/newspaper-article/2013/07/24/us-wind-turbines-kill-14-million-birds-and-bats-every-year>.
  15. Lefton, S.A. & Besuner, P., “The Cost of Cycling Coal Fired Power Plants”, Intermountain Power Agency, URL=<http://www.ipautah.com/data/upfiles/newsletters/CyclingArticles.pdf>.
  16. Anscombe, Nadya, “Increased cycling of coal plants should not boost emissions”, Environmental Research Web, July 22, 2013, URL=<http://environmentalresearchweb.org/cws/article/news/54123>.
  17. “Total Number of U.S. Households”, Statistics Brain, URL=<http://www.statisticbrain.com/u-s-household-statistics/>.  I extrapolated growth from the previous census to get a rough number for 2013.
  18. The rebate would help the joblessness by providing a safety net.  It would not help the psychological problems associated with unemployment such as lack of self worth and excessive idle time.
  19. In fact, all government subsidies should be eliminated, since, as I mentioned above, they distort markets and are short-sighted.  Doing so would also slightly decrease federal discretionary spending.
  20. “Consumption tax”, Wikipedia, URL=<http://en.wikipedia.org/wiki/Consumption_tax>.

November, 2013


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