I Put a Deal on the Table

Bruce Krasting's picture

 

The lack of anything concrete coming from either side on the cliff debacle is troubling. I don't think the process should be as hard as it is made out to be. I have a plan. I try to address all the hot-button issues. I also try to force significant concessions. I attempt to craft something that has a chance of working.

 

Before the specifics, I have to address the broad topic of "Debts and Deficits". My thoughts on the "big picture" drive some of the details in my proposal(s):

 

A) It is not possible, nor is it desirable, for the USA to have a balanced budget at anytime in the foreseeable future.

 

B) It is possible to reduce the deficits to a more manageable percentage of GDP. Achieving this will result in a lower trajectory of the rate of increase in the national debt.

 

C) All talk of deficits, budgets and taxes is a fools game. There is only one thing that matters. Economic growth will solve the debt problem, or it won't.

It doesn't matter what the tax rate on the top 2% is, or if the retirement age is pushed out a few years. For the next ten-years, it will be grow-or-die. Washington has to focus on that side of the equation. As of today, all the focus is in the wrong direction.

 

It proved difficult for me to solve all of the crushing economic issues facing the country in 300 words or less. My thoughts are presented first in summary, after that, the details.

 

SUMMARY

 

A series of compromise on taxes and spending that results with:

1) Income of $250 - $450 > to 37.5%.

2) Income of $450+ to 39.6%.

3) Income <$250 - Bush tax cuts are made permanent.

4) Long-term Cap. Gains - unchanged.

5) Patch the AMT for one-year.

6) The Payroll tax for Social Security reverts to 6.2% - A 2% increase.

7) Deductions for state and local taxes paid will be capped at $30,000. Deductions for mortgages and charity will be retained.

8) Inheritance tax will be 40% over $4m.

8) The Transaction Account guaranty will be allowed to expire.

9) Emergency unemployment benefits will be extended for one year.

10) The programed cuts in spending (the Sequestered Amounts) will be reduced by 50%.

11) Social Security and Medicare spending will be reduced by $1T from 2014 - 2023. 50% of the savings will come from Medicare, 50% from Social Security. The framework that achieves the savings at Social Security will be applied to both the Military and Federal Workers retirement funds.

12) A four-year, $500b spending program dedicated to infrastructure building will be established. A portion of this program will be funded with new federal excise taxes.

 

Now the long-winded discussion:

 

On Taxes

- The Bush era tax breaks for those under $250k should be made permanent. (Both sides can take credit for this)

- The Bush breaks for those >$250 will be increased as follows:

a) $250-450k goes to 37.5%

b) >$450 goes to the full 39.6%

The change in tax rates would be a substantial concession by Republicans. This is nearly 100% of what Obama has demanded. Note the carve-out for the $250-450 set. That actually is a significant portion of the top 2%, so when you look at the reality, the Republicans don't do so bad.

This increase in taxes would fail to achieve the minimum of $800b of increased revenues that Republicans have offered. To bring the revenue number up to $1trillion (Obama now wants 1.4T, but he previously agreed to 800b) I propose that there be limits put on deductions. This is an issue that Republicans have insisted on. Democrats hate this topic as it hurts homeowners (mortgage deduction) and charitable giving (this is about Religion).

To defuse this very tender topic I propose to limit deductions on only one class of deductions. State income and local property taxes deductions would be subject to a cap. The cap would be around $30,000. ALL other deductions would remain as they are today.

Who would win with this cap on "other taxes paid"? Red states like Texas would win very big (no state income tax). NY, California and Illinois would get crushed (all big Democratic states with big income and property taxes). It would drive a stake into the political "prizes" in the country.

All the big-ticket fund raisers for the Democrats on both coasts would pay for this compromise. If Republicans want some additional revenue, and to set themselves up for 2014, they will push for this. The Democrats won't have a leg to stand up on with any opposition.

 

-AMT would have to be patched over for another year. There simply is not enough time left for this complex topic to be worked out before New Year's Eve.

This is a terrible, stupid, awful, unfair and ill-conceived tax; but some form of it is necessary.

The classic example is Mitt Romney. He made $10m and paid 11% tax. Sorry, there has to be a minimum. The current minimum level for AMT is an absurdly high 28%. I think it should be 20%. A new minimum tax has to be part of a deal; it broadens the base, it raises revenues and insures that fat-cats like Warren Buffett finally pay their "fair share" (I want Warren to get what he's been saying).

Let's be clear about the implications of a minimum tax. Yes, it does some good things, but it will also have the effect of reducing charitable giving. Mitt would not have given $4m to the Mormon Church if he'd been faced with a 20% minimum tax. The "tax-efficiency" of his giving would have capped out his charity at only $2m. (It's about the money, after all)

Anyway, we're talking budgets and taxes; hard choices have to be made. Last I heard, there was something about Church and State anyway.

 

-The 2% reduction in payroll taxes will be eliminate. Sorry. Either Social Security (SS) is a self-funded program that doesn't add to the deficit (as so many liberals have claimed), or it is an entitlement program that sucks down $170B a year from the general tax payers. Those who love SS can't have their cake and eat it too.

Note: The 2% increase on payrolls is a very regressive tax increase. Come January, it will be felt by 155m workers. They will all hate that. This is a perfect opportunity for Republicans/Conservatives to swing popular opinion away from SS. This "mind change" of the voters away from SS is the only hope that Republican's have.

 

-The current low tax rates on dividends and capital gains will be retain. However, the establishment of a minimum tax (see above) will raise the effective tax on capital to 20% for those who have incomes/deductions that make them subject to the minimum. Again, this is a compromise that both sides should be willing to accept.

 

-Inheritance taxes will be set at 40%, the threshold for the tax will be set at $4m. (another compromise)

 

 

Okay, that solves all the tax matters that people have been fussing about. Now the rest of the issues:

 

Regulatory

- Do not extend Transaction Account Guaranty (subsidy for banks, TBTF issue - Trust me, the world will not end when this happens).

- Extend unemployment benefits for yet another year.

These trade-offs are on political lines. No one should argue about this horse-trade.

 

Sequestered Spending

IMHO, the cutback amounts that were agreed to as part of lat year's Budget Control Act were draconian. They were more of a "show-pony" to prove to the public that D.C. was serious. Recall that a lot of the maneuvering on this was driven to placate the likes of S&P. The motivations for setting the sequestered amounts were misguided. If there is to be a deal before the end of the year, a very big concession has to be made by both sides on spending.

Time does not permit much finesse in this important area. My simple solution is to cut the sequestered amounts in half.

 

Multi Year Stimulus Program

The problem, and the solution, is staring us in the face every day. The country needs a big investment in infrastructure. All our "stuff" is falling apart. Want construction jobs? Build things. Want high paying jobs? Build complicated things. Want economic growth? Build things that will have a long-term return on the investments. The list of things that need fixing/new is endless. The only question is, "Where does the money come from?"

 

I propose doing something radical. I would like to establish a national sales tax. The tax would be 1/2%; it would be applied to all retail sales EXCLUDING autos. The tax would be collected by the individual states. Washington would put up an additional $5 for every dollar of federal sales tax.

The retail sales number (again- ex-autos) is nearing $4T. A 1/2% national tax would raise only $20b. Such a small amount would not have a significant negative consequence to the economy. D.C.would contribute 5Xs the amount collected; bringing the total in year one to $120B. I would create borrowing authority for up to 75% of the next few years of anticipated revenues (this borrowing is secured by a dedicated source of revenue. This is a different type of debt, it gets paid back.) Borrowing will facilitate/accelerate the timing of the new infrastructure investments. 100% of all of this is spent on infrastructure - no leakage permitted. The states choose the projects.

$120b is a decent sized stimulus (equivalent to the 2% payroll cut). To be effective, there would have to be a commitment to do this for a minimum of four years. Every year, there would be an obligation of Congress to either extend it for an additional year, or let it die in the remaining three.

This would help the broader economy. Jobs would come fairly soon after inception; every month the demand for labor would rise. The results would be visible in a matter of years (new roads, bridges, airports, seaports, water projects etc.)

What I am proposing is very modest. By itself, it will not create a boom. Economically, it is a step in a direction that must be taken. Remember, it's grow or die. There will be opposition to any new tax, especially a federal consumption tax. It will add to the bill at the grocery store, gas pump and Wall-Mart.

Call me a fool, but I believe that everyone should have some skin in the game. Yes, the cost of a quart of milk for a family already living on the poverty line will go up by a penny. And the cost, all in, for those new spiked heels, will be $2.50 extra. But the fact is, the milk is probably being bought with food stamps, and who cares about the cost of those stilettos (or a boat for that matter).

I say to D.C., "Suck it up!" and get this done. If there is no movement on this front in 2013, then you can kiss off any chance for digging out of an economic hole for the rest of the Obama years.

The politics of this are interesting. I would like to hear a Pol say that this (or some/any version) is "off the table". That legislator would get their picture in the paper, for being a fool.

The deficit hawks will not like this. It would add $100b a year onto the deficit ledger. To this, I say that there are two kinds of debt; one is bad, the other is okay. NYC's Triborough Bridge has paid for itself 50Xs over. Same with the Golden Gate,the airports, the interstate, the water clean up/availability investments etc.

Who would love this plan? All fifty Governors would cheer. The states would have a pot load of money to spend. Yes, this will create its own set of problems, but governors can be held accountable a lot easier than some technocrats in D.C. If money has to be spent (it does) then I think it is better spent by the states.

Another group that would cheer, would be the 1,000,000 small business's (and their employees) who would benefit. What needs building requires steel, aluminum, concrete; it needs welders, masons, truck drivers, architects, engineers and designers.

So far I've covered all of the critical variables (including a nifty stimulus idea), save two. What remains are the thorniest of all issues. What to do with the debt limit and what to do about entitlements (Social Security/ Medicare/all other federal retirement plans).

 

The Debt Limit

The debt limit is one of the dumbest things ever created. It is an issue that, at the extreme , could send the country into a depression in a matter of months. (We came fairly close a year ago.) The debt limit creates the opportunity for a self inflicted wound that could lead to a systemic implosion. With these things in mind, it's easy to say "Fix this!".

But, sadly, the debt limit is a speed bump that must exist in some form. The US debt trajectory is simply unsustainable. Something has to exist that acts as a "check" in the system. That check is not coming from the White House, Congress or the Federal Reserve. The only thing left holding back exponential growth of red ink is the debt limit. So, as flawed as it is, the concept of a debt limit has to be retained.

This would be a big concession by Obama. In exchange for giving in on this, the Republicans would be forced to set a new debt limit that would cover the country through the 2014 elections. The debt limit agreement would be held hostage to a resolution of the final, and most difficult of all issues, entitlement reform. There is not a chance in a million that there can be any agreement on entitlements in the next 17 days; the issue is too complicated and too emotive.

 

Entitlements

There would be a framework for reforms as part of a deal to get over the cliff. In order for all of the tax fixes and other compromises I've described to get inked before the lights go out, there would have to be a deal that outlined the scope of the cuts in entitlements. Both sides would know what has to be accomplished, and be committed to the process.

Legislators would have a short window to complete a final agreement. If there is no deal on what gets cut to achieve the agreed target by April, then everything falls apart in a very big way. The debt ceiling extension (required in April) will be contingent on a final agreement on entitlements. The targets for entitlement cuts that will be agreed to in December and made into law by springtime:

2014 - 2023 Cuts in Social Security and Medicare = $1,000,000,000,000.(The Big T)

The cuts will come 50% from Medicare, 50% from Social Security.

 

I can hear the screams already. Obama wins the election, then turns on his base and guts America's favorite social programs? Not a chance! Hear me out.

- Over the ten-year period, Medicare (Does not include Medicaid and CHIPS) will pay out 4% of GDP. In real dollars that comes to $9T. $500B (5.5%) of savings/cuts has to be found as part of the final deal.

- Social Security will pay out $11 Trillion. Both sides of the aisle will have to find ways to cut $500b (4.5%).

What I'm proposing is by no means "gutting" these programs. If the folks in D.C can't agree on cutting $1T out of $20+T over ten-years, the country would deserve the consequences (Shutdown, default, downgrade). To get the complete package of a cliff saving deal, all of the parties would have to agree to the $1t, and sort out the details in 90 short days.

Obama has said that he would have a discussion on entitlements, "sometime next year". That doesn't work, it's not what most Americans want. It's asking for a fight. Obama, a number of Democrats, and the House Republicans, have to do what the have already promised.

I'm certain there is a political consensus to take a walk in this direction. No "new thinking" is required. The tools to achieve this have been discussed to death. Age and COLA adjustments, means testing, more taxes on benefits, higher fees. A beat down on the providers, blah, blah blah.

It would not be difficult to suck $1t out of these two very big pieces of the pie. To a significant extent, this would have to be born by those with both means and/or income. We are headed in the direction where medical benefits will be priced at 100% of the Social Security checks for those who have done well for themselves. Sorry.

Liberals will hate this. Their opposition is ideological, not economics. I think they have no argument at all. The objective of the changes in entitlements is to strengthen these programs so that they can achieve what they were intended for. An insurance safety net, not a retirement program will free medical.

70+% of the people who get these benefits are heavily dependent on them for basic necessities. The goal is to ensure that the 70% get what they need, the 30% who are less dependent (or don't really need it at all) have to pay a price.

One can't take a more liberal position than this. So folks like Krugman, Pelosi and all of the other defenders of "the safety net" will have to stand by and watch this happen.

Conservatives won't be pleased either, by and large, this is money out of their pockets. What they (and the country) get in return is an economic plan that has a chance, and a very important directional change for entitlements. That result would be worth the cost.

 

If Obama wants a legacy he will have to solve the fiscal cliff in a way that addresses the real problems the country faces. That means he has to take on entitlements. If Obama chooses to extend the Roosevelt Dream, there will be no fiscal cliff deal, and he will have no legacy at all.