Sequestration – How To Get $1.2T Without Killing Demand In The Economy

Demand is what drives business growth, opportunity and economic prosperity.  Over the past few years, demand has contracted in many industries, yet over the past 24 months, we have begun to experience a slow and measurable path towards real GDP growth.  Demand is increasing in the US and American businesses are in fact responding appropriately by slowly and carefully increasing investments.

In 2011,  Congress (The Super-fail Committee) created a self-inflicted wound commonly referred to as Sequestration.  With December 31, 2012 fast approaching, Congress has turned the situation into what is commonly referred to as the” fiscal–cliff”.  If Congress has its way, it will attempt to destroy growth for the foreseeable future by inaction and stupidity.  And to think, these folks are getting paid to reach this conclusion.

First, let’s start off with a baseline.  Sequestration.

Congress wants to reduce the deficit by $1.2T over the next 10 years by implementing across-the-board cuts of $600B from Defense and $600B from the Discretionary budget.  VA, Homeland/National Security, Medicare and Social Security were excluded.  Sequestration is how Congress refers to this process.

To be clear, the Discretionary budget includes the FBI, National Institute of Health and Farm subsidies to name just a few; while Defense includes Pentagon, spending, weapons systems and troops.  Each of these budgets represent jobs and demand.

For the people that say government does not create jobs, the sequestration reality clearly contradicts that assertion.  Observe the gnashing-of-teeth going on as defense contractors and Congress warn of massive job losses if the government reduces spending.  Government not only creates many jobs of its own, it creates the demand for solutions that unleashes the private-sector to satisfy that demand.  The private-sector responds by creating innovative solutions, products and services – which in turn creates value for the entire nation.  This is how private industry and the public sector work together in a healthy symbiotic manner that can create economic prosperity for all citizens.

However, cutting $1.2T out of the economy in the manner outlined in Sequestration will negatively impact demand to the point where the cascading effect will be major job loss, de-funding research and development, elimination of valuable services, and further consumer/business contraction.

Yes, there are expenditures in the discretionary budget and the defense budget that can be trimmed; however, by practicing the naive concept of straight-line cuts without any departmental input or strategic logic, we put efficiency at risk.  In other words, I might be willing to cut 100% out of a low-priority program while needing to invest 5% more in another program to make it more efficient.  Cutting both programs by the same percentage is not prudent.  As long as a department can achieve the ultimate cost-reduction goal while preserving the effective deployment of the mission, why would we want Congress to tell them exactly how to do it?

While they dither, let’s see if we can find our own solution which can be implemented over the next 30 days.

Solution:

1.  Issue a directive for the individual departments to identify spending cuts totaling  $550B (not $1.2T) in spending and give to the appropriators in Congress by December 30.  $275B in discretionary, $275B in defense.  Since these departments have been staring at $1.2T in cuts for the last 12 months, they have already determined how to cut $550B and can provide those answers quickly.

As a business person, I understand that allowing the individual departments to budget to a net goal (scalpel)  is preferred over an across-the-board (hatchet) cut since it encourages the departments to prioritize and build performance-based budgets. The economy can handle $550B in spending cuts if done in a strategic manner.

2. The President has offered $450B in savings from Medicare.  Don’t be an idiot – take it.

3.  Tax rates are returning to Clinton-era rates.  We can hate it/fight it/deny it but everyone knows that after this particular election, tax revenue is going to be on the table.  If you can get a deal to permanently exempt the first $250k in adjusted income from taxation – for all Americans –  don’t be an idiot – take it.

Some might feel it best to let these tax cuts expire for everyone and they may be right.  However, that plan does not seem to be in vogue.   However, the tax cut will cost the Treasury $650B.

This means upper-income rates are going up to 39%.  Treasury savings will be $450B.

4.  Fight to limit the increase in Capital Gains rates to 25% versus 40% and keep Dividend rates at 25% as well.  By the way, neither capital Gain or Dividend income is ever “taxed-twice”.  What is taxed is the gain, not the principal.  If you earned $100k in adjusted income and paid taxes of $35,000, you are left with $65k.  If you then invested your $65k in stock that either dispersed a dividend of say $5k or sold your stock and earned $5k, you are taxed on the $5k not the underlying principal of $65k.

To be honest with you, if you lost the $5k and lost the entire $65k, you can actually take that loss against your future gain/earnings.  In America, we reward “capital and investment risk” … twice.  So in reality, you are only taxed once on principal and once on gain but if you lose money, you actually are credited for losing principal.  Treasury savings will be $300B.

5.  Make this all happen the first week of January so those finding it impossible to ever support a tax-rate increase can be freed from their self-imposed restriction.  Since the rates expire on December 31, 2012 and that expiration was approved by a previous Congress, any rise in rates is actually the fault of the previous Congress.  “Yeah … that’s the ticket .  This allows the Congress in place in January to go on record as permanently lowering taxes for current and future generations of tax-paying Americans.

6.   Spending for the budget actually fell  last year lowering the need to cut the full $1.2T.  The spending reduction is projected to save $50B over 10 years; therefore lowering the Sequestration goal to $1.150T

Goal : Achieve $1.2T in reduced spending or new revenue.

Solution: Achieved a combination of cuts, reductions and revenue valued at $1.2T.  ($1.2T -$550b – $450B + $600B – $450B -$250B – $50B = $0).

This resolves the dollars necessary to stave off Sequestration.

This does not deal with the “BIG DEAL” of $3T more in deficit reduction but it does take us off the cliff and add certainty to the marketplace.

This does not deal with the expiration of the Unemployment benefit extension , the Medicare tax-holiday or the Doctor-fix for Medicare; which represent a cost of close to $130B.  However, I have also not accounted for the change in the Inheritance Tax once the rates expire on December 31, 2012.  The 10-year value of the Inheritance-Tax change is over $120B .

I have also not added any new spending for infrastructure and education as the President has requested in his $4T “BIG PLAN”.  He is asking for at least $80B in new spending.

Nor have I attempted to capture the elimination of any deductions at this time since i am not exactly sure how long it will take for everyone to be honest about which to eliminate   As you know, the total value of all deductions – individual and corporate, is over $100B per year.

Nor have I accounted for the savings related to ending the wars.  Many have panned the President for using spending related to the wars in his savings calculations.  Unfortunately, many in the public do not recall the Bush Administration purposely excluded the cost of the wars from their budgets and Congress did not add the costs either.  These costs were considered extraordinary expenses and were treated as an off-budget line item.  Supposedly, since no one knew how long the wars would last, no one thought they should actually include the spending in their 10 year budget projections.  The GAAP gods were not be happy.

The off-balance budgeting process made the budget appear lower yet everyone knew we were still going to spend the money for the wars because no one was talking about ending them.  Long-term deficits forecasting would not include the wars.

Obama included the wars in his budgets – immediately creating deficit spending in his first budget.  He took a lot of heat for his “on-budget” war model because it added and compounded the deficit.  However, now that he is out of Iraq and getting out of Afghanistan, (date-certain), he is removing $1T from his 10 year budget forecast.  This is how he can claim $1T in budget savings.

When it is time to negotiate the BIG DEAL, as you can see, there are a number of opportunities.

However, for now, we are focused on the $1.2T related to Sequestration and we appear to have a solution for that particular problem.

 

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2 Responses to Sequestration – How To Get $1.2T Without Killing Demand In The Economy

  1. btg5885 says:

    You are always very thoughtful in your posts. I like the way you present the math problems that face us. The significant majority do not seem to focus on the math. I made a comment in a group setting yesterday that started some provocative conversation. I said both parties are misleading the American people and we need to increase taxes on everyone as well as cut spending – otherwise the math won’t work. There were several who agreed, but some who were clinging to the notion we need to cut taxes. People do not realize that falling off the cliff actually gets us closer to where we need to be; it is the abruptness of it that is the consternation that could cause the economy to stall. Barneysday advocates ripping the band aid off. Intellectually, it would be interesting to see that approach, yet I would tend to advocate a staged approach which gets to much more revenue than is being discussed above (along with spending cuts). Well done, BTG

    • vincentmudd says:

      Is it just me, or does it seem like there are folks in Washington who feel like there job is to get elected … not govern. It’s almost like a pass/fail grading system where getting elected is pass; losing is fail ; governing is only an elective and no points are given out.

      I say this because how is it possible for the answers to be so apparent yet purposefully presented to the public as elusive? However, if the goals and rewards are only based on getting elected, it is easy to see why governing simply does not count to some of these folks.

      To be clear, intra-party line votes for every piece of legislation is not governing. Disagreeing with your own party is the best part of governing because it forces people with the same ideals to argue, fight, compromise , or respectfully agree to disagree – while still agreeing to get something done.

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