Federal Income Tax, Government Spending, and the National Economy

That title promises a lot, but it is very difficult to talk about one of these without talking about the whole system.  The Internal Revenue Service and the Federal Income Tax it collects are foremost in the minds of most people when it comes to discussing taxes.  I guess it is because we all (well almost all) have to deal with that April 15^th deadline every year whether we are paying any income tax or not.  And, about half of us are not paying any income tax. 

Actually that particular tax is not the big issue.  The big issue is government spending because all government spending will eventually have to be financed with taxes of some kind, and in 2009, the last full year for which data are available, total government spending in the United States was $5.87 for every dollar collected in Federal Income Tax.  So, where did the rest of the money come from?

The single biggest source was borrowing.  Even Social Security and Medicare taxes topped the Federal Income Tax.  So, while the president may try to blame our economic problems on Bush Tax Cuts for Millionaires and Billionaires, it is clear that funding our current level of government spending with tax increases on folks earning more than $250,000 a year (Euphemism = “Millionaires and Billionaires”) is not a remote possibility.  The grand total after Federal Income Tax-income of people earning more than $500K (Only breakdown available in the data) is less than $1T, and from that all the state and local sales and income and property taxes and Medicare and Social Security taxes must be paid.  So, if every single after-tax dime such folks earned in 2009 had been confiscated, Hugo Chavez style, it would not have come close to eliminating the need for borrowing to fund government spending that year.  And the data for 2010 and 2011 will be much worse.

And that is why spending must be cut dramatically.

Here is a longer term look at the trends on these important variables, total government spending and Federal Income Tax Revenues, as percentages of GDP.  Here again, this picture will be much uglier once final numbers for 2010 and 2011 are in.   

 Income taxes are down, not because of income tax rate cuts but because incomes are down.  Note that income tax revenue was growing, at the lower rates, until the real estate market crashed.  Surely we can understand that, beyond a level needed to provide essential government services, government spending has to force out private spending and investment and will result in lower incomes and profits and lower income and corporate taxes.  The single biggest thing we can do to improve the economy is get total government spending back to 30% of GDP with a combination of improved GDP and reduced spending to free up more of the nation’s resources for private spending and investing which will improve earnings and profits and government income from taxes.  I know that is a convoluted sentence, but it is a convoluted system I am trying to describe.  One variable cannot be changed without impacting all the others.

All the raw data from which the above are derived can be found here and here and here. 

Getting to the Bottom of Things: Universal Toilet Paper

Admittedly, we have become extremely materialistic, but given the expanding population and the tendency of folks to want to flock together in cities, I don’t see any other options for feeding, clothing, sheltering, medicating, educating, communicating with, transporting, and employing billions while still respecting human dignity and creativity.  It is too late, and there isn’t enough space, for everybody to have forty acres and a mule and enjoy, or suffer from, living off the land by the sweat of their brows the way many of our great grandparents did.  That is an option available now only to the wealthy.  And the Soylent Green solution and similar extreme approaches result in complete destruction of human dignity and elimination of rights to life, liberty, and the pursuit of happiness.

The US economy in particular comes under especially heavy criticism for rabid consumerism and wasteful excess, often linked with or blamed on free market competition.  I have heard the proliferation of toilet paper brands and varieties within brands put forth as an example of such waste.  “Why do we need a hundred kinds of toilet paper and all the advertising that goes with them?” the back to the earth advocates ask.

The answer to that question is tied closely with the value of competition and free enterprise as means of meeting the needs of the world.  Here's a parable: Suppose that prior to invention of toilet paper several cases of poison ivy occurred because of kids using leaves to clean themselves, and the idea of toilet paper (based on the fact that some had been using Sears catalog pages) was born.  Initially, the paper was a very expensive and scratchy novelty and used by only a few wealthy folks.  Entrepreneurs saw opportunity, entered the fray, and came up with cheaper paper, softer paper, multi-layer paper, flowered paper, service station bathroom paper, and brands and varieties proliferated.  TP Advertising emerged as a creative outlet, productivity and production expanded, costs decreased, prices dropped, distribution expanded, employment increased, and toilet paper became available everywhere at a variety of prices and qualities making it possible to pay as little as a half cent per wipe or as much as ten cents per wipe.   

Probably few of my readers shop at Dollar General, but those who do can get six rolls of toilet paper for a dollar.  (I did talk to one lady who said she couldn’t afford toilet paper and took it from her mother’s supply when she visited.  Probably the paper is cheap enough that her mother didn’t really mind.)

Alternatively, the government could have stepped in at some point in my parable, concerned about too much of the GDP going to toilet paper, and established a standard product, thereby avoiding the competition and advertising and proliferation of brands.  If that had happened, the results would have been only one producer and one product, manufacturing probably outsourced to China, all the paper rough, wipes costing fifty cents each, frequent shortages, and a third of the population unable to afford toilet paper requiring the government to begin issuing Toilet Paper Stamps.  Well, free enterprise competition does have some advantages.  

And of course this little toilet paper parable explains why health care costs are out of control in the United States.  Competition has been stifled and federal money has been pumped into the system and health care prices have expanded faster than any except perhaps education prices where we find exactly the same root causes: competition has been stifled and federal money has been pumped in.  The extent of government control of the health care market is such that we are very close to “universal health care” which would mean that everybody would have access to exactly the same expensive health care at the same or no immediate out-of-pocket cost, with no options available.  I had the thought several months ago that if that is a good thing for health care, it should apply just as well to food and housing.  So, why not Universal Food Stamps (Soylent Green?) which I blogged about and even Universal Housing?

But let’s get to the bottom of things: It's not too late for Universal Toilet Paper!  

And, if you are really more interested in the actual history of and other information about toilet paper than in free markets and competition, check out this website.

Three Simple Truths

Simple economic truths are easily buried under the avalanches of partisan rhetoric, empty promises, meaningless projections, nonsensical statements, ideological declarations, and emotional appeals that have flooded the country over the past few months.  Sometimes it helps to set up a simple example to call attention to some basic principles.

Suppose that, starting from scratch and recognizing the need for taxation to fund essential government services, a new nation imposes an impartial progressive income tax with no deductions, exclusions, exemptions, or credits.  Under this fresh and simple new system, all income is treated equally and everybody pays an easily calculated tax bill with little or no documentation required except for the self-employed who have to keep track of costs in order to calculate their taxable income.  The system is generally perceived to be fair because everybody with income pays something and those with higher incomes pay proportionally more but not so much that incentive is destroyed. 

Everything rocks along for a few years with a balanced government budget, reasonable tax rates, thin and simple tax returns, and a small and efficient IRS, but somebody becomes unhappy with the profitability of their business or their industry or their own personal income and has a bright idea.  Let’s say in this case that it is the homebuilding industry that becomes unhappy and argues that a tax deduction for mortgage interest would be “good for America,” helping citizens realize “the American dream” by owning their own homes, and “boosting the economy” (well one segment of it at least, and that at the expense of all the other segments).

So Congress, having received many letters and phone calls from home builders and material suppliers and would-be homeowners, a few free meals from industry lobbyists, and hundreds of $1000 campaign contributions, passes a bill to exclude from taxation any money spent on mortgage interest.  As a result of the spending of this money on a tax break for mortgage holders, because that is clearly what has been done, the government will have to do one of three things: Spend less elsewhere, increase tax rates to keep total tax revenue the same, or borrow money and start building debt. And that is the first simple truth!

Of course many will argue that the increased spending on housing will stimulate the economy.  It will stimulate housing and associated businesses, and will result in inflationary and bubble inducing price increases in those parts of the economy, but the additional money spent on housing has to come from somewhere and will result in less spending and de-stimulation in many other industries.  The effects on hundreds of individual businesses will probably be barely noticeable, but the total impact on them will totally offset the increased economic activity in housing. There is only so much money to be spent, after all, and spending it on one thing means it cannot be spent on another.  That is the second simple truth.

Once people begin seeing home buyers and builders benefit from the mortgage interest tax break, a long line will form of businesses and individuals who feel they are being treated unfairly or, at least, are missing out on something good.  They will be requesting their own special concessions in the form of tax deductions, exclusions, exemptions, and credits to benefit themselves and, of course, “help America” and “boost the economy.” 

 Charitable organizations will want gifts given to them to be tax deductible and auto makers will want special allowances for interest on car loans and for cars that burn less fuel.  Home appliance makers will want concessions for appliances that use less energy.  Farmers will want special consideration and protection against bad weather.  Somebody will want to build windmills and will want the government to reduce their tax bill if they do so.  Somebody will want the government to pay for their solar cells or wetlands nature trails.  Big Oil will want depletion allowances.  Farmers will want tax benefits for producing ethanol from corn.

Gifts and political donations will be made, laws will be passed, the tax code will grow, debt will accumulate, and fewer and fewer will pay more and more of their incomes in taxes even as an ever expanding portion of the population will pay no income tax at all.  And fairness will have died. And that is the third simple truth.

Well, that is the situation we have now in America.  We are fast becoming a nation of selfish and greedy fools, demanding more and more from Washington, and electing as our senators and representatives, selfish and greedy fools who will meet our demands in return for our votes, and we are getting just what we deserve: Debt and Inflation.  Many seem to be happy with current trends because they believe the government is in a better position than individual citizens to decide how to spend the earned income of the citizens.  Many are happy because they are paying little or no income tax and are getting lots of benefits.  But this big government nanny state that is rapidly expanding is bad news for the national economy on which we all depend. The trend will eventually lead to demand for a Hugo Chavez to rescue us.  That will be real class warfare.

Here is my suggestion.  Let’s reform our personal and corporate taxes to reduce rates and eliminate the exemptions, deductions, exclusions, and credits, yes all of them, even yours and mine, and improve our international competitiveness and maybe we won’t have to suffer any more stories such as the recent one about GE paying zero corporate tax on earnings of $5B.  I would be quite happy to see higher federal tax revenues to help reduce our debt if we get there with a much broader tax base and lower marginal rates.  And if we quit trying to send a check from the federal government to everybody in America, we will have plenty to help those who are truly unable to support themselves.