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A Common Sense Approach to Resolving the Deficit

Garrett Fisher
April 28, 2020

It seems almost foolish to bring this idea up during coronavirus and the trillions of non-recurring spending being utilized to combat the economic effects of the virus; however, it is worth analyzing as the magnitude of the deficit will soon become a talking point, once the biology of the virus is behind us.

As stated in more than one article, I have viewed the annual trillion-dollar deficit in the United States as an existential threat to the wealth of the country. The simple takeaway from generating so much debt, during boom times, is that our economy is false. Nothing can be taken for granted as being sustainable or reflective of the economic, political, or social health of the nation, as the entire structure is sustained by record deficits during good times. That argument was bad enough before COVID-19; now, it is even more paramount. I will address some common sense methods to narrow the deficit hole, once we have gotten past the current crisis and the economy isn’t in shambles.

I must preface that I think the most any President could do in one sitting is reduce annual deficits from $1T to $250B, and that is an optimistic scenario. Anything greater than that would shock the economy by the magnitude of the change as well as deliver unpalatable political realities. Any politician interested in his or her own self-preservation would likely only be concerned with getting out of what I call the “danger zone” of astronomical deficits, bringing them down to a level where the damage isn’t irreversible.

Cutting Spending

I think this idea has seen its expiration date. I say this, not as a partisan statement, but as an objective reflection of what 10 years of howling about deficits by the likes of the Tea Party has produced. During the time as an opposition party, some spending was trimmed, but not a material amount to use spending cuts as a means to close the budget gap. During the period that the entirety of Congress and the Presidency were under Republican control, material spending reductions were not put into law. While a tax cut package was passed, meaningful cuts to spending didn’t happen. I think the takeaway is that, if cuts didn’t happen during the 2017-2018 Republican majority, then they likely will not happen at all.

It would be impossible to make the above statement without somebody having a fit that it’s all the Democrats’ fault, etc. My contention is that, the moment in the sun for the electorate to have selected the parties in power and furnished a clear mandate has passed. Nobody is protesting in the streets to cut spending; the people have had other concerns. Most are happy with the size and function of government (in that they have not cohesively demanded action otherwise), so continued talk of drastic reductions in the size of the federal government would likely be rhetoric or a minority rallying cry. Perhaps some nips and tucks to the tune of 5% could be done without upsetting the apple cart. For example, President Trump had asked for various military spending increases, and Democrats insisted that those increases be matched dollar for dollar toward regular programs. Reducing both increases would be a simple start.

Raising Taxes – the Problem

George HW Bush is a great example of what happens to politicians that champion the increasing of taxes: they get voted out of office. It is inherently a poison pill to sell to the populace a broad tax increase. The opposite is also true: to sell an illusion that citizens can have their cake and eat it too (cut taxes and maintain spending) is a recipe for political success. It is for this reason that I wrote “A New Political Template – Fiscal Solvency as a Constitutional Bedrock,” as the current system is wildly broken. Whether a left- or right-wing spending package or tax cut is passed, there is no requirement for Congress to pay for it; they merely appropriate and Treasury borrows money. That allows one Congress and President to get their policy way, while kicking the financial consequences to the next session, guaranteeing nonstop acrimony and dysfunction. To link policy to spending would force some more adult conversations.

Nonetheless, there is a more current matter of how to address raising revenue without asking a President to commit political suicide. Can it be done? As we know, nobody likes income taxes. While it’s easy to say, “tax the rich,” there is a certain limit to the wellspring of other people’s wealth. That, and is it moral to take more than half of someone’s income? It has been done, though the concept isn’t vastly popular. Estate taxes are greatly disliked as well, so that leaves quite a quagmire. How does one raise revenue when nobody wants to pay?

Raising Taxes – Some Practical Ideas

  • Capital Gains Tax – I had to do some research on this tax, and it’s interesting that a different tax rate for capital gains has been around for decades, with rates somewhat arbitrarily selected, albeit most of the time lower than ordinary rates. The most recent reduction was during the George W Bush administration, and the rationale was touted to afford an opportunity for Americans to save and invest. I find some ironies with this tax, as it charges less for income earned without the performance of work (sometimes there can be value added labor, but most of the time it is passive), yet taxes where people work full-time are in a higher bracket. Why is the reverse not true? Economists say to “tax what you don’t want,” and it seems to be that we punish work. Anyhow, my proposal is to split the baby and adopt both Mr. Bush’s idea and mine: keep lower long-term capital gains rates for incomes up to $500,000 to allow rich and poor alike some annual preferential rates, and then tax everything above $500,000 in capital gains using normal rates. This type of income is exempted from social security tax, so it still receives preference.
  • Qualified Dividends Rates. The W Bush administration championed the idea of the unfairness of double taxation, that a corporation would pay tax, and then the shareholder would pay full tax again on the dividend. I agree with the moral of the argument; however, there is a giant hole in the budget, so ideally there is a productive policy solution. My proposal would be to afford qualified dividend rates, provided that the paying corporation met certain tax guidelines. If it did not, then the dividend would be taxed at normal rates, creating a shareholder revolt and encouraging the company to voluntarily come into compliance. What kind of criteria am I suggesting? For public and large companies, an alternative calculation would be used to ensure that the total, global tax paid on all internal net income (not taxable, but accrual) meets a reasonable threshold (not necessarily as high as the listed tax rate). It would be a lot like the individual Alternative Minimum Tax. If, after all corporate tax scheming and planning was done, the company was paying too little tax, then the dividends would be forced to be reported as non-qualified, and the shareholder would pay more. If the converse were true, the shareholder gets preferred income tax rates. Reporting would be done at the payor 1099 level.
  • Corporate Income Tax. The 2017 tax cut package doubled the size of the current deficit. There was a good component in the tax package in that a long running problem where corporations were perversely encouraged to keep money abroad was closed (albeit with another loophole where the tax rate and effective tax of repatriation was minimal). That should be kept, with loopholes closed, and corporate rates taken halfway to where they were: 28.5%. It’s a form of keeping the spirit of the 2017 reduction, while working to bring the budget down. America would no longer have the world’s highest corporate tax rate, while still having delivered a business-friendly tax cut. Impact: $106 billion per year.
  • Corporate Share Buyback. I contend that share buy backs are an inefficient use of capital, especially if debt was used to finance it. There are market forces that demand conservative Boards and CEOs engage in this kind of act even if they didn’t want to, so some form of tax policy adjustment would rein in this kind of behavior. I would propose that share buybacks be treated as a qualified dividend disqualifying act or face a tax surcharge (in the case of no dividend) if the buyback exceeded certain balance sheet ratios. In other words, companies should be allowed to buy their shares back, but not using debt or other mechanisms if the company wasn’t strong enough. Tax code edits to encourage dividend payouts instead would dovetail nicely, as the more income paid out means more tax paid and more income distribution, whereas share buybacks are limited in who they benefit.
  • Pass-through Tax Deduction (QBI): This tax deduction is in effect from 2018 until 2025 and affords a 20% deduction on the “pass through” portion of income from partnerships, sole proprietorships, REITs, PTPs, and S corporations. I see no real benefit for this on a non-targeted scale, as its benefit is indiscriminate and somewhat arbitrary, inclusive of yet again penalizing getting a normal job and working. On the other hand, there is a policy benefit to encourage the formation of businesses, so I would propose limiting this deduction to the first $50,000 or $100,000 of pass through income. Estimated impact: $20 billion per year.
  • Step up Cost Basis. This is an interesting tax loophole. When a person dies and bequeaths an asset to an heir, the cost basis for that asset is the fair market value on the date of death. If the decedent bought stock for $20/share and it is bequeathed worth $400/share, that $380/share is income tax free for the estate and recipient. The estate tax used to be at a much lower threshold, so this provision made sense as some heirs would be slapped with as much as a 40% estate tax. Who needs to pay capital gains as well? With the increase of the floor to the estate tax to $11MM+, it becomes non-existent for the middle class and part of the upper class, while also eliminating any capital gains on the assets held during the decedent’s life. I propose that this loophole is closed, in that estates that are not subject to the estate tax would either have to pay capital gains rates on unrealized gains at the time of death, or cost basis would be transferred to the recipient, ensuring that capital gains tax is eventually paid.
  • Estate Tax. Step up Cost Basis lends to a discussion on estate tax. It’s an unpopular tax that at best, prior to recent increases in the threshold for the tax, covered around 1% of federal tax receipts. Much of the tax can be avoided by a complex web of estate planning, which basically forces a dance with lawyers and accountants to set up trusts and other functions to get around the tax successfully. If it is such a small amount collected with needless amounts of paperwork, it might be worth scrapping altogether, while ensuring that Step up Cost Basis is eliminated as well. I have not done a cost study to compare the revenue differential, though I would suspect an increase in collections would occur from my plan while being deemed less draconian and odd.

It is impossible to confirm, without access to additional tax data, the exact amounts that would be generated by my slew of plans, though I would estimate it would raise around $250 billion. That would be 1/3rd of my target best case scenario of a reduction from $1 trillion to $250 billon annual deficits. The goal here is to pick items that seem reasonable and fair in light of who they affect, are not extreme, and also spread the impact. Notice also what is left alone: 50% of the 2017 corporate tax cut remains, individual income tax rates in effect from 2018 to 2025 cut in 2017 are not changed, part of QBI remains. What is affected is a merger of the estate tax into an elimination of step up cost basis and a ceiling on preferred capital gains tax rates.

The above are common sense low hanging fruits that would likely create few ripples if passed. The hard work comes afterward, as we’d now be approaching new revenue generation. Individual income tax rates are the default next stop, though one could consider an ultra high net worth wealth tax as Senator Warren proposed. The idea with a wealth tax is not unheard of, as it is successful in Switzerland due to its reasonable rate. The bargain would be that a wealth tax is paid in lieu of extremely high income tax rates; basically, the few who would pay the wealth tax would be the specific few that would not get targeted with European marginal income tax rates.

One basis for my insistence on at least incrementally addressing the deficit problem is threefold: a) rapid and large adjustments shock the economy, b) the economy needs time to adjust to new market realities created by tax and c) most importantly, we do not want to wait until the damage is done and outside forces inflict consequences for such profligate indebtedness. By the time that happens, either inflation, stagflation, or market forces will have run amuck, and no incremental revenue raise will make a dent in the monster we would have created at that point. If we would like a fiscally sustainable society, it is in our best interests to have adult conversations about the problem as soon as practicable after coronavirus is behind us.