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Can This Federal Deficit Be Fixed?

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With Rick Newman, Author and Senior Columnist for Yahoo Finance

Steve talked with Rick Newman, a Senior Columnist at Yahoo Finance, and the author of Rebounders: How Winners Pivot from Setback to Success to get his ideas on how to deal with the federal deficit that’s currently running at about $1 trillion per year. Steve regularly reads Rick’s column and recommends it to listeners.

The State Of The Deficit

Steve opened the show by citing the Congressional Budget Office’s current deficit figures and projections. (Historically, their projections beyond two years into the future only have about a 50/50 track record of being correct.) Steve reported, “The Congressional Budget Office recently forecast annual federal deficits of more than $1 trillion for 2020 and for the next 10 years. Economists generally think a fiscal deficit of around 3% of GDP is healthy and manageable. But deficits over the next decade will average 4.8% of GDP, according to the CBO.

What’s Driving The Deficits?

Rick believes two primary factors are to blame for the continuing deficits: healthcare costs and the Trump tax cuts. He says, “Healthcare costs are going up by more than overall inflation. They’re going up by more than average incomes, and they’re taking a bigger bite out of everybody’s budget, including Uncle Sam’s, and Washington has not figured out what to do about that.” The primary money eaters are Medicare and Medicaid, two programs that Congress talks about fixing all the time.

So, what about the Trump tax cuts? Steve made the point that according to the Laffer Curve—the theory made famous by Reaganomics economist, Art Laffer—the eventual result of cutting tax rates will be an increase in total tax revenues because cutting taxes leads to increased economic growth and thus, a larger total tax base. Rick Newman is no disciple of the Laffer Curve, but, in fact, Laffer’s theory appeared to be proven correct during Reagan’s Presidency following the Reagan tax cuts. Total federal tax revenues actually increased by a whopping 50%, rising from approximately $600 billion in 1983 to around $900 billion by 1988, and topping the $1 trillion mark for the first time in 1990.

Thus far in the wake of the 2018 tax cuts, revenue from individual income taxes has gone up about $100 billion; so on that front, the tax cuts appear to be working as predicted by the Trump team. But revenue from corporate income taxes has fallen by about that same amount, effectively canceling out the gains on the individual income side of tax revenues. However, corporate income tax revenue is projected to reach new all-time highs by 2024, and total individual income tax revenue is projected to keep rising, so the Laffer Curve effect may yet pay off for us.

Rick was careful to point out that “we haven’t seen a significant increase in business spending since the tax cuts, even though that was one of the main arguments put forth in favor of the cuts.” Capital expenditures by U.S. businesses have risen the past couple of years, however, only by a very small amount.

A Worrisome Future

Steve bravely brought up “the elephant in the room,” the question no one wants to think about: “At what point do the chickens come home to roost from the continuing deficits and ever-growing federal debt (now nearing $30 trillion)? I mean, at some point, we’re going to have to pay the piper. But when? When does all this deficit spending start to really hurt us?” He pointed out the basic fact that we’re upside down from where we should be. Basically, tax revenues should go up when the economy is doing well, just as they contract when the economy is in a recession. But here we are with record-low unemployment, good economic growth, and a huge bull market in stocks, and yet we’re still looking at a trillion-dollar deficit and a growing national debt.

Rick expressed concern that a significant increase in interest rates could trigger problems for us. If the government suddenly had to start paying, say, 6% interest on its $20+ trillion debt, that could be a real problem. But for the moment, very low interest rates seem to have become “the norm.”

Fixing The Deficit Raising Taxes

Steve then asked Rick the trillion-dollar question: “So, how do we get rid of the deficit?” The problem is a pressing one. Medicare is projected to start running out of money in just another five or six years. Rick offered five possible solutions, all of them one form or another of tax increases.

Solution #1: Bring back the all-but-gone estate tax. But there are two problems with that approach. One, it wouldn’t be a popular move, as most people rightly see an inheritance or estate tax as an instance of double taxation. Two, a moderate estate tax, with an exemption threshold of $2.5 million, is only estimated to provide an extra $30-$90 billion per year, less than 10% of the current deficit.

Solution #2: A slight twist on the inheritance tax idea is a “wealth tax,” an idea touted by virtually all of the Democrat Presidential candidates. A tax on the already accumulated wealth of the ultra-rich might bring in up to $300 billion per year—still not even half of what we need to cover a trillion-dollar deficit. But according to Rick, a huge caution sign on this idea is the fact that many economists think it would be ruled unconstitutional before it ever brought in a dime.

Solution #3: The next “eat the rich” idea is a financial transaction tax. As Rick explained it, “A financial transaction tax would put a fee of, say, 0.1% on every financial transaction—stocks, bonds, exchange-traded funds—all those things.” But this is another “solution” that isn’t really a solution, as it would probably only provide an extra $60 billion a year in revenue.

Solution #4: Raise corporate taxes. Essentially, reverse the Trump tax cuts and take us back to having the highest corporate tax rate in the developed world, 25-28%. The obvious problem with this one is that all those companies that moved their headquarters back to the U.S. when Trump lowered the corporate tax rates might well just march right back out the door to overseas locations. So, you might end up with even lower corporate tax revenues.

Solution #5: The tax Rick likes best is the VAT, the value-added tax. He explained the benefits of a VAT: “It’s relatively efficient and it can raise a lot of money. All developed nations except the United States have a VAT, which is a tax levied at various levels of production of goods and services.” Although businesses technically pay most of the VAT, practically speaking, it’s largely paid by consumers as prices rise. In other words, companies just pass on the cost of the tax to consumers. Therefore, Rick cautions, “You need provisions protecting low-income consumers, small businesses, and other vulnerable parties. But many other nations have managed that, and a 10% VAT would likely raise around $1 trillion per year.” So, unlike all the other proposals, this one should actually take care of the problem, or at least most of it.

Check out Rick’s columns at Yahoo Finance to get more information and more of his insights on the economy.

Disclosure: The opinions expressed are those of the interviewee and not necessarily of the radio show. Interviewee is not a representative of the radio show. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by the radio show.

Read The Entire Transcript Here

Steve Pomeranz: The Congressional Budget Office recently forecast annual federal deficits of more than $1 trillion for 2020 and also each of the next 10 years as well. They say that by 2030, the deficit will hit 1.7 trillion. Economists generally think a fiscal deficit of around 3% of our GDP is healthy and manageable. US deficits over the next decade will average 4.8%, according to the CBO. Let’s kick this around with one of my favorite guests. He is Rick Newman, Columnist for Yahoo Finance, the author of four books including Rebounders: How Winners Pivot from Setback to Success. I follow his column regularly and you should too. Rick, welcome to the program.

Rick Newman: I always enjoy it.

Steve Pomeranz: Great. Well, so what is driving these trillion-dollar deficits I speak about?

Rick Newman: Two things, basically. One of them is healthcare costs. The federal government pays a lot for healthcare—that’s mostly Medicare and Medicaid—and also pays a lot for Social Security, but that’s in a better position than Medicare is. And as anybody who’s ever been to the doctor knows, healthcare costs are going up by more than overall inflation. They’re going up by more than average incomes, and they’re just taking a bigger bite out of everybody’s budget, including Uncle Sam’s, and Washington has not figured out what to do about that. So that’s part of it. The second part is the Trump tax cuts, which went into effect at the beginning of 2018 are making this situation a little bit worse.

So the federal government is bringing in less revenue than it would have been bringing in under the old tax regime. Now the supporters of that tax cut said, “Don’t worry, it’s going to stimulate so much additional economic activity that we’re going to actually be bringing in more tax revenue, not less tax revenue,” but that has not happened yet. And the Congressional Budget Office, which you just mentioned, in their outlook for the next 10 years, they don’t think that’s going to happen either.

Steve Pomeranz: So that was all based on, from what I recently read, an idea which was put on the back of a napkin during the Reagan era. And that is… it’s called the Laffer curve, L-A-F-F-E-R, not L-A-U-G-H-E-R.

Rick Newman: Some people laugh at it though.

Steve Pomeranz: Yeah, yeah, some people do. And the idea was that if you raise taxes to a certain point, it reduces government revenue because people feel a disincentive to work and that at some point, as taxes come down, people are more productive. They want to work, they want to make more money, and that adds to the tax base. So I think that was the idea behind that tax cut. So what really has happened? This is the $64,000 question. I ask this a lot to people. What do you think has happened because of those tax cuts, in addition to creating this huge deficit?

Rick Newman: Yeah, and the Laffer curve you’re referring to, that’s named after Art Laffer, he’s a supply-side economist. He actually is a supporter of President Trump’s policies and kind of an informal advisor to Trump. I mean, this theory has been out there for a few decades, the idea being that if you lower taxes enough, it puts more money in people’s pockets, so consumers spend more money and businesses spend more money and that is the stimulus, this so-called supply-side stimulus effect. Except it has never happened that way. And we have a real world, a case we can look at now with the tax cuts that went into effect in 2018.

So if you look at tax receipts that the US Treasury is bringing in, corporate tax revenue, that’s federal revenue that comes from businesses paying taxes, that has gone down significantly. And as a measure of all federal revenue, corporate tax revenue is at the lowest level ever as a percentage of all revenue. The corporate tax brings in something like maybe $250 billion per year. Income tax revenue, that’s individuals paying income taxes, has gone up a little bit. And that’s basically, even though the tax cuts from 2018 did cut those rates a little bit, but we have more people working and we’ve had economic growth. So overall revenue from individuals has gone up a little bit, but not by as much as it would have under the old tax regime. And then meanwhile as we just discussed, you’ve got healthcare expenditures paid by the government going up by more than all of this. And that’s where we get to the deficits.

And one important thing that has not happened, this is very important, we have not seen an increase in business spending since the tax cuts. That was one of the main arguments in favor of those tax cuts because the biggest part of the tax cut really was that cut in the corporate rate from 35% to 21%, and we’ve actually seen flat line in business spending and it has just not picked up. I mean, businesses are just not spending money on new factories, on buying new equipment. I mean there could be several reasons for that. Nobody knows exactly why, but we’re just not seeing any of the stimulus effect that the backers of that tax cut said we would see.

Steve Pomeranz: Yeah. It reminds me of Donald Trump’s method of managing his business. He would buy properties, he would take on loads of debt, and on average, he was successful. But there’s a lot of areas where he was not successful, a lot of bankruptcies and so on. So it’s like the country’s got the same thing. We now have leveraged ourselves up over a trillion dollars. Now we’re not supposed to have really a deficit this size when the economy is good. Now when the economy is bad, tax receipts go down because business is slower and the government is stimulating. So spending is higher and you expect to go into a deeper deficit. And then when the economy improves, you expect tax revenues to increase and stimulus spending to decline. And then you kind of get back to normal. This is the time when we have the historically low unemployment, businesses are doing well, corporate profits are rising and so on. And yet we’re at a period of highest deficit.

So eventually, moving on with this idea, these deficits at some point, nobody seems to know the point because I’ve been involved in the investment community now for 40 years, and I started out in the Reagan era, the beginning of the Reagan era, and they were talking about high deficits, government borrowing conflicting with corporate and individuals borrowing, interest rates were going to rise, and none of that has really happened. There is some number which gets us to a place where we hurt, but I don’t think anybody knows where that number is. Do you?

Rick Newman: I have no idea. Economists have all kinds of different ideas about this. Many economists thought that we would be having problems by now, but that the old way of thinking, which you talked about going back to the Reagan years and even in the Clinton years, I mean, people forget this. We had four years of budget surpluses from 1998 through 2001. That used to be what happened fairly northerly when the economy was strong. You’ve got all this tax revenue, and we actually had a little bit leftover after all the spending. But I think the thing that’s new in the way economists were thinking about this is we have extraordinarily low-interest rates indefinitely. I mean, interest rates right now are way below long-term averages and there’s no sign they’re going to go up.

And I think if you had asked an economist, I mean I know what they were predicting 10 years ago. No one thought interest rates would be as low as they are right now. And that that’s important because one of the line items in the federal budget is interest payments on that federal debt. And with 10-year treasuries were, what, around 2%?

Steve Pomeranz: Less than that.

Rick Newman: Interest payments are very, very low. And if that would go up to, I mean what’s normal? You might say that 6% or probably between 5% and 6% is the historical norm. If we had interest rates at that level, we would have a problem because we’d have a lot more of this revenue would have to go just to pay the debt and that can become a mushrooming problem. So for now, we’re sort of off the hook on that, but nobody knows when this … The so-called bond vigilantes have been worrying about this for a long time and their worst-case predictions have just not come true and nobody knows if they ever will.

Steve Pomeranz: If you think of this as a household, if you think of the United States as a household, you think that the amount of debt that you have is only important as you measure it against your level of income. With $10,000 in debt for someone who’s making $1 million is meaningless. $10,000 in debt to someone who’s making $30,000 is meaningful. So it’s all really relative. So we have to remember that the GDP of the United States is continually growing. We’re a bigger country, or think of it as a company or as a family, whatever. We are bigger now than we were 10 years ago, than we were 20 years. We’re much bigger, so we can afford to take on more debt. That’s not the problem. We don’t really know the answer to this, but what I want to do is I want to shift our focus and ask the question. If at some point the piper will have to be paid, what is that going to look like in the years hence?

Rick Newman: Yeah, and the piper is going to have to be paid because of this healthcare problem. I mean, the forecasts are terrible. Medicare is going to start running short of money by 2026. That’s the latest projection. That’s only six years away. That is not so far off into the future that you can basically forget about it. And everybody knows, I mean healthcare, we have Baby Boomers now streaming into Medicare. It’s just not going to be sustainable. So the good news is that the United States is a relatively low tax nation. I mean the tax burden on the typical family here in the United States is lower than it is in most other countries of the world for a bunch of different reasons. But because we have the dollar, I mean that’s a big part of it, the world’s reserve currency, but at some point, we’re going to need more revenue.

And there, I don’t know if you can call it good news, but we can raise revenue in a bunch of different ways, and there are some tax experts who’ve been looking at this recently and there was a big a book published by the Hamilton Project, which is part of the Brookings Institution think tank in Washington. And they’re saying there are new ways you could impose an inheritance tax that would be supplemental or it might replace the estate tax, which really raises almost no revenue anymore. There’s this wealth tax that Bernie Sanders and Elizabeth Warren are talking about, problematic, but it might work. The biggest one would be a value-added tax, which basically all the advanced countries in the world have except the United States.

Steve Pomeranz: Let’s talk about that.

Rick Newman: That could raise a ton of money fast.

Steve Pomeranz: Yeah. Let’s talk about a value-added tax. So if you’ve ever been abroad, you’ll notice that all goods have this extra tax on it. It’s like a sales tax, right? We have sales tax in the state of Florida.

Rick Newman: Well, people yell at me when I try to use that shorthand. To consumers, it is the equivalent of a national sales tax. It’s administered in a different way. But, yeah, I mean from a consumer’s perspective, that’s how it works. You pay a little bit more at the point of purchase.

Steve Pomeranz: Yeah. So I think, and if I remember correctly when I was in Italy, it’s 15% or some number like that. So I know it’s changing, it often changes, but so the stuff that you buy is increased by the amount of that value-added tax. You don’t actually see it because it’s built into the price. I think that’s the differentiation between a sales tax is that in the state of Florida we add 6%.

Rick Newman: Yeah. I mean at a technical level, the way you would administer it is it would be a tax at various levels of production. So this tax would be paid by whoever is producing or providing the good and service at some point in the production process, which makes it actually very efficient. I mean it’s actually, it’s relatively easy to impose a tax like that because it’s easy to collect and then they can, those providers and producers, they can raise their prices a little bit and pass all of it or some of it onto consumers. I mean the market sort of figures that out, but that’s why of all taxes, not that they like taxes, but economists do like this tax as taxes go because it’s relatively efficient and it can raise a lot of money.

Steve Pomeranz: Well, according to what you wrote, a 10% VAT tax would raise around $1 trillion per year. I guess that’s from the Brookings Institution.

Rick Newman: That’s a lot of money.

Steve Pomeranz: That’s an awful lot and that would do a lot to fix this thing. The inheritance tax, I mean all of these things right now are off the table because the idea of any kind of higher taxes and especially I think the idea of a VAT tax in the United States is very unpopular, the idea. But again, we’re just looking at some alternatives. So a new inheritance tax, increasing that. Right now, it’s just 2.1% and so increasing that would raise some tax. A wealth tax, I’ve read articles pro and con. That’s something that some of the Democratic runners are talking about. What is that?

Rick Newman: Well, it depends who you’re asking. But Bernie Sanders and Elizabeth Warren and the main proponents of this, and they have some well-known economists helping them out with the analysis. Basically, you would impose just a tax, pick your number, Elizabeth Warren’s begins at 2%. That’s what she calls it two cents. What she means is two cents of every dollar, but let’s say starting at $35 million, and this is wealth, not income. And the idea behind this tax is that-

Steve Pomeranz: That’s tough.

Rick Newman: … very wealthy people don’t have a lot of labor income. A lot of them don’t even work. They make all their money from investments and they pay at the capital gains rate, which is much lower than the regular rate that working people pay generally. So the idea is to tax some of that wealth because we have a lot of wealth inequality in the United States and that’s getting worse. So you would put, let’s say it’s a 2% figure above $35 million that would be assessed every year. And you would just have to value all the stuff you have. That includes your houses, your portfolio, your investments, but also your real estate, your artwork, your jewelry. I mean all these things. So, two problems with this.

Steve Pomeranz: Yeah, there lies the problem. Yeah.

Rick Newman: That’s right. So there’s the problem. Number one is it’s hard to value. It can be hard to value anyway. And the other problem is there is a clause in the Constitution that may seem to prohibit this kind of tax and it gets technical, but it would be if Congress were to impose a wealth tax, it would be challenged immediately on constitutionality basis. And I mean, let’s call it 50-50 based on how that would end up going. But it’d be a long court fight and it would probably go to the Supreme Court. So that does not seem … We have other ways we can impose taxes that we know work. So maybe stick with the ones that work.

Steve Pomeranz: Yeah. Well, we’re low on time. So a financial transaction tax would put a fee of 0.1% on every financial transaction, stocks, bonds, exchange-traded funds, all of these things. There would be a tax just on the transaction portion of it. And then, of course, there’s always higher corporate taxes to try to capture some more of that money back. So I think these things, or some variety of these things are in our future. And it’s a question of how much of the population is really going to put up with higher taxes now that we’re all so used to being in a time period of very low taxes.

Rick Newman: Yeah, and I think you had it right before. We’re hearing a lot of discussion about these various things in the Democratic presidential campaign. So I think it’s worth listening to the different ideas the candidates have and notice the differences. But I think you had it right before. It’s really unlikely that we’re going to see any tax hikes until they’re completely necessary. I do think they are going to be completely necessary at some point. We’re not going to have a choice. I’m not sure that’s going to be next year or the year after that, but it’s coming.

Steve Pomeranz: My guest, Rick Newman, columnist for Yahoo Finance. Follow him on Yahoo. Again, his name is Rick Newman. He’s a great columnist. He writes about a lot of different topics and I’m a regular reader. Rick, thank you so much for joining us.

Rick Newman: Thank you for having me, Steve. See ya.

Steve Pomeranz: See ya. I want to remind you all that my mission is always to educate you and remind you week after week, segment after segment that we love to get your questions because we do. These are complicated times, as you can see from the topics that I choose, and these complicated topics may raise some questions for you, and we’re always here to answer them. So if you have questions about your portfolio, your kids, your kids’ kids, your retirement, your 401(k), how to better take care of your family, anything financial on your mind, we’re here to help you, and I’d love to help you in any way I can. So go to stevepomeranz.com, go to the contact section and let me know how we can help. That’s stevepomeranz.com, P-O-M-E-R-A-N-Z. Skip the T. What is it? Skip the N. Go right to the T. Erica, my producer, is shaking her head. She hates that. Anyway, P-O-M-E-R-A-N-Z.com, and contact us.