In this series of articles on insolvency, we’ve seen that:
- The Federal government takes in about $2.5 trillion in tax revenue – In Joe’s terms, a $25,000 salary.
- The Federal government is spending much more than it gets in revenue – in excess of $1 trillion more, which would be Joe spending an extra $10,000 per year (spending $35,000 a year when he makes $25,000).
- Our governments at the federal, state, and local levels collectively owe a lot of money – somewhere around $20 trillion, which is like Joe owing $200,000 to creditors.
- The government has large and looming unfunded liabilities – somewhere around $100 trillion of today’s dollars, which would be like Joe needing an $1,000,000 in the bank right now to cover his future obligations. These unfunded liabilities will inevitably worsen the deficit, which will increase the debt.
- Governments at all levels are already paying a lot to meet the interest obligations of their debt, and that’s with very low interest rates. The principal of the debt is not being paid down, and is in fact increasing rapidly.
- The Federal government can only default on its debts if it chooses to, because it has the power to print its own money, but such actions have serious consequences. Sooner or later, paying debts with newly printed money will result in a currency collapse, which is true insolvency.
Can insolvency be avoided?
What would we need to do to prevent insolvency? It’s actually fairly simple: we would need to eliminate the deficit, by spending only what we get in revenue. Inflation would slowly whittle down the value of the current debt until finally we could begin to pay it off.
Unfortunately, something being simple doesn’t mean that it is easy.
To eliminate the deficit, we would have to reduce spending, increase revenue, or use some combination of both, that added up to more than $1 trillion dollars a year. In addition, we would have to either reduce the unfunded liabilities by taking away some of the benefits that have been promised to people, or reduce other spending to make room to pay for them.
Let’s look first at the numbers. What are we getting in revenue, and from where? What are we spending, and where is the money going? Let’s look at income first. These 2012 numbers come from the President’s 2013 budget on the White House’s web site:
Revenue in 2012
| Category | Amount (in billions) |
| Individual income tax | 1,179 |
| Social Security payroll tax | 635 |
| Medicare payroll tax | 203 |
| Other retirement collections | 9 |
| Corporate taxes | 281 |
| Customs duties | 31 |
| Excise tax | 80 |
| Estate/gift tax | 7 |
| Unemployment insurance | 57 |
| Federal reserve deposits | 81 |
| Other | 24 |
| Total | 2,590 |
What revenue might be raised? Let’s look at these revenue items.
Personal taxes such as income tax and payroll taxes would be very difficult to increase significantly. The article Who Pays? shows that the bottom two-thirds of all tax returns make less than $50,000 a year and pay less than 10% of all of the federal taxes. Most of them would suffer from any significant tax increase. How long can a politician stay in office after doing something that is deeply unpopular with two thirds of the voting public? Knowing this, our government is not planning any significant tax increases for that segment of the population.
Let’s consider a whopping 20% income/payroll tax hike on everyone else – those making $50,000 or more. They pay 90% of all federal income taxes (about $900 billion in 2009) so a 20% increase would only mean about $180 billion in revenue – and that is if people actually paid the increased taxes. Hauser’s Law, mentioned in the article What is Progressive Taxation?, shows that the government is limited in what it can collect in taxes because beyond a certain point, revenues do not increase. The UK recently came up against this when they attempted to raise the top tax rate to 50% on incomes of £1 million. From a newspaper article:
Almost two-thirds of the country’s million-pound earners disappeared from Britain after the introduction of the 50p top rate of tax, figures have disclosed. In the 2009-10 tax year, more than 16,000 people declared an annual income of more than £1 million to HM Revenue and Customs. This number fell to just 6,000 after Gordon Brown introduced the new 50p top rate of income tax shortly before the last general election. The figures have been seized upon by the Conservatives to claim that increasing the highest rate of tax actually led to a loss in revenues for the Government. It is believed that rich Britons moved abroad or took steps to avoid paying the new levy by reducing their taxable incomes. […] Last night, Harriet Baldwin, the Conservative MP who uncovered the latest figures, said: "Labour’s ideological tax hike led to a tax cull of millionaires. Far from raising funds, it actually cost the UK £7 billion in lost tax revenue."
A 20% income tax increase would give the United States a top tax rate of 49.87%: 39.6% increased to 47.52%, plus 1.45% Medicare tax and 0.9% additional Medicare tax. Even if all or part of it was disguised by raising payroll taxes, such as raising FICA to tax all income rather than it having a ceiling, no one will be fooled. This is almost exactly equal to the 50% rate that the UK enacted, but it would affect more people because it would apply to a far lower income threshold – around $400,000 rather than £1 million (about $1.5 million in US dollars). We would see a similar result, or likely even worse as so many more people would be affected. There are many means for higher earners to avoid taxes. They can hide income, shift income offshore, or even leave their country to emigrate to somewhere with lower taxes. Gerard Depardieu and Tina Turner are two recent examples of this kind of "tax flight". The federal Congress is extremely unlikely to attempt raise taxes this much, but even if they did and no one avoided the increase, it would raise only about $180 billion.
Corporate taxes in the United States are already among the highest in the world. Any significant increase would cause some businesses to close. Others would avoid the taxes by moving some or all of their operations offshore. Not only would we lose revenue, but we would lose jobs as well. Customs duties could not be raised much without retaliation from other countries, which would cause more losses than the increased revenue. Still, let’s say we could raise both of those things the same whopping 20% we tried on individuals, and somehow no businesses closed or avoided the taxes. We’d only raise around $60 billion. Raising excise and estate/gift taxes would cause more tax avoidance, but let’s say it didn’t and we managed to raise those by 20%, too. We’d raise less than $20 billion.
In summary, there really isn’t much of any room to raise tax rates further without causing damage, with a net effect of lower revenue, but if some kind of magic allowed us to raise most taxes 20% and somehow there was no tax avoidance, we’d get a total of $180 billion from income tax, $60 billion from corporate tax and customs duties, and $20 billion from other taxes, for a total of $260 billion. This is not even a quarter of the 2012 deficit of over $1.1 trillion.
Assuming we managed to raise that $260 billion, that would still leave an $840 billion deficit. The next item to look at is our spending. From USGovernmentSpending.com:
Spending in 2012
| Category | Amount (billions) | Notes |
| Pensions | 805.6 | Includes social security and federal employee retirements |
| Health Care | 866.1 | Includes Medicare, Medicaid, and public health services |
| Education | 121.1 | Includes educational grants and some government research |
| Defense | 925.2 | Includes the military, veterans, and foreign economic aid |
| Welfare | 431.5 | Includes various welfare programs, SSI, and unemployment |
| Protection | 58.7 | Includes federal police, courts, and prisons |
| General Government | 32.6 | Includes core federal costs |
| Transportation | 104.9 | Includes federal highways and airports |
| Other Spending | 141.5 | Includes many government departments such as agriculture, community grants, and government research |
| Debt Interest | 241.6 | No principal paid |
| Total | 3,729 |
Where do we cut $840 billion? Pensions such as Social Security, and Health Care such as Medicare, and Medicaid are widely considered untouchable. We will not see any significant reductions proposed for those items. In fact, they are set to increase far more than we have the funds to pay, and make up the bulk of the unfunded liabilities. Let’s ignore those for now, except to say it isn’t possible to see any savings on these items.
The rest of the spending totals $2057 billion. To cut $840 billion from this, we would need to cut an average of 40% across the board to all other programs. Congress is currently facing what is called the sequester, a set of automatic spending cuts that will add up to a paltry $85 billion in cuts per year – about 10% of the $840 billion we’ve outlined here – and we are seeing a serious reluctance to allow the cuts. Still, let’s go over what 40% cuts would mean.
In the education budget, about $50 billion goes to primary, secondary and vocational schools. About $22 billion goes to higher education. About $48 billion goes to various government programs, subsidies, and research items. Cutting 40% of these programs would mean $10 billion cut from schools, $4.4 billion from higher education, and almost $10 billion from those programs, many of which would have to be eliminated.
When people consider cutting defense, what they mean is the Department of Defense, which had a budget of about $708 billion of the $925 billion we spent on defense. We would need to cut the DOD’s budget by about $185 billion to make the 40% cut. How much can we cut this much from defense without leaving ourselves vulnerable?
Welfare is a difficult item to cut, and we’d need to cut it by more than $172 billion to make our 40% goal. Unemployment is funded by its own fees on businesses, so it’s off the table. Workers’ compensation (e.g., for disability) cost about $7 billion and can’t be reduced without significant reforms; similarly, SSI cost $47 billion and can’t be reduced without significant reforms. Such reforms are extremely unlikely to happen because they would need to restrict eligibility. Foster care cost about $7 billion and is a money-saver since taking care of the children otherwise would be far more expensive. The rest totals about $370 billion and would have to be cut more sharply – almost 50%. Many of these programs are now relied on; cutting them suddenly would cause a lot of pain. Aid to families and children gave out about $108 billion, almost all for food and nutrition programs; cut by $54 billion, millions would go hungry. Housing assistance cost $60 billion; cut to $30 billion, a huge segment of the population would be made homeless. TANF (temporary assistance to needy families, the traditional "welfare") only spent about $17 billion; cutting that by $8 billion would leave a lot of people helpless, many of whom are in dire need. The rest is in various items including tax credits, many of which would need to be eliminated, pushing people who rely on them into poverty or perhaps even over the edge. Cutting this $172 billion would cause so much pain and panic that it is inconceivable that it would happen.
The Protection and General Government categories are very difficult to cut. Police and courts are already overloaded. Cutting $18 billion here would certainly result in a reduction public safety and even further delays in obtaining justice.
Transportation would need to be cut by almost $42 billion. We already are not spending enough on our highways and bridges, which are falling into greater and greater disrepair; this is sometimes referred to as the "third deficit". We would have to cut highway spending from $72 billion to $43 billion, with catastrophic results. Cutting air transportation from $23 billion to $14 billion would mean the end of the TSA, since air traffic controllers can’t be cut, which would invite terrorists back to our airports.
Cutting the final other spending category by $57 billion would mean the end of many community grants, which we spent $25 billion on, and severe cuts to agricultural ($26 billion), research ($17 billion), and energy programs ($16 billion). While we could cut these things, there would be an enormous number of complaints from those who benefit from the programs. Community grants, for example, often go to paying for extra police.
Even with all of these severe cuts, which won’t happen, we still have the unfunded liabilities to deal with, which will increase spending for programs such as Social Security, Medicare, and Medicaid. Every dollar of increased spending on these items would require even further reductions in other areas.
Summary
Increasing tax rates is unlikely to gain further revenue, and there is little agreement that taxes should be raised, leading to a lack of any action, so it is extremely unlikely that the government will gain much in tax revenues. In fact, as the economy gets worse, government will lose revenue, widening the deficit.
Cutting spending enough to help the deficit is extremely unlikely to occur. Instead, there are many both inside and outside of government who want to increase spending. With a lack of agreement, no action will be taken. Spending will stay the same, or increase from automatic increases. Social Security payments and Medicare spending are examples of spending that automatically increases.
Inflation won’t get us out of the debt, either, since the debt is increasing far too quickly. Besides that, sufficient inflation can and will bring about a currency crisis by itself.
Because of the extreme unlikelihood of either revenue increases or significant spending cuts, we are on our way to national insolvency. The fuse has been lit, and it isn’t being put out.
Watch Congress carefully. They would need to enact huge tax increases and Draconian spending cuts to deal with the deficit — and soon. If they do not, insolvency is inevitable.