I was recently inspired to write this article by two efforts. The first was enduring that yearly chore of ‘doing’ my taxes. The other was picking up J.S. Gordon’s Hamilton’s Blessing: The Extraordinary Life and Times of Our National Debt. His writing for American Heritage and being a commentator for NPR’s “Marketplace” program recommended him as someone who might know a little more than I do—which was virtually nil—of the history and rationale behind those forms or internet questionnaires that all of us—well, at least the law-abiding ones—complete each February to April. What I discovered was a reasoned and relatively centrist discussion of the history of the national debt, evolution of the corporate and personal income tax structure, and the debilitating effects of how both have been mismanaged in recent generations. Whether or not you paid out or are still waiting for that deposit into your account from Uncle Sam, this directly concerns each one of us in our vocational, economic, and personal decisions. As things currently stand, this influence seems to be increasingly negative.
The following are Gordon’s central points; my comments follow. Feel free to respond to all or specific points.
1. A national debt does not have to be a curse but can actually be a blessing.
The United States periodically ran up large amounts of debt during its first two hundred years of existence. However, there were several trends that ameliorated this. As the government was primarily composed of the wealthier part of society, it was basically spending its own money. It didn’t hurt that the majority of the tax burden was borne by industries and agriculture through tariffs, taxes that arguably hit the rich harder than his poorer counterparts. This made Congress a bit more careful than recent eager generations to spend someone else’s money. Second, Congress only ran up large debt during wars and a few financial panics of the 19th and early 20th centuries. Third, it always either tried to pay it off completely or pay it down over time. (In an apparently extraordinary aside, the U.S. actually paid off its debt completely in 1834 under Andrew Jackson, the first and only nation-state in modern times to do so.) Finally, the ever-increasing economic growth of the U.S. made the national debt an ever-decreasing percentage of GNP regardless of the payment schedule. For instance, in the decades leading up to WWI, the percentage of the debt to GNP went from 8.5% in 1890 to 2.54% in 1916 even though it was allowed to remain at approximately one billion dollars. 2. There wouldn’t have been a United States without a U.S. national debt.
Gordon argues that the fledgling U.S. would not have survived much past the War of Independence, especially against the specter of the Napoleonic Wars and impending War of 1812, if it had not been able to achieve an effective credit rating necessary for financing military outlays. This was accomplished essentially through indebting the nation to domestic and European creditors. He notes with prosaic relish how Hamilton navigated the shoals between his Federalist supporters and Jeffersonian detractors to establish the Bank of the United States (BUS). Its initial bonds/debt subscription was received so well that the U.S. was judged an excellent investment risk and received a higher rating than any contemporary European state. Gordon goes on to chronicle the apparent catastrophe that occurred with the disestablishment of the BUS under the Jeffersonian-minded Madison in 1811 just in the knick of time for the War of 1812. Apparently, the U.S. had to rely on the good nerves of certain bankers in Philadelphia and New York to personally finance the government’s debt in militarization. Apparently the Jeffersonian Democrats gave in for a time and allowed a second BUS to be established, only to be taken down again by Jackson in the early 1830’s. Interestingly, a combination of his administration’s financial policies and the lack of a central regulating force caused the Panic of 1837 (the first nation’s first major economic downturn) in both East and West and the end of the temporary pay-off of the debt.
2. The national debt has only become a problem in the last half century with the combination of two factors—the evaporation of the moral imperative to pay it down and the ever increasing mutual desire of politicians and constituencies to avail themselves of public coffers.
The first factor is due to the trumping of Adam Smith by John Maynard Keynes. Like each of the personages that characterize each of the nation’s financial eras, Keynes’ story is told by Gordon with an eye for how it affected the national debt. Since Keynes, each succeeding generation of economists and politicians have excused themselves from the historic impetus to ‘pay as you go’ and rationalized ever-larger expenditures with the call for the federal government to micro-regulate the economic and banking system. While I have read little of Keynes, it seems that his ideas neatly fit the pressures of a post-WWII world needing huge financial outlays for rebuilding. The problem, as we later see, is that any constituency, nursed on public coffers, does not easily give up those moneys, a fact that politicians quickly capitalized upon. The idea of scientifically-intervening through infusions and withdrawals of capital in banks and the market was understandably attractive but proved to be relatively ineffective and impossible. Our current preoccupation with what “Bernanke will say next” and the instability that it drives is directly related to the Federal Reserve’s inability to effectively forecast and manage an ever-increasingly complicated system. Furthermore, Keynes ultimately excused the build-up of national debt as acceptable in the sense of lots of people owing each other money. The national debt is obviously owned by domestic and international creditors (including other governments) who, in turn, owe money to others, and so on and so forth. Too big to fall, right? Well, this system has worked to an extent in the past and there are apparently fairly strong disincentives (I’ll let the experts give the details if you want them) for major problems stemming from having a large national debt. However, there does seem to be an informal acceptable limit ceiling to creditors of a country’s debt obligations historically. We see this today in the current Greek fiasco (admittedly strained due to years of juggling books and overspending). We also see it with countries that have been spending far more than their GDP’s for years and whose accumulated debt is much higher than their annual GDP (the U.K. stands at approximately 200%; tiny Luxembourg at over 5,500%).
A much-touted benchmark has been when a country annually spends more than it brings in revenue, the budget deficit. The U.S.’s annual budget deficit in 2009 stood at 9.9% (spent that much more than its revenues). For a comparison, Greece and the U.K.’s are both approximately 12%. For more comparisons, the 2008-09 fiscal year’s budget deficit was 1.42 trillion, more than triple the record set in fiscal year 2007-2008. Good times ahead.
We have seen the national debt increase nearly exponentially over the last decade as a combination of economic downturns, wars, and ever-increasing payouts to constituencies have drained national coffers. The first two of these factors, while arguably avoidable, have many historic precedents in this country. The last factor (and overwhelmingly the largest consumer of public moneys) is a modern creature. As of my writing this sentence, our national debt stood at over 12 trillion dollars (12,691,271, 829, 488.6). That equals an additional 40 billion per day since September 28, 2007. At that moment, each citizen’s share stood at $41,138.70 with that number increasing approximately a penny a minute per person, more than $3,000,000 total every minute, and the speed obviously only increasing with each passing second. That is one of the scariest statistics I’ve ever read. (Forget global warming--these are real numbers and while Florida might not flood because of them, they have as much or more potential to harm life there and everywhere else in this country.)
What kind of harm? Well, besides the possible immoral example that it sets for all of U.S. citizens and the world as a whole (Why pay our debt if the feds can get away with it?), several possibilities lurk in the near future. Some experts argue that creditors may refuse to buy U.S. national debt (as is imminent in Greece), causing the government to default (as Argentina has done multiple times in the last century and the Russian Federation did a decade ago). Of course, a developed nation-state declaring bankruptcy has fairly strong consequences, perhaps the most basic being the raising of interest rates of loans from creditors domestic and international. This can lead to inflation, higher prices, less production, and lots of other fun effects. That combined with our current economic woes could be a real economic ride. 3. The income tax as we know it is essentially an outdated tool of social engineering at its best and class warfare at its worst that produces opposite effects of its purported good intentions.
Our income tax system, beginning in the Civil War an emergency measure and enshrined in 1913 in the Constitution, is an interesting look at the evolution of social expectations and goals. Gordon effectively charts how progressives in the late 19th century picked up the nearly-moribund (having apparently outlived its usefulness as an income stream) income tax as a means of social engineering—forcing the bad old rich man to give up some of his to everybody else. I’m being simplistic here, but Gordon shows how the proposed policies, once implemented, had the opposite affect. As a revenue stream, it had to be progressively broadened and expanded to include an increasing number of taxpayers. However, as the ultimate goal was social engineering, not government income, the income tax continued to be pushed as a viable alternative to tariffs and other traditional ways for the government to make money.
This was seen most clearly in the see-saw between income tax policies of the last century. When the income tax was instituted permanently into national debt through the 16th Constitutional Amendment in 1913, the tax burden was shifted ever increasingly to the highest income brackets of earners. As the U.S. prepared for and subsequently entered WWI, the Feds logically turned to the income tax to generate revenue quickly. The exemption was dropped (from $3,000 to $1,000 personal yearly salary), rates were increased (up to 77% for top earners by 1918), bringing ever more payers. And rightfully so—there were apparently few complaints about that in war-time.
Although rates and exemptions would be relaxed in the post-war era, the federal government’s revenue stream had permanently shifted. From then on, it would rely primarily on income tax revenues instead of through tariffs, thus shifting the tax base’s dramatically as it heavily affected the higher income brackets much more. Shouldn’t be a problem, right? They can afford to pay more… That was the ‘common’ wisdom then and now, but an interesting thing began to happen. In 1920—following nearly a decade of interventionist-minded Democrat control of the Federal government—the 5.5 million returns actually filed represented only 13% of the total labor force. Of that 5.5 million, only 1% of that group earned over $20,000, and that highest 1% bracket bore an astounding 70% of the income taxes. Going from being virtually untaxed in 1909 to bearing the major revenue burden of the entire country precipitated action, forcing or at least encouraging the wealthiest and wealthier to shift their assets to corporations (more on that later) and to simply try to earn less.
Elections of Republican majorities in the 1920s broadened the tax burden by lowering tax rates three times until the top rate was only 25% (instead of the previous 77%). This led to a very curious result. Although in 1921 those earning less than $10,000 had paid $155 million in taxes (21% of personal income tax revenues), in 1926—after Republican initiatives—they paid only $33 million (5% of personal tax income revenues). Simultaneously, the highest bracket earning more than $100,000, saw their portion of income taxes rise from 29% to 51%, paying $194 million in 1921 and $362 million in 1926.
Simply put, a leveling out of the income tax system created more revenue for the government, not less, and dramatically reduced both the total revenue burden and percentage of the middle class (the lower classes didn’t pay anything anyway). To the liberals of the day, this didn’t make much difference, as the goal was not primarily revenue generation but social-engineering. [“Stick it to the man; he can pay it.” The problem was (and is) that sticking it to the man actually means less money for you, him, and all of us.]
4. The conscious creation of two income tax systems—the corporate and personal income—allows wealthy individuals to decisively limit or eliminate their tax burdens altogether.
When income taxes were passed, corporate income taxes were allowed to remain, creating, Gordon argues, a two-tiered income tax system. The beauty or travesty of this was that it allowed wealthier income earners to virtually eliminate their personal income tax burden altogether. While this constituency had already gained in the 1920’s by having its overall tax burdens dropped, apparently politicians remained willing to go extra miles to build in a labyrinth of deductions, exemptions, and loopholes that allowed higher earners to shelter most of their income. Over time, of course, this has been broadened to include lower strata of earners (e.g. the 1040 deductions). However, this philosophy of artificially promoting certain economic actions (like writing-off an expense for purchasing a business-related vehicle even if you really didn’t need it or one of those lovely $8,000 home purchase tax credits) over other ones (like simply saving money) which produces some fairly big discrepancies when compounded across the nation. (Did all of those people really need to purchase houses? What about those people who bought their home a few months before the program began but who could really have benefitted from this—like me?)
When exemptions and subsidies are written into law to benefit just a handful or even a single payer, the nation as a whole suffers. Over time, this has left the middle class increasingly more responsible for the tax burden as the lower classes pay nothing in (and often receive quite a bit in return simply by merely existing) and the rich have built-in protections. Unless this trend reverses any time soon (and will very likely only be accentuated under the current administration), we will soon see more people actually receiving some kind of aid from the government (e.g. social security, Medicare/Medicaid, subsidies, tax refunds, child deductions, etc) than who are actually paying in. When that watershed event happens, it has the potential of being an economic and socially dangerous bellwether for decades to come.
6. The solution for both problems is to actually have a fiscal policy, not simply a scheme for borrowing from the next generation to fund current largesse.
Gordon reserves the book’s invective for politicians here, named and nameless, who have essentially sold off the nation’s potential and future under an increasing burden of debt for historically novel purposes. We live in the flowering of the welfare state, true, and this week’s passage of the federal health care bill attests to that. Another story, another article. However, Gordon’s isn’t your typical rightist rant, as he points out that many programs propping up inefficient or undeserving industrial/ agricultural concerns through subsidies and protectionist policies have both outlived their usefulness and strangle our future flexibility and ability to compete. (As this book is over fifteen years old, I wonder what he would have said about the billions expended in the recent bailouts and stimulus bills…) He is candid here, blaming the citizenry as much as their elected officials. If the man on the street and corporate tycoons alike didn’t demand certain aids, Gordon argues, politicians probably wouldn’t pass the bills. On the other hand, he details certain government protocols (like the paucity of oversight of Medicare and other annual expenditures that apparently don’t require an actual vote) that allow Congressional representatives to absolve themselves of personal responsibility for funding these ever-increasing outlays.
7. Gordon’s recommendations are fairly simple, painful and necessary.
A. Have everybody pay something in if they expect to get something out of it. Pass a flat tax or greatly simplify the income tax code to limit deductions and exemptions while lowering the base rates. This would lessen the incentives to cheat and make economic and financial decisions less desirable for the long-term. He also strongly counsels the removal of the two-tiered tax system of the personal/corporate income tax. Don’t soak the rich, but do make them pay their share. Make everyone pay their share. We can debate on what exactly that means, but I don’t see how anyone could effectively defend our current Byzantine tax structure that. In the words of the late Jack Kemp, “If you tax something, you get less of it. If you subsidize something, you get more of it. In America, we tax work, growth, investment, savings, and productivity. We subsidize nonworking, consumption, welfare, and debt.”
B. Stop raiding tomorrow’s closet for today’s feast. Corporations, government-mandated programs, non-profits, cotton growers, homeowners, day-care operators (and the list goes on nearly ad infinitum) all receive some measure of government support. How much are we personally willing to depend on other people’s money to live? How much are we willing to give to others who are unable, much less unwilling¸ to give themselves? These are questions that will we will be asking more and more as we, the U.S. taxpayer, becomes a rarer breed.
C. Resist the “Madison Effect.” Gordon winsomely coined this from James Madison’s dictum, “Men love Power.” It has benefitted several generations of economists to advocate an increasing debt and ever-complex tax code. It benefits politicians who use their ability to spend for personal constituencies and offers a negative incentive to either save, pay off the debt, or—heaven forbid—restrict payouts. It benefits constituencies (especially those who bear less, little, or none of the overall tax burden) as it distributes other people’s income indirectly to them through an impersonal agent (the government bureaucracies, who, of course, get their lion’s share-sized cut).
This wouldn’t be that big a deal, I suppose, if this whole system affected people equally. However, it doesn’t. It hurts those people who actually want to make a difference the most. Entrepreneurs, those men and women willing and able to invest a combination of time, resources, and risk to succeed, have traditionally been the economic and social engines in this nation. Not perfect in their perspectives and choices, obviously, but they afforded the most consensual and broadest distribution of resources based on public and private desires, talent, and actual success. Not perfect, but the best we have. These people are the first and the greatest to suffer in our long-standing and current debacle, and their loss affects everyone else. A few quotes to consider:
"Since the war two guiding principles have dominated the financial policy of the Government. One is the balancing of the budget, and the other is the payment of the public debt. Both are in line with the fundamental policy of the government since its beginning." Andrew Mellon (1925), treasury secretary under Harding, Coolidge, and Hoover
"It seems difficult for some to understand that high rates of taxation do not necessarily mean large revenue to the Government, and that more revenue may often be obtained at lower rates…The Government…can and should be run on business principles." Arthur Laffer, economist (1970’s)
"It is ironic that in the most un-Marxist country on earth, so central an issue as taxation should have to be fought out using a basically Marxist vision of society." Gordon, author of Hamilton’s Blessing (1996)
"In 1916, the richest man in the country, J.D. Rockefeller, could have paid off the American national debt all by himself. In 1997 William Gates and Warren Buffet together could not pay two months’ interest on it—about $50 billion—without going broke." Ibid
"Don’t tax you and don’t tax me. Tax the man behind the tree." Sen. Russell Long, Louisiana
Some solid links to stories and information related to national debt and income tax
Story on record 2009 deficit:
http://content.usatoday.com/communities/theoval/post/2009/10/620000005/1
U.S. National Debt Clock:
http://www.brillig.com/debt_clock/
Times Square's National Debt clock refurbished in 2008 in anticipation of quadrillion (1000 trillion)-sized debt:
http://www.usnews.com/money/blogs/new-money/2008/10/09/maxing-out-the-national-debt-clock.html
Great article from the Cato Institute on the hidden costs of consumer taxes:
http://www.cato.org/pubs/briefs/bp-015.html
Nuanced Forbes article on flat tax and problems with current projections and plans with Obama tax proposals (soaking the rich won't work--just ultimately poorer.
http://www.forbes.com/2009/03/09/flat-tax-plan-obama-opinions-columnists-taxes.html
NYT article on connections between debt and spending:
http://www.nytimes.com/2009/06/10/business/economy/10leonhardt.html?_r=1
Bloomberg article on Pres. Obama's 2009 discussion of how to cut national debt (and pro/con arguments):
http://www.bloomberg.com/apps/news?pid=20601103&sid=aei7Fn0ISrwo&refer=news
Greece deals with affects of higher consumer taxes within their own national debt crisis:
http://articles.sfgate.com/2010-03-15/business/18831579_1_austerity-greece-tax-hike
http://www.newsday.com/business/tax-rises-hit-greece-as-eu-to-discuss-debt-crisis-1.1811733
Collateral damage by Greek debt crisis:
http://www.guardian.co.uk/business/2009/dec/08/greece-debt-crisis-single-currency-eurozone
http://www.salon.com/wires/techbiz/2010/03/03/D9E7978G0_eu_greece_finding_the_money/index.html
Just in case you want to make a personal contribution to pay the debt, you can make a contribution online either by credit card, checking or savings account at http://www.pay.gov/. You can also write a check payable to the Bureau of the Public Debt, and in the memo section, notate that it's a Gift to reduce the Debt Held by the Public. Mail your check to:
Attn Dept G
Bureau of the Public Debt
P. O. Box 2188
Parkersburg, WV 26106-2188
http://www.treasurydirect.gov/govt/resources/faq/faq_publicdebt.htm#DebtMakeup
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