The Telescope: Letter to Sue

The following email came from an A Line of Sight reader.  It struck me as a particularly sincere series of questions and stimulated this month’s Telescope.

"From what I understand, in order to keep the Tax Cuts that Bush implemented, the USA will have to borrow Billions of $$ from over seas.  Please tell me why this is OK.  Especially if we must borrow from China and other anti democratic governments.  We already owe so much money to foreign governments, and have borrowed billions, maybe trillions to fight the Iraq and Afghanistan wars."

"Another question.  Why is the gulf between the rich and poor growing in this country?  Those who have, continue to receive, those who work for those who have continue to lose jobs, lose pay, lose benefits, and their quality of life continues to diminish.”
"

"One more.  Why, when the mess this country is in came about during the 8 years of George W Bushes reign, and the lack of regulation and accountability during those years, is President Obama and the democratic majority, being blamed for everything that is wrong with the country today?”

“This is not a mass mailing from some off the wall democratic group, these are questions coming straight from little ole Silly Sue."

Dear Sue:

I can tell that your questions are sincere.  To offer a complete answer would take a lot of research time to document all that I’d like to provide you.  I hope you will accept my following explanation with considerable references, and know that there is much more evidence that could be provided. 

The presumption that extending the so-called Bush Tax Cuts from 2001-03 will cost the U.S. Treasury hundreds of billions is at best a one-sided argument.  It assumes that the government forgoes an enormous tax increase (collecting revenue) without any positive impact on the economy that creates more wages as well as more business profit from which more taxes are paid. 

It also assumes that government could impose a huge tax increase on all or a segment of the population with no adverse consequences.  Both one sided assumptions are false because they don’t consider both cause and effect of either keeping the tax rates low and in place, or raising taxes. 

First, let me refer you to the short essays by Rep. Dave Camp and Shonda Werry that appeared in the September issue of A Line of Sight regarding the Bush Tax Cuts and the Democrats’ stated plan to eliminate all or some of the Bush Tax Cuts.   Reading each of them will familiarize you with the diversity of the tax cuts implemented in 2001 and 2003, and also the impact if Congress should allow them to expire on December 31, or vote in a lame duck session after the election to extend only some of the cuts.

Extending the current tax rates does not mean any reduction in current rates being paid by you, me, or any other American individual or business; it simply means keeping the tax rates where they have been for years.  Central to the whole discussion is the question of whether the huge deficits that are being accumulated now are a result of America being taxed too little, or spending too much?  Let’s explore that question.

Recall that when the 01-03 cuts were implemented, it was in the middle of a recession that was magnified dramatically by the 9/11 attacks.  Our economy was in trouble, and 3 million jobs went away almost overnight.  Since I voted for the 2003 cuts, I had an acute interest in their impact, so I followed the economic numbers very closely.  Since the cuts were across the board – meaning EVERY tax rate was reduced – everyone got a break; everyone got to keep a little bit more of their own money.  In addition, the marriage penalty was eliminated and the child tax credit doubled, so families especially got to hang on to more of what they made.  Because of these two big changes and the lowering of the bottom tax rate from 15% to 10%, an additional 3 million people paid no income tax to the federal government at all – and believe it or not, the higher income people paid a still higher proportion of the total tax collected by the government.

For example, based on the most recent numbers available, the top 10% of wage earners pay 69.94% of the total income taxes in the US.  The top 5% pay 58.72% and the top 1% pay 38.02% of the total income taxes collected.  The bottom 50% contributes just 2.70% of total income tax revenue, and has an average tax rate of 2.59%. 

This is from IRS data tabulated by the Tax Foundation for 2008 data, updated this month.  You can refer to the chart below for much more detail, or go tohttp://www.taxfoundation.org/news/show/250.html for further information.

For reference, in 2001 the top 10% paid 64.89% of all income taxes, the top 5% paid 53.25%, and the top 1% paid 33.89%.  So, after the Bush Tax Cuts the wealthy actually paid an even higher proportion of all income taxes collected. 

Summary of Federal Individual Income Tax Data, 2008
(Updated October 2010)

Additionally, in 2003 there were some business incentives.  Most notably, the tax rate on capital gains and dividend income was slashed and the limit for expensing of depreciable equipment and assets by small business was increased from $25,000 to $150,000 (think things like small machinery, furniture, computers, etc).  These measures incentivized investment in job creation and manufacturing tremendously.   Purchases started happening, capital started moving, people went back to work, and the GDP shot up over 8% in just one quarter. 

Because of  combined impact of all of these measures, the recovery from the recession in 2000 and the 9/11 attacks was rapid and sustained.   And, important to your questions, despite predictions of huge losses of revenue to the federal treasury because of reduction in tax rates, federal treasury revenues increased dramatically, as the following chart demonstrates.

Inflation adjusted 2009 dollars – Source: Heritage Foundation 2010, Budget Chart Book

As the chart clearly demonstrates, tax revenue did fall as the recession began in 1999-2000, and fell precipitously after the 9/11.  But, notice the rapid increase in revenue beginning already by the fourth quarter of 2003 after the tax cuts were passed.  Notice as well that total tax revenue came from both increased individual and corporate taxes.  

This happened for one simple reason, the economy was growing, people were working and earning more, and business profits were up – so more taxes were being paid.  The exact same thing happened when Jack Kennedy pushed through tax cuts when he was President.   Reagan did the same, aided then by a Democrat majority in Congress.

Revenue to the treasury continued to increase until 2007. George W. Bush cannot escape responsibility for the economic downturn in 2007-08, but I’d be very remiss if I failed to mention that the most significant political change in Washington in January of 2007 was that the Democrats took over control of both the House and Senate. 

As revenue began to dip, Congress and George Bush increased spending – a lot.  The two largest deficit spending years during the Bush Administration were his last two – both with Democrat majorities in Congress.  I’m sure you understand that Congress holds the nation’s purse, and any President can only spend what Congress authorizes and appropriates. 

The next chart demonstrates that spending did escalate under George W. Bush’s eight years and most significantly in his last two.  Rather obvious, too, is the nearly vertical escalation in spending in the first two years of the Obama Administration.

Inflation adjusted 2009 dollars – Source: Heritage Foundation 2010 Budget Chart Book

Some argue that the huge spending increase was necessary to “avoid catastrophe” as the President has said.  However, as I wrote about in an article titled This isn’t the First Time, there have been six recessions in the last five decades.   America recovered quite well from all of them, and never tried to spend ourselves into prosperity as we are now doing. 

Whatever guilt is appropriately placed at the feet of George W. Bush, it should not be for implementing the tax cuts.  The current economic mess is NOT a result of Americans being taxed too little, it is primarily a result of a collapse in the housing market that precipitated the financial industry crisis, and government over spending wildly beyond its means.  I’ll address both of these below.

Republicans and Democrats share the blame for not reforming Fannie Mae and Freddie Mac long before the crisis hit.  Should you wish, you can find well over a dozen articles on the subject at this link on A Line of Sight.   The problem traces to the 1970s and the creation of the “Community Reinvestment Act” (CRA) originally passed to make sure banks weren’t “red lining” some areas with their lending.  Rapidly and increasingly over the years, the CRA became a vehicle for activists to force banks to do more and more lending, specifically home mortgages, to low income people who under normal underwriting criteria would not qualify for the loans they were granted – the subprime market was born. 

Particularly through the 1990s Fannie and Freddie ramped up subprime loan guarantees until they were actually purchasing mortgages based upon “no income, no asset” (NINA) verification.  Buyers could even “qualify” for mortgages with a zero down payment, and up to 125% of appraised value.  Politicians reveled in the surge in the increasing number of Americans that owned homes, but it was a house of cards.  So long as inflation and home appreciation kept on rolling, the house of cards didn’t crumble, but a day of reckoning was coming. 

As early as 2001, Bush was asking Congress to look into Fannie and Freddie fearing that the rapid increase in the government’s guarantee of problematic loans created systemic financial risk for the country.  Fannie and Freddie mounted an aggressive lobbying effort on Capitol Hill and held off Congress looking under the sheets of the two GSEs (government sponsored enterprises).   In 2003, the Administration warned of “systemic risk” and called for a separate regulator to oversee the GSEs.  Barney Frank (D-MA) led the fight against the Bush Administration calling any concerns about Fannie and Freddie “exaggerated” and insisting that rather than reform them, the GSEs should be expanded even further into non-traditional home loan products- and they were.  Eventually, the two agencies either owned or guaranteed over $5 trillion of mortgages; about half of the entire total in the U.S.

Politicians know it is a lot more popular to make home mortgages easy to get than to rein in access to easy credit.  In 2005, Senator Richard Shelby (R-AL) as chairman of the Senate Finance Committee launched an effort to reform the lending practices of the agencies, and was defeated by a filibuster led by Sen. Chris Dodd (D-CT). 

Repeatedly, the Inspector General’s office (these are the people required to audit the various departments of government and report their findings to Congress) warned Congress of substantial risk.  Even financial officers of the GSEs themselves testified to Congress that there were enormous problems.  Still Congress took no action. 

Once the Democrats took back control of the Congress in January of 2007, the chance of reforming the agencies completely disappeared.  In fact as late July of 2008, with Fannie and Freddie stock already rapidly declining amid the markets’ growing concern about the health of the agencies, Sen. Chris  Dodd proclaimed that the GSEs were “fundamentally strong.”  "The economics are fine in these institutions and people need to know that," Dodd said. There's no reason "to talk about failure," he added.  Sixty days later, the economy was in free fall, Obama and McCain had suspended their campaigns and went to Washington for a summit, and everywhere there was talk of a financial catastrophe.

Since banks, insurance companies, and pension plans hold as investments huge amounts of government guaranteed mortgage backed securities, when the valuation of these investment tanked those institutions followed them in free fall.  It was the politicians’ blind obsession with buying favor back home through misguided and poorly managed public policies that precipitated the economic mess we are in.

Next, let’s look at the huge increase in overspending at the same time all this was happening.

Your question implies that spending on the wars in Iraq and Afghanistan is at the core of government debt; specifically the “billions, maybe trillions” we borrow from foreign countries.  Certainly spending allocated to our military increases the total cost of government.  However, as you can see in the next graphic, since 1965 defense spending as a percentage of GDP has actually decreased rather dramatically and is projected to continue on that trend.  For the last 55 years, average defense spending as a percentage of GDP has averaged 5.3%.  During the Bush years, the average was below 4%, and recently as President Obama has escalated the war in Afghanistan, it has crept up to 4.9% of GDP.

Source: Heritage Foundation 2010 Budget Chart Book

Total spending, by the way, shot up to about 25% of GDP.  

War is costly, for sure, and the questions about every war will always be debated. However, as we learned on 9/11, America does have enemies.  Our national interests and security will require an extensive military and intelligence community, so some reasonable level of support will be necessary.  Other than complete pacifists, most experts think that level should be somewhere around 4% of our GDP.
  
The reality is that even if the President brought all of the troops home from Afghanistan and Iraq tomorrow, the deficit for next year as projected by Obama’s own budget office would still exceed $1 trillion.  Worse, though, increasing the exposure to future attacks by al Qaeda and radical Islam by not taking the fight to the enemy is an incalculable risk.  As Bob Woodward’s new book Obama’s Wars documents, that is the conclusion that the President reached as well.
  
In fact, the 9/11 Commission found that the reductions in military and intelligence spending during the Clinton years contributed greatly to the vulnerabilities that al Qaeda exploited on 9/11.  As the commission stated, America suffered four kinds of failures: imagination, policy, capabilities and management.  Further, the Commission said that in many ways the 9/11 attacks were more devastating than Pearl Harbor, and they recommended extensive upgrades to our capacity to defend ourselves. 

The chart below documents that historically the federal government has spent more than it takes in on average.  The consensus among economists is that annual deficits less than 3% of GDP are “sustainable,” and, as you can see, over the last 60 years the U.S. has been just under that benchmark.  However, current deficits are over 10% of GDP and by the Obama administration’s own budget office projections, they are not going to come down anytime soon – as in ever.

Source: Heritage 2010 Budget Chart Book

A CBO report to Congress last week noted that in just the last two years there government spending has increased an alarming 21.4%.  Entitlements and other social safety net programs, particularly unemployment benefits, exploded.  Defense spending as a percentage increased about half as much, 12.1%, for that same two year period even as Obama escalated operations in Afghanistan.   Stating the obvious, the CBO says this is an “unsustainable path” and that “significant changes in policy” are necessary to get our financial house in order.” 

Instead of recognizing that the current course of spending is “unsustainable,” Obama’s budget projects an additional 56% growth in federal spending over the next ten years.  If that isn’t alarming enough, consider that our federal government’s current fiscal house is in such disarray that the U.S. could not even qualify for membership in the European Union.  

In commenting on the recent CBO report, the Wall Street Journal wrote, “The 21.4% federal spending increase in two years ought to put to rest any debate about the nature of America's fiscal problem. The Pelosi Congress has used the recession as an excuse to send spending to record heights, and its economic policies have contributed to a lousy recovery. The solution is to stop the spending and change the policies.”

The 2010 fiscal year for the federal government ended on Sept. 30 with a staggering $1.29 trillion deficit.  This follows a $1.41 trillion deficit in 2009.  The White House has projected another $1.4 trillion of red ink for next year, and nearly a trillion average annual deficits for the balance of the decade.  Prior to Obama, the largest deficit ever recorded was $459 billion in Bush’s last year of 2008.  

These numbers can numb the mind and become impossible to comprehend.  To help put it all in perspective consider that the 2010 deficit alone is $45 billion more than the total of the twelve years of GOP Congressional majorities from FY1996-FY2007.  In other words, under Barack Obama, Nancy Pelosi, and Harry Reid the average monthly deficits are greater than the average annual deficits under a GOP congress, including all eight years of George W. Bush.  

Sue, in a nutshell, that is why Obama and the Democrats are increasingly loosing favor with the American people and attracting criticism.  

The “policies” that the both the CBO and the Wall Street Journal were referring to would include the $800 billion “Economic Stimulus” that a majority of Americans now believe was either a waste of money, or actually made the economy worse.  Vast amounts of the money went to grow government, and at one point 10 new government jobs were being created for each one in the private sector.  That increased cost of government that is reflected in the 21.4% spending level increase over the last two years will likely be with us forever and is at the root of the CBO’s reference to a need for “significant changes in policy.” 

It would also include the health care legislation, ObamaCare.  Instead of reducing cost and increasing access, a plethora of reports both before and after passage of the bill found that cost will increase and individual choices will diminish.  Although Nancy Pelosi claimed that “400,000 jobs would be created almost immediately” after passage of ObamaCare,  in reality thousands of jobs have already been eliminated, and many more jobs are at risk with the cost of operations escalating for businesses as a result of the legislation.  As I’ve written about on this website before the NFIB estimates 1.6 million jobs will be lost as a result of ObamaCare.  Another report estimates more than 5 million jobs could be destroyed.  

While the bailouts (TARP) had their beginning under Bush’s last days, this administration put them on steroids and went far beyond the original intent of providing a safety net for the financial industry, most notably the takeover of General Motors and Chrysler.  Today, a majority of Americans believe the bailouts were a bad idea, wasted more money, were full of corruption particularly for big labor, and didn’t “save or create” jobs either. 

Again, the current financial crisis was precipitated by the housing and banking industry collapse yet it took over two years for the Congress and Obama to pass their much touted Financial Reform legislation.  Yet, amazingly, in 2800 pages of new government regulation that creates hundreds of new agencies, regulations, and mandates, there is no mention at all of Fannie Mae or Freddie Mac – the two government sponsored enterprises (GSE) that precipitated the whole mess.  As with the other signature pieces of legislation, the financial reform package will cost billions more in compliance costs, tighten government control, and, yes, cost jobs rather than create them. 

Sue, you asked why “President Obama and the Democratic majority, being blamed for everything that is wrong with the country today?”  These are some of the reasons.  You can’t spend trillions, grow government regulation, pass landmark legislation, expand war efforts, and escape responsibility for the results.  If it had all turned out well, don’t you expect the Democrats would be basking in their glory and claiming credit?    

Obama promised that his policies would keep unemployment below 8%.  That he would “rescue the economy from catastrophe.”  It hasn’t happened.  Unemployment has exceeded 8% for twenty consecutive months now, the last seventeen above 9%, and even his Administration predicts it will remain high for quite some time.  

His agenda isn’t working, and that is why by a huge margin of 63:30 Americans currently believe the country is on the “wrong track.” 

Lastly, you asked about the “gulf between the rich and the poor.”   And, why “those who have, continue to receive, those who work for those who have continue to lose jobs, lose pay, lose benefits, and their quality of life continues to diminish.”  

Since the Great Society days of the 1960s the U.S. has spent hundreds of billions trying to eliminate poverty.  Yet, the more we spend, the more the number of people below the federal poverty level seems to grow.  The nature in which you asked the question implies that the reason we have so many poor people is at least in part because “those that have” are doing something unfair or even immoral.  I hope that is not really the starting point for your opinion.  

The American free-market economy has always allowed for more mobility through economic classes than anywhere else in the world.  Poor people migrate upward through hard work, invention, talent, or sometimes just good luck.  Similarly, many fortunes are lost when a wealthy person mismanages their wealth or fails to calculate real inherent investment risk.  

Walter E. Williams, the noted economics professor at George Mason University, has devoted much of his life to the study of the causes of poverty.  He happens to also be an African-American.   In one of his most comprehensive essays titled, “Are the Poor Getting Poorer?”Williams offers some keen observations. 

I cannot possibly top either the content or the prose of Williams, so I’ll just refer you to a considerable excerpt from the entire work published in October, 2007.

“In 1971, only about 32 percent of all Americans enjoyed air conditioning in their homes. By 2001, 76 percent of poor people had air conditioning. In 1971, only 43 percent of Americans owned a color television; in 2001, 97 percent of poor people owned at least one. In 1971, 1 percent of American homes had a microwave oven; in 2001, 73 percent of poor people had one. Forty-six percent of poor households own their homes. Only about 6 percent of poor households are overcrowded. The average poor American has more living space than the average non-poor individual living in Paris, London, Vienna, Athens and other European cities.”

“Nearly three-quarters of poor households own a car; 30 percent own two or more cars. Seventy-eight percent of the poor have a VCR or DVD player; 62 percent have cable or satellite TV reception; and one-third have an automatic dishwasher.”

“For the most part, long-term poverty today is self-inflicted. To see this, let's examine some numbers from the Census Bureau's 2004 Current Population Survey. There's one segment of the black population that suffers only a 9.9 percent poverty rate, and only 13.7 percent of their under-5-year-olds are poor. There's another segment of the black population that suffers a 39.5 percent poverty rate, and 58.1 percent of its under-5-year-olds are poor.”

“Among whites, one population segment suffers a 6 percent poverty rate, and only 9.9 percent of its under-5-year-olds are poor. Another segment of the white population suffers a 26.4 percent poverty rate, and 52 percent of its under-5-year-olds are poor.”

“What do you think distinguishes the high and low poverty populations? The only statistical distinction between both the black and white populations is marriage. There is far less poverty in married-couple families, where presumably at least one of the spouses is employed. Fully 85 percent of black children living in poverty reside in a female-headed household.”

“Poverty is not static for people willing to work. A University of Michigan study shows that only 5 percent of those in the bottom fifth of the income distribution in 1975 remained there in 1991. What happened to them? They moved up to the top three-fifths of the income distribution -- middle class or higher. Moreover, three out of 10 of the lowest income earners in 1975 moved all the way into the top fifth of income earners by 1991. Those who were poor in 1975 had an inflation-adjusted average income gain of $27,745 by 1991. Those workers who were in the top fifth of income earners in 1975 were better off in 1991 by an average of only $4,354. The bottom line is, the richer are getting richer and the poor are getting richer.”

“Poverty in the United States, in an absolute sense, has virtually disappeared. Today, there's nothing remotely resembling poverty of yesteryear. However, if poverty is defined in the relative sense, the lowest fifth of income-earners, "poverty" will always be with us.”

“No matter how poverty is defined, if I were an unborn spirit, condemned to a life of poverty, but God allowed me to choose which nation I wanted to be poor in, I'd choose the United States. Our poor must be the envy of the world's poor.”

I share Williams’ sentiment and observation.  Sue, as you know, America has been a land of enormous opportunity to me and my family.  My grandfather came here as a penniless immigrant in 1907.  My own parents spent the majority of their long lives in back breaking farm work just barely getting by most years.  But they persevered and left a better starting point for each of their children than they had enjoyed.  That same ethic served me and my three siblings well, too.  

My parents believed that a man was entitled to the bread he earned, and if he worked smarter and harder and had more to show for it – well good for him.  I never knew them to expect something they hadn’t worked for from someone else – or from government.  That was the America I grew up in, and I still believe in.  

Jobs create opportunity, and rather obviously it is the wealthy that create jobs either directly by providing resources to expand business, or through spending their wealth which increases demand for goods and services.  They also are the most charitable people among us.  We need more of them, not less, and we especially need the opportunity to become wealthy – the American Dream - to survive and flourish.  

Today’s leadership is waging class warfare against the wealthy as though it were a curse.  I call it The War on Prosperity, and have written extensively about it.  It’s not only wrong; it is un-American and immoral.  If someone is unjust to their employees, is corrupt in their business practices, cheats on their taxes, endangers the public welfare – well, there are lots of laws with which to prosecute them.  See Bernie Madoff.  

America was built on a belief in enormous opportunity for wealth creation through invention, entrepreneurship, entertainment, artistry, or any other acceptable means.  Reward is a great incentive for those willing to push the envelope and take considerable risk, and it is the incentive that made us the greatest nation in the history of the world.  How did we get to a place where success was somehow a bad thing to be vilified by even our President? 

Government could seize and redistribute all of the wealth created by those at the top, and we’d still have people living at the bottom of the ladder we call “the poor” as Walter Williams explained.  We would also quickly have no one left at the top – and no one willing to work to get there - if what they earn is just going to be taken away by government.  

Debating whether the current mess is the fault of George Bush or Barack Obama doesn’t change the terrible circumstances we find ourselves in.  Further, both men were elected and so in fairness, maybe we all got exactly the kind of government we deserve – so, it’s really our own fault.  

But, we are where we are. It is not a very pretty picture, and the trend is terrifying.  

In a letter to his fellow Virginian, James Madison, in 1789 (the same year that the Constitution was adopted), Thomas Jefferson addressed the role of government and the fiscal discipline envisioned by the Founding Fathers. These two men would become our third and fourth Presidents.

"The earth belongs to each of these generations, during its course, fully, and in their own right. The 2d. generation receives it clear of the debts and encumbrances of the 1st. The 3d of the 2d. and so on. For if the 1st. could charge it with a debt, then the earth would belong to the dead and not the living generation. Then no generation can contract debts greater than may be paid during the course of its own existence."

Our sixteenth President, Abraham Lincoln, offered us these ten principles to live by: 

1.    You cannot bring about prosperity by discouraging thrift.
2.    You cannot strengthen the weak by weakening the strong.
3.    You cannot help small men by tearing down big men.
4.    You cannot help the poor by destroying the rich.
5.    You cannot lift the wage-earner by pulling down the wage-payer.
6.    You cannot keep out of trouble by spending more than your income.
7.    You cannot further the brotherhood of man by inciting class hatred.
8.    You cannot establish sound security on borrowed money.
9.    You cannot build character and courage by taking away man’s initiative and independence.
10.    You cannot help men permanently by doing for them what they could and should do for themselves.
 

Sue, my answer to your very good questions is likely much longer than you wanted or expected, and perhaps I have been unsuccessful in changing your opinions.  I do, however, hope you have an appreciation for more of the totality of the problems our nation faces, and that something fundamentally has to change.  

America was founded by people with a tremendous sense of fairness, devoted to maximum individual liberty, and minimum coercion by government.  Those principles served our nation very well for 200 years.  How much farther will we drift before we right the ship?