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Where Did The Money Come From?

paying taxesThe Congressional Budget Office (CBO) released their preliminary estimate of the monthly budget deficit for January.  The CBO estimated the government overspent by a measly $2 billion in January 2013. This compares to a monthly deficit of $27 billion in January 2012.

Hold on before you think we’re making much progress towards reducing the $1 trillion plus deficits of the past four years.  This was only one month out of twelve.  The CBO estimates the cumulative deficit for the past four months is $295 billion (the U.S. fiscal year starts on October 1), and the Fiscal 2013 total deficit is projected to be $850 billion.

The CBO reported a $36 billion uptick in revenues collected in January 2013 over those collected in January 2012.  Some politicians and pundits are already citing these numbers as being indicative of the success of the increased taxes, which were part of the fiscal cliff deal reached on January 1, 2013. It’s a stretch to make this claim, but that rarely matters in the world of politics.

The CBO estimated the government collected $9 billion more in Social Security taxes.  These additional taxes arose from the additional Social Security taxes collected after January 1, 2013.  The 2% temporary tax holiday was scheduled to expire December 31, 2012, and further extension was never a serious consideration.  Social Security is already headed towards insolvency, and continuing a reduced rate would have only exacerbated the problem.  It’s a stretch, but since Congress could have extended the lower rate, you could make the argument these additional revenues were part of the fiscal cliff deal.

Although the remaining additional $27 billion may have been collected in 2013, most of it is not attributable to the fiscal cliff deal.  The increased tax rates only affected high income individuals on income earned after January 1, 2013.  Most super wealthy people pay their taxes through estimates, not withholdings, and the first quarterly payment is not due until April 15th.  Thus, the first real increase in revenue from the higher 2013 taxes won’t be collected by the Treasury until April 2013.

So where did the money come from?  In all likelihood, most of it was additional 2012 taxes which were paid in 2013.  Quarterly estimated taxes for individuals are due April 15th, June 15th, September 15th and January 15th of the following year.  Based on my experience, most wealthy people pay their fourth quarter installment in January of the following year.  Odds are that most of the additional $27 billion in tax revenues actually relates to taxes paid for 2012, not the increased taxes due for 2013.  It’s a reasonable conclusion, since many high income taxpayers accelerated income into 2012 to avoid the anticipated higher 2013 tax rates.

The additional revenues may be good for the country and the economy.  However, I think it’s a little too early to declare success and victory from the increased tax rates.  I believe the verdict is still out, but to make a fair assessment, you have to understand where the money comes from.

Avoiding the Cliff but what about the Abyss?

US Capitol-WinterCongress and President Obama finally reached an agreement to solve the “fiscal cliff.”  The compromise, the American Taxpayer Relief Act of 2012, was reached in the early morning hours of January 1, 2013.

Many of our illustrious leaders in Washington tried to sound reasonable by saying no one got what they wanted but it was the best deal they could reach.   Essentially, they were saying you may not be happy, but be satisfied.

It’s a sad day if this was the best they could do.  I have two primary contentions with the deal they reached.  First… the timing and process of the solution, and secondly, the absence of any meaningful changes in federal spending.

The process was extremely political, and the American electorate should expect more… no demand more… of our leaders.  The fiscal cliff was primarily created by two pieces of legislation.  In December 2010, Congress temporarily extended the “Bush tax cuts” until December 31, 2012.  Thus, they have known for two years tax rates would increase unless they passed legislation to extend or change the rates.  The other part of the equation was the spending cut provisions agreed to in August 2011 to settle an impasse on increasing the debt limit.  Thus, Congress and President Obama have known for 18-24 months the fiscal cliff was coming but didn’t resolve it until after the deadline passed.

I have many smart and successful clients.  It has been exceptionally frustrating and difficult for them to make business and financial decisions without knowing what the future tax rates and rules will be.  Even on December 31st, no one knew what the rules would be the next day.  In my opinion, it was an absolute lack of leadership and prudence on behalf of both branches of government, both houses of Congress and both political parties.

Although the process was frustrating, the most upsetting part of the compromise was the complete absence of spending cuts.  The tax increases are projected to raise over $600 billion of additional revenue over the next 10 years, and all spending cuts are postponed, at least for another two months.

Fiscal Cliff statementPresident Obama campaigned on a balanced approach to deficit reduction.  How can you consider $620 billion of additional revenue and no spending cuts a balanced approach?  Our political leaders have promised the spending cuts will come soon, but that’s what they promised when they passed the law in August 2011.  It was easy to promise future cuts, but when it came time to actually implement a spending reduction, they postponed them once again.

Don’t be deceived into thinking the new tax revenues will make any significant dent in our debt or deficit.  $620 billion is a lot of money, but it’s over the next 10 years.  The U.S. Government is currently overspending by $1.3 trillion each year.  The additional revenues will help, but we’ll still rack up an additional $10+ trillion in debt over the next decade, based on current spending.  The exclusion of spending cuts in this deal was another missed opportunity.  Spending cuts are never easy or popular, but I’ll offer two guarantees; 1) spending cuts will come and 2) the longer we wait, the more painful they will be.

There may have been some political winners from the whole fiscal cliff debacle, but I believe we, the American public, were the real losers.  The deal cut may have averted the fiscal cliff, but the absence of any real spending cuts pushes us closer to a financial abyss.

Check Please

November 1, 2012 1 comment

The Congressional Research Service  issued a report to the Senate Budget Committee outlining the federal spending for benefits to lower income people in the U.S. during Fiscal 2011 (year ending September 30, 2011).  The U.S. government spent $746 billion on programs for lower income people.  If you add in state spending, the total exceeds $1 trillion.

According to the Census Bureau, there were 16.8 million families living below the poverty level in 2011 ($23,000 for a family of 4).  By simple math, this means the federal and state government spent nearly $60,000 for each family in poverty, which is nearly three times the amount they earned during the year.

Less than 10% of the support is in the form of direct cash payments.  Of the $746 billion spent by the federal government, $318 billion is for Medicaid and prescription drug subsidies.  Approximately $66 billion is in the form of direct cash assistance and $73 billion is in the form of tax credits.  The remaining $290 billion of support is delivered through 80 different programs designed to help lower income families.

Given the choice, a number of families might choose to ask for a $17,000 in lieu of the other programs.

It might seem crazy, but do you think it’s efficient to have 84 different programs to help needy people?  Each program has its own objective and purpose, but there is a cost for employees, office space, computers, etc.   The more money spent on overhead, the less is being spent on actually helping people.

A few years ago I helped a school with a grant for an afterschool educational program.  I was surprised and dismayed to discover that over 20% of the grant money was going to be spent for a grant administrator, who would do nothing but complete reports and monitor the work of others.  Sadly, I think that grant is indicative of how many government programs and grants operate; a large chunk of the money is gobbled up in administrative costs.

I’m not against helping lower income families.  In fact, I think we have an obligation to help those who are most vulnerable and in need.  The issue is how the assistance is delivered.

It has been nearly 50 years since Lyndon B. Johnson declared a war on poverty and introduced the Great Society.  Trillions of dollars have been spent over the past 5 decades, yet the poverty rate in the U.S. is almost exactly the same as when this great endeavor began. 

Maybe we should consider eliminating a number of programs and giving more cash to those who are in need.  This seems outrageous to most conservatives, who often think people are abusing the system.  Many of us have witnessed people using their food stamps to purchase cigarettes and alcohol.  There will always be people who abuse the system, and they should be punished when possible.  I also believe the current bureaucratic morass often aids them in taking advantage of the system.

Conservatives frequently complain about people being dependent upon the system.  Part of the solution may be giving people more money, which will allow them to be more independent and self-sufficient.  However, this independence must be coupled with more responsibility for their choices.

Your willingness to embrace such an idea is probably influenced by your view of people.  Do you see them as lazy and untrustworthy, requiring a rigid bureaucracy to monitor and keep them in line, or do you trust people to be independent, make good decision and do what’s right when given the opportunity?  Personally, I would rather be trusted to do the right thing, than have some bureaucrat watching over me.  Given the choice, I would prefer to forego all the programs and simply say… “Check Please.”

Arithmetic

A few weeks ago, former President Clinton scored political points while criticizing the economic plan of Gov. Mitt Romney.  He touted the Federal budget surpluses during the final years of his presidency.  He went on to say he was able to balance the budget by simple arithmetic.  He also invoked the simple arithmetic principle to argue that Gov. Romney’s plan didn’t add up and would result in a large tax increase on middle class Americans.

The truth is that neither Gov. Romney nor President Obama’s plans pass the arithmetic test.  A detailed analysis of their plans is far beyond the scope if this article, so I’ll briefly summarize.

The highlights of Gov. Romney’s plan:

  • Cut tax rates by 20% for individuals and lower the corporate rate to 25%
  • Have preferential rates for interest, dividends and capital gains
  • Eliminate loopholes and limit certain deductions for higher income taxpayers

The criticism of Romney’s arithmetic is there aren’t enough loopholes to close which will offset the reduced revenue from the lower tax rates.  Deductions would also have to be limited for lower income taxpayers to make the numbers work.

The main point of President Obama’s plan:

  • Increase the tax rates for people making over $250,000
  • Eliminate the preferential rate for dividends and increase the capital gains rate

These changes are estimated to raise an additional $70 billion in annual tax revenues.

The arithmetic doesn’t work for either of these plans to balance the budget.  For the 2012 budget year, the federal government overspent by $1.1 trillion, and the total national debt has exceeded $16 trillion.  Since the government spends approximately $3.5 trillion each year, it’s a monumental task to close a $1.1 trillion deficit.

The U.S. Treasury collects approximately $2.2 trillion in income tax revenue each year.  To balance the budget under the Romney plan, all current deductions would need to be cut in half to raise another $1 trillion.  Deductions would have to be limited even more if the tax rates are reduced.  The Obama plan is no better.  Even if his tax changes were implemented, he’s about $1 trillion short to balance the budget.  By simple arithmetic, the numbers don’t add up… for Romney or Obama.

We can’t tax our way out of the hole we are in.  We must cut spending in order to balance the budget.  This is not Washington semantics for cuts by reducing the rate of growth or cutting the amount you hoped to spend.  It means actually spending less than the $3.5 trillion we spent last year.

On this front, I give the edge to Gov. Romney.  You or I may not agree with his proposals or priorities, but at least he’s willing to talk about cutting federal expenditures.   He was criticized and ridiculed after the first Presidential debate for trying to kill Big Bird, because he advocated ending the federal subsidy to the Public Broadcasting Service.  He has also been willing to tackle the “third rail” of politics – Medicare and Social Security.

In contrast, I can’t think of one significant cut in federal spending proposed by President Obama.  Counting money which would have been spent for the war in Iraq but isn’t going to be spent doesn’t count in my book.  It’s like saying you cut your spending by $5,000 for the vacation you didn’t take.  Furthermore, the budget deficit for 2013 will still be over $1 trillion without any spending for Iraq.  Instead of talking about spending cuts, the President is pushing for more “investments” (aka spending) for teachers and infrastructure.  These may be good things, but it doesn’t address how to balance the budget, and taxing the rich more isn’t going to close the gap.

Politicians are very good at using sound bites and obscuring the truth.  President Clinton was right… balancing the budget is simply a matter of arithmetic.  In this case, both candidates (and most members of Congress) probably need a remedial math class.

Ignore the WARNing

The Worker Adjustment Retraining and Notification Act (WARN) is a federal law requiring an employer with more than 100 employees to provide at least 60 advance notice of any mass layoffs or plant closings.  The law is intended to alert employees and communities of upcoming layoffs, and a company can be penalized for up to 60 days of employees’ wages for failing to comply with the WARN notification.

The WARN requirements have created a serious political problem.  According to the Congressional budget deal worked out last year, defense spending will be reduced by $55 billion starting on January 2, 2013.  If the spending cuts occur many defense contractors are concerned about a significant reduction in their contracts, which could lead to massive layoffs on January 2, 2013.  In order to avoid penalties and meet the 60-day WARN notification, employers need to notify their employees before November 2, 2012, which just happens to be 4 days before Election Day… ala the political conundrum.

On Monday, the Department of Labor (DOL) mailed a letter to state agencies stating it would be “inappropriate” for employers to send out WARN layoff notifications in anticipation of the defense spending cuts.  This immediately raised many eyebrows as to whether or not the DOL’s letter was politically motivated.   Suspicions were heightened, because the Department of Labor previously issued guidance to employers saying it could not give WARN advice regarding specific situations.

Three primary concerns come to mind regarding this matter.

Undue Political Influence

It’s hard to get away from politics in an election year.  Every decision is interpreted through a political prism, and it’s hard to divorce politics from the process.   Decisions like this one are made by high-ranking political appointees, and their jobs and influence are dependent upon whether or not their boss retains his job.  Thus, it can be near impossible to think politics won’t influence the decision makers.  However, it seems like elected and appointed officials are predisposed to make most of their decisions based on what’s best for their career and pocketbook, instead of what’s best for the country.  We can’t honestly know the motivation of the DOL personnel involved in this decision, but choosing to provide guidance on an issue they previously refused, certainly raises questions.

Meaningless Laws

The primary rationale for the DOL’s conclusion for employers to refrain from sending out WARN notices was the uncertainty of whether or not the cuts would remain in effect. The DOL essentially acknowledged this law was a sham in the first place and was passed for political expediency.  Irrespective of whether Congress ever intended for the cuts take effect, are the spending cuts the law or not??  According to the legislation on the books, the cuts will occur unless a new law is passed to restore the spending.  As a citizen, you’re penalized for disobeying a law or regulation, so why do politicians and government bureaucrats get to decide which laws they enforce or follow?

Ineffective Government

As a nation we are probably more divided than any time in history since the Civil War, yet the problems we face are immense.  The sluggish economy and $16 trillion debt are enormous problems.  Rather than having serious discussions and working towards creative solutions, our leaders are more focused on partisan brinkmanship and political machinations.  If history repeats itself, the defense spending cuts will probably never happen.  Rather than face a disgruntled electorate and risk losing an election, our leaders will forge some “compromise” which maintains the status quo and allows both sides to declare victory.  Meanwhile, nothing is resolved and the country plunges further into debt each day, and our leaders are able to pass laws that are never intended to go into effect to maintain the charade of getting something accomplished.

The DOL’s guidance for employers to ignore the WARN notices should set off a much larger warning.  Aside from the political ramifications, it’s a dangerous place for politicians and bureaucrats to selectively choose which laws to follow and enforce.  We’re either a nation of laws or not.  If not… then God help us.  Lawless nations and those which allow its leaders to use the laws to reward their friends and punish their enemies are always destructive to the people at large.

The Supreme Court Rules on Obamacare

In a 5-4 decision, the U.S. Supreme Court upheld the constitutionality of Obamacare (the Patient Protection and Affordable Care Act).  Lawyers, politicians, journalists and citizens are scouring the judicial rulings to understand its implications.  The law is exceptionally complex, so it will take time fully comprehend the ramifications of the ruling.

Here are a couple of the most significant elements of the Court’s ruling.

  • The penalty for failing to purchase health insurance is equivalent to a tax, which Congress has the authority to assess.  Thus, the individual mandate is Constitutional.
  • Congress does not have the power under the Commerce Clause to force you to purchase insurance.
  • Congress can require states to increase their Medicaid roles and provide financial incentives to do so, but it can’t withhold all Medicaid funding if it doesn’t.  It seems confusing and contradictory and will likely lead to further litigation.

Here are a couple of quick thoughts and observations.

  • The logic of the Court regarding the individual mandate was interesting.  Apparently, Congress can’t force you to purchase something, but they can tax or penalize you if you don’t.
  • The Medicaid issue is one of the most unclear parts of the ruling.  Unlike the individual mandate, it seems Congress can require the states to increase their Medicaid roles, but can’t penalize them if they don’t.  The issue hinges on state sovereignty, and it will be interesting to see how this plays out, especially since several states have already passed legislation opting out of Obamacare or the individual mandate.
  • The split ruling was no surprise, but it was a shock that Chief Justice John Roberts upheld the constitutionality and Justice Anthony Kennedy did not.  The unpredictability of judges and juries is what’s often referred to as the hazards of litigation.  No matter how strong you think your case is, a judge or jury may see it differently.

Today’s ruling by the Supreme Court isn’t going to end the discussions or fights over Obamacare.  There is still a lot more to come.

I welcome your comments and thoughts regarding the Supreme Court decision.  Click here if you would like to take a quick poll on whether you agree or disagree.

Social Security Groundhog Day

You may have seen the movie “Groundhog Day” which was released in 1993.  In the movie, Bill Murray plays weatherman Phil Connors who was sent to Punxsutawney , PA to cover Groundhog Day, only to find himself repeating the same day over and over again.  No matter what he does, he can’t seem to escape Groundhog Day.

The annual report from the Trustees of the Social Security Administration seems like its own version of Groundhog Day.  Every report seems to be a repeat of the prior one.  The reports warn of the coming insolvency of Social Security and Medicare, but it’s projected to be far enough into the future, that no one seems to worry too much.

The 2012 report estimates the Social Security system will become insolvent in 2033, three years earlier than what was predicted a year ago.  The fiscal status of Social Security has been known for years, yet Congress and President Obama reduced the employee’s contribution rate to the Social Security system from 6.2% to 4.2% for 2011 and 2012.  The rate reduction was intended to stimulate the economy, and they argued it would have no long-term impact on the solvency of Social Security.  Anyone with a rudimentary understanding of economics and finance could tell you paying less taxes into a system that is already paying out more than it receives, will have a negative effect.  Only Washington politicians are surprised by the updated figures, or at least act surprised.

The staunch defenders of this ridiculous argument also contend the system is solvent for more than the next two decades.  They point to the trillions of dollars in the Social Security Trust Fund as the saving grace to the system.  You can read this article to learn the fallacy of this belief.

There are a couple of other facts in the report which might cause concern.  In 2011, the government collected $691 billion of Social Security Taxes and paid out $736 billion in benefits.  It appears there was a $45 billion shortage in 2011, but there wasn’t.   The Social Security Administration collected $111 billion of interest on its IOU’s from the US government, so it reported a surplus of $66 billion, rather than a deficit.  So where did the $111 billion of interest come from?  It’s part of the $1 trillion of additional debt the U.S. Treasury issued over the past year.

It’s easy to get lost and confused by the Federal government’s accounting methods, which may be intentionally arcane.  So here is the bottom line… call it what you want, but the U.S. government borrowed an additional $45 billion to pay out Social Security benefits in 2011.  If you read the report and analyze the projections, you’ll see this number is only going to grow exponentially over the next two decades.

What is it going to take to change the situation?  I really don’t know if we’ll ever realize what’s happening as long as the government keeps sending out checks.  But what happens if they stop?  It’s unlikely to occur, at least for a long time, but what would have happened if the U.S. Treasury wasn’t able to borrow the additional $45 billion? Since there are no real assets in the Social Security Trust Fund, $45 billion in checks would not have been sent.

So in essence, it’s like we’re stuck in our own Social Security Groundhog Day, but there is a difference between us and the character Phil Connors; Phil Connors recognized he was stuck and tried to change it.  Sadly, most of us don’t believe we’re living our very own Groundhog Day.