Tuesday, July 26, 2011

They want to do what!?!?!?

We've all been hearing (non stop) all the discussion and debate about the need for the U.S. to raise the debt ceiling. Negotiations continue and we are currently in "gridlock" over what to do. So I started thinking "I wonder if most Americans understand what is happening and how cold I help explain it?" Well, here goes.

As is usually the case in any argument, the debate is centered around the short term problem and the short term fix and ignores the two bigger and more obvious questions:

  1. How did we get in this mess?
  2. How do we keep it from happening again?
Well before we do that, let's look at some of the data from the Office of Management and Budget that has been compiled in this very cool webpage put together by Adeeb Karam. Click on the "Deficit" tab and you can clearly see the answer to #1 - We got in this mess because the U.S. Government is always spending more than it collects in taxes AND, incredibly, they develop the budget each year without concern of this fact!

For the rest of this article, to make the rest of this a bit easier to understand, I'm going to provide some analogies between the U.S. approach and and individual's personal finances.

Look carefully again at the graph. You can see that all the way through 2016, the "plan" is to spend more than is collected! In order to keep doing this, OUR elected officials want to INCREASE the U.S. debt limit. This would be same as if you went to your credit card company and asked them to raise your credit limit because your card is "maxed out" and you want to keep spending!

What happens when you don't pay back your debt and have to get more credit to have enough money to continue to pay your bills? Your credit score suffers and the interest charged to you for loans increases. This is exactly what is about to happen to the U.S. credit rating and will undoubtedly result in a rise in interest rates for all of us.

So, to answer #2, how do we keep this from ever happening again? The simple answer is we have to have a balanced budget which means Spending must equal Taxes collected. To accomplish this we have two choices: Raise Taxes or Cut Spending. While there are plenty of people on TV right now that are debating which course of action to follow, there is only ONE, course of action to take even though it will be very difficult: cut spending AND not "raise" taxes but rather adjust the tax code to collect more revenue.

Cutting spending will not be easy. There will be hard and difficult choices to be made but they must be made the same way you do when you have an unexpected medical bill arrive. Less going out to eat. Less shopping on Amazon. Focus on the necessities. The government routinely wastes our money and when you're in a financial crisis, you can't waste your money on silly things. That's how you do it and the government has to do the same.

You know that you can not spend more than you have, at least not for long. The government must have the same financial discipline. The simple way to do this is to budget for next year based on this year's taxes collected and not a penny more! If you have to balance your budget and every government institution from the U.S. Congress to the local public school should have to do the same.

So why not just raise taxes to balance the budget? If you are getting in over your head financially, you can not demand more pay from your boss. What would that conversation be like? "I need more money because I don't know how to manage it well." Have that conversation with your boss and you'll find yourself job hunting and your "economy" completely out of whack! The government needs to realize it can not do a similar thing and simply raise taxes without severe consequences to the U.S. economy.

We already work until April 12th to pay all our Federal, State and Local Taxes. That is 101 days or 27.6% of the year. So, almost 30% of your income is "collected" by government to pay some type of tax either on your income, or sales tax, or property tax or other fees, etc. That should be enough to run the government right? Well, everyone pays this amount except those at the extremes: the poor and the rich pay little or no tax. This is why the tax code needs to be changed and simplified.

The poor pay little or no tax because they don't have any money to tax! The rich pay little or no tax because they pay attorneys and accountants to help them "shelter" their income from taxation. That leaves the rest of us to carry the load.

We can revise the tax code to make the amount paid in taxes simplified so that it doesn't take two lawyers and an accountant to know what you have to pay. One suggestion is a Flat Tax coupled with a Negative Income Tax as outlined by Milton Friedman here (it's a lot to digest so read it carefully). This would be a "fair" way to help the less fortunate and still generate ample revenue for government to perform its functions.

To summarize, balancing the budget through a combination of elimination of waste, reducing spending, and simplifying the tax code will not be easy but is the only way to get us out of and keep us out of this mess. When you break through all the bickering, posturing, speech making and drama it is all very simple: the government has to do the same simple thing you do if it wants to be financially successful - "collect" a "decent" amount of money and spend less than what is collected.

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