Reducing the Federal Deficit
This essay was written in 1992. I am publishing it as is until I have time to revise it to more precisely fit the current situation
The federal deficit hampers economic growth
by causing the federal government to compete with private business for
investors' dollars. Federal borrowing to finance the deficit has encouraged
high interest rates that reduce the ability of businesses and consumers
to repay borrowed money.
Congressional willingness to spend money without
regard to tax revenue encourages spending on noneconomically productive
activities that distort the economy. Government can be an economic parasite
if it takes money from the general population without returning an equal
value of services to that population. Expenditures on nonessential programs
at a level exceeding revenue indicates that government has become a parasite.
The National Endowment for the Arts(NEA) provides
an example of a parasitic program. Critics of NEA have focused on the wrong
issue. The issue is not whether the federal government should subsidize
art some consider pornographic, but whether government should use tax money,
or more accurately borrowed money, to give some people's idea of "art"
preference over art favored by others. A democracy that supports the concept
of free expression should allow individual citizens decide what art includes
and what art their money should support. Government subsidies to artists
who meet government standards provide those who meet the standards a greater
freedom of expression than others and distorts the art market by encouraging
artists to please government rather than consumers.
Richard Nixon was the last president to seriously
attempt to control the deficit. His policy of impoundment attempted to
spend money slower than authorized by Congress. Senator Sam Ervin initially
fought this policy in the courts and then used the Watergate incident to
destroy Nixon politically. No subsequent president has seriously attempted
to challenge irresponsible congressional spending except through occasional
vetoes of spending bills.
If the President and Congress really want to
reduce budget deficits they will need to adopt a more sophisticated approach
than simply raising taxes or attempting to cut or freeze spending. They
will need to change such procedures as the way they look at the deficit,
the way various agencies spend money, and the way the federal government
Congress needs to overhaul the individual income
tax system. However, unless Congress is willing to raise taxes on those
making over $30,000 a year, this source cannot produce sufficient revenue
to reduce the deficit. Taxes on those making less than $30,000 could increase
the deficit because these taxpayers would have to reduce their spending
on goods and services. Reductions in personal spending would in turn reduce
the number of people needed to provide these goods and services and thus
reduce federal revenue and increase spending for social programs.
The proposed energy tax would be counterproductive.
The tax would increase prices and all products and thus reduce consumer
spending power. The tax could easily spark inflation with resulting increases
in unemployment and interest rates.
Reducing spending provides a desirable but
difficult to achieve goal. Members of Congress are willing to cut the spending
of any agency except the ones they like. Unfortunately most agencies have
more friends in Congress than do the nation's taxpayers. Government agencies
seldom will recommend spending cuts except for popular programs they realize
Congress will not allow to be reduced. Reducing spending will require either
replacement of at least 50% of members of Congress with people who do not
have any commitment to any government agency, or development of a better
way of evaluating spending proposals and comparing expenses with revenues,
or some combination of the two.
Reducing the deficit by raising taxes may be
even more difficult. Increasing the amount of tax revenue involves more
than simply raising tax rates or imposing new taxes. Raising tax rates
reduces the amount of money available for businesses or individuals to
spend. The reduction in business or individual spending reduces business
and individual income which then reduces tax collections. Thus the ultimate
result of a tax rate increase can be a reduction in net federal tax revenue.
General changes in the budgetary process fall
into two categories: evaluation of economic impact and allocation of debt
to specific spending programs. Taxing and spending both have economic impacts.
Some spending has a greater positive impact than other spending. Some spending
can have a negative impact. Allocation of debt to specific spending programs
would help determine if borrowing for such programs was desirable.
The first step to understanding the nature
of the deficit should be removal of separate funds such as the Social Security
Fund and the Highway Fund from the general budget. Taxes for these funds
can have a high negative economic impact, but using the funds for the original
purpose(providing retirement benefits or constructing highways) can have
a high positive impact.
Economic impact of spending
F.I.C.A. taxes reduce consumer spending power and increase labor costs(employer
matching tax). These two factors combine to reduce employment. Social Security
recipients spend most of what they receive on food, shelter, transportation,
and medical needs. This spending increases jobs and offsets the negative
impact of the tax. The Social Security Fund should maintain a surplus to
cover future periods when expenditures may exceed revenues. This surplus
should be in federal government securities.
However, money loaned by the Social Security
Fund should be shown as a portion of the deficit in the general fund budget
to provide a clear picture of the size of the deficit and to discourage
irresponsible members of Congress from diverting F.I.C.A. taxes to other
uses. The current practice encourages politicians to think that Social
Security benefit increases contribute to the federal deficit when in fact
such increases, at most, only reduce the Social Security fund surplus available
for diversion to cover the general budget deficit. The fact that most of
those receiving Social Security benefits spend all the money they receive
means that benefits increase enployment and thus increase Social Security
and other tax revenues.
Highway taxes, and other transportation taxes
or fees, increase business costs. Such taxes increase the cost of shipping
goods from interior manufacturing plants to coastal areas reducing the
ability of American companies to compete with foreign manufacturers who
only have to worry about highway transportation costs when shipping goods
to interior cities. Spending highway tax revenues to maintain and improve
highways, particularly freeways, reduces transportation costs and improves
the ability of American companies to compete with foreign companies. When
government uses highway taxes to fund roads, business receives a benefit
to match the cost of the tax.
Fund should never have more than a small temporary surplus necessary
to cover payments for lengthy construction projects during periods of low
tax revenues. A company that transfers funds needed for maintenance and
improvement of buildings and equipment to other uses will eventually go
broke when repairs or improvements are needed.
Some government spending has a much greater
positive economic impact than other spending. Spending for transportation
improvements, especially for intercity transportation, promotes commerce
and thus has a high positive impact. Purchasing manufactured goods has
a higher impact than purchasing services or providing grants to state and
local governments. Spending on new technology has the highest impact. Spending
for education can also have a very high positive impact.
The federal government has been using military
spending to encourage technological developments since the purchase of
rifles made of interchangeable parts from Eli Whitney around 1800. Indicentally
Whitney invented the military cost overrun at the same time. Military spending
helped finance development of the computer industry during and after World
War II. During the fifties military spending financed development of jet
The space program has literally paid for itself
through development of new industries including the microcomputer industry.
Companies created to market space program spin-off products provide jobs
and federal tax revenue.
Some federal housing construction programs
actually reduce jobs and federal revenue. Increasing the demand for materials
and setting artificially high pay scales can increase construction costs
past the point where private companies can afford to expand manufacturing
plants or add office space. Those companies that cannot afford to expand
have lower profits and thus pay lower taxes. Cost increases also increase
the price of new housing beyond the price most potential homeowners can
afford to pay.
The current method of treating the federal
deficit as simply the amount the federal government needs to borrow to
cover the difference between revenue and expenses obscures the causes of
borrowing and prevents determination of whether borrowing is desirable
or not. When a successful company borrows money it usually borrows for
a specific purpose or group of purposes. The company may borrow a million
dollars for inventory or equipment. A company so out of touch with its
needs that it borrows simply to finance unspecified operating expenses
probably faces a grim future.
The federal government needs to examine its
proposed expenditures to determine if it should borrow to finance them.
Private business will normally borrow money for building and equipment
purchases. State and local governments borrow to construct new schools
and office buildings. The federal government should follow a similar practice
and treat purchases of buildings and equipment(e.g., aircraft carriers)
as using borrowed money if necessary.
A company borrowing money to construct a building
normally treats the cost of borrowing as part of the cost of the building.
This practice provides a more accurate picture of the cost of the building
and helps company officials decide whether the purchase is financially
The federal government should also treat the
cost of borrowing as part of the cost of purchasing items in this manner.
The cost of borrowing and the amount needed to cover repayment of principle
should be shown in the budget for the purchase of specific items until
the debt has been repaid. This approach would show the true cost of specific
items and help determine whether or not the item was affordable without
altering it to reduce its cost. Using such a procedure for military purchases
would not conflict with the constitutional time limit on military appropriations.
The procedure deals with the financing of purchases rather the process
of appropriating money for purchases. Congress has used borrowed money
to finance war time expenses without violating this provision.
If the budget still has a deficit after allocating
debt to the purchase of building and equipment items, the remaining debt
should be assigned to proposed expenses beginning with the least essential
until the entire debt has been assigned to some specific budget item. The
most essential items would be those involving the actual operation of the
federal government's principle activities. The cost of operating Congress,
the White House, and the federal courts would be at the top of the list.
Next would be such departments as Treasury and State. These costs should
be considered essential even though the level of some expenses including
congressional salaries might be debatable. Much of the Justice Department
and Defense Department operations would also rate high.
Programs at the bottom of the needs list would
be the equivalent of luxury items and should be dropped or handled as coming
from borrowed funds. Debt for these programs would be handled the same
as for building and equipment purchases except that the agency handling
the program would show debt costs as part of its budget if the program
was dropped before the debt was paid off.
Current procedures for purchasing new military
equipment need to be completely altered. The current approach inflates
costs and often produces faulty equipment that could hamper American forces
attempting to use it in a combat situation. The new system should assign
design and purchasing decisions to civil service personnel with professional
skills(such as engineering and accounting) instead of military officers
or political appointees. Modernization of the nation's military equipment
should shift from a revolutionary approach to an evolutionary approach.
Modifications of other federal programs could
reduce expenditures without eliminating the services the programs provide.
For example, replacing many current income supplement programs with a Guaranteed
Wage program could save money by eliminating separate administrative costs
for other programs. Replacing current agricultural programs with a program
designed to insure farmers against loss would reduce government costs while
providing more effective protection for farmers.
The current method of taxing corporations based
on their "profits" ignores the fact that "profit" is more of an accounting
term than a real measure of corporate income and exaggerates the impact
of consumer purchases of foreign manufactured goods. The federal government
needs to replace the corporate profits tax with a Value
Added Income Tax(VAIT). The VAIT would be a cash flow based tax.
In the simplest form the tax would apply to
gross cash receipts minus cash expended for purchases from companies subject
to the VAIT. (Labor costs subject to the employer's matching F.I.C.A. tax
might also be deddeductible because this tax applies uniformly to such
labor costs and serves the same function as the VAIT.) This approach would
eliminate duplicate taxation while insuring that the federal government
collected approximately the same amount of tax from all consumer goods
regardless of country of origin. Government would receive tax revenue from
each manufacturing stage for domestically produced goods. Importers would
not be able to deduct the cost of imported goods when determining their
VAIT because the manufacturer would not have paid the VAIT.
Switching to the VAIT would increase federal
tax revenues even if rates are set in a way that guarantees that an average
American manufacturer would pay no more federal taxes under the VAIT than
under the profits tax. Increases would come from the effective elimination
of current deductions for the cost of imported goods.
Presidents and members of Congress have talked
for years about reducing spending or raising taxes to balance the federal
budget. Neither approach has worked because neither has been laced in a
meaningful evaluation framework.
Simplistic economists often estimate the impact
of government spending as if all forms of spending had the same impact.
What government buys with its money does more to determine economic impact
than how much government spends. Raising taxes in a way that reduces consumer
spending or increases business costs can reduce government revenue instead
of increasing it.
The federal government needs to assign debt
to the programs responsible for it rather than treating debt as the difference
between total federal revenues and total federal expenses. Adopting a more
cost effective method for buying military equipment would reduce defense
costs and improve the ability of the nation's armed forces to respond to
Finally, the way the federal government taxes
corporations needs to change from a system based on paper profits to one
based on cash flow. Switching to a Value Added Income Tax could increase
federal tax revenues without increasing the tax burden of American manufacturers.Both
the corporate and individual income tax systems have become an almost incomprehensible
maze of deductions, exemptions, and credits. This maze often reflects the
relative strengths of various lobbying organizations rather than any national
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