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Reducing the Federal Deficit

Copyright 1992

by Jalexson

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 taxes corporations.

     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.

     The Highway 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 aircraft.

     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.

Debt Allocation

     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 feasible.

     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.

Corporate Taxes

     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 military threats.

     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 economic interest.



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