Explaining Deficits

The New York Times has an excellent piece describing the US Federal debt that I highly recommend. One of my favorite parts of the piece is a multimedia chart on the left-hand side showing how deficit/surplus projections have changed since 2001. It seems a basic rule of thumb is to take the official surplus projection and cut it in half. Then take any deficit projection and double it.

Why are the official deficit/surplus projections so off? And why do we have such a propensity for deficits and an inability to raise credible surpluses. I believe a big part of the answer lies in our taxing structure.

Think of the United States government like your average Mr. Joe who goes out to get a job. He finds one where he is paid by commission. The problem is Mr. Joe thinks it is a salaried position. During the heydays of the company, he thinks his salary is, say, $150,000. So he plans accordingly. When all of a sudden the company hits a rough spot, his commission drops precipitously. Because Mr. Joe thinks he was living on salary, he keeps spending as he did before, thinking his company just delayed printing his check. When times are good again, he might be back up to his $150,000 commission but he now has all this debt. Mr. Joe will forget about it until the next time his company loses his check in the mail.

My point is, the US tax structure is too performance-based to be stable, yet we make projections and assumptions that it is relatively stable over time. First, it relies heavily on corporate taxes. Businesses, particularly small businesses are the first to encounter trouble in a financial crisis, so relying on businesses to help pay in rough times is foolish. Equally, trying to up their taxes in good times is difficult since they are wont to wander. Second, our progressive tax system relies on the rich who are extremely prone to cyclical swings. The reason is the rich put their assets in everything that goes down during recessions: property, equity, debt, and commodities. So the rich are very willing to file their taxes in a recession showing how much they have lost and how little taxes they owe relative to the good times.

As a group, middle class Americans have less income fluctuation: in the good times, they don't do hugely better but in the bad times they don't do hugely worse. Yes, there are layoffs, but those who keep their jobs don't see their income falling precipitously. But more and more, middle class America is not sharing the taxing burden. For obvious reasons, politicians are loathe to tax their voters and voters are loathe to be taxed. A smaller and smaller percentage of the population is bearing the larger and larger burden of America's taxing. That makes the US budget very prone to economic conditions.

Now some "commission" pay structure is good: it motivates politicians and government to create and promote a good business environment. But it has to be balanced with consistency. For that reason, I feel a broader tax base is necessary. I like the idea of a graduated progressive flat tax wherein everybody has to pay taxes, albeit at increasing levels of income. In the same manner, there needs to be a simplified corporate tax structure that applies across the board and severely punishes tax evaders.

Politically, the idea is perhaps not very viable. But we will surely need to move in that direction if we are to solve our fiscal challenges.