Musings on Social and Political Policy

As anyone who has been reading the economic blogs for the past year or so knows the federal government is spending more than it is taking in. In addition the country is buying more from abroad than it is exporting. Both these actions have led to record deficits and many are warning of severe consequences.

There are two approaches to solving a deficit: spend less or save more. Pressing national issues seem to preclude much in the way of spending cuts in the near term. We are fighting three wars simultaneously (Afghanistan, Iraq, and "Terrorism"), we have serious rebuilding to do in the Gulf region as well as elsewhere, and we have health and retirement issues that are being shifted to the government.

Conservatives are upset by this level of spending, but are unable to see how to change the spending programs. Attempts to cut back on social spending are mean spirited, insufficient and politically impractical in the run up to elections.

So the only avenue open is to raise taxes. I think the Democrats should take the lead in this, now. It will have to be done sooner or later and if steps are deferred until after 2008 the situation will have just gotten worse by then. In addition raising taxes as one of the first steps in a new administration leaves one open to the "tax and spend" mantra used by the conservatives. The problem happened under the present administration and thus needs to be corrected now.

Here are some initial ideas on how to raise taxes. Please feel free to add to the list.

First, the issue of the estate tax is irrelevant. What is being debated is whether a future tax break will go into effect or not. There is little practical effect on current tax deficits. The Democrats can continue to push for an appropriate estate tax policy, but we need changes which take effect immediately.

I suggest imposing a war surcharge on the top three income tax rates. The 28% rate would be raised to 31% (about a 10% surcharge). The 33% rate would be raised to 39% (a 20% surcharge) and the 35% rate would be raised to 45% (about a 30% surcharge). Examination of the brackets will show that this will effect those most able to pay the most. Those who have been squeezed by rising costs and stagnant pay scales will be unaffected.

In addition I would limit the amount of interest that can be deducted for a mortgage. The amount of interest that could be deducted on the income tax would be capped at $25,000. Second mortgages and home equity loans would not be eligible for interest deductions. At present interest rates near 5% this would allow borrowing $500,000 in principal which is sufficient to finance the bulk of homes in the country. Median home prices for existing homes are currently in the range of $320,000 so a $500,000 cap on principal would only affect the most expensive houses.

To compensate for the hidden rise in the cost of living I would suggest reactivating the deduction for interest on consumer loans. This deduction would apply to home equity, revolving credit and auto loans. There would be a cap of $10,000 in interest on this. At current common loan rates of 20% this would allow borrowing of $50,000 in consumer debt. Credit card debt balances now average about $7,000 per household which means that most families would be able to deduct their entire credit card interest.

Common stock dividends should be treated as regular interest again rather than being taxed at a 15% rate. Those with large amounts of dividend interest can afford it and those with a small amount of stock holdings will only be affected minimally.

Corporate taxes should be subject to a surcharge as well. Retained earnings should be taxed at a suitable rate, somewhere in the 25-35% range. Earnings paid out to shareholders would not be considered retained earnings. Business expenses for capital improvements would be counted against earnings as is done currently, but expenses incurred in mergers or acquisitions would not. Companies buying companies does not produce any real wealth or provide economic stimulus.

Foreign earnings need to be repatriated annually and not be allowed to accumulate overseas tax free. The recent tax holiday for overseas earnings exempted billions from US taxation. This must stop.

Stock options and other indirect payments must be treated as regular income in the year granted and taxed appropriately. Consideration should be given to imposing an excess compensation tax as well.

These new tax programs would be considered as temporary, war and disaster finance taxes. They would be repealed or readjusted two years after US troops withdraw from Afghanistan and Iraq, and provided no new major troop deployments have taken their place. Troops left abroad, as in Kosovo, for peace keeping purposes would not be counted when figuring the date for the surcharges to end.

The Democrats need to propose these actions as emergency measures taken in time of war and national disaster as soon as the November elections are over. They can all be set to take effect as early as Jan 1, 2006. Unwillingness by the Republicans to consider this type of legislation can be countered by appeals to common sacrifice, patriotism and fiscal responsibility. These appeals have been very successful in other times of economic distress. Look at the sale of War Bonds during WWI and WWII as examples.

The longer range issues of the negative effect of our current tax policies can be addressed after the immediate issues are taken care of. I have a short essay on more far-reaching tax reform ideas here:

Corporate Taxes

By raising taxes now we will reduce our need for current borrowing from abroad, this will eventually lower the amount of current government expenditures for interest on the national debt and reduce the cost of borrowing for the private sector as well. This may seem to run counter to the Federal Reserve policy of raising interest rates to curb inflation, but even the Fed has acknowledged that federal spending is out of control.

The Democrats need to take the lead on this and continue hammering on the issues until some rationality is restored to fiscal policy. The policies I have outlined here affect only the wealthy, so we can expect to hear lots of criticism from the conservative punditry, but concrete examples showing how little the average person will be affected should help to deflect the self-serving critics.

The alternative to raising taxes now is runaway inflation later and devaluation of the dollar. The stock market is already showing signs of weakness. A big decline in the market will ultimately cost the wealthy class much more than these modest tax increases. Perhaps this time they will think things through for themselves.