Tag Archives: Debt

The Cliff That Isn’t

Washington is abuzz about the Fiscal Cliff, a combination of tax increases and modest cuts in spending growth. Since the Old Media and most of Washington always favor tax increases, the fear must be over spending. But even with the cuts, Washington will remain overfunded. So, what is not to like about the Fiscal Cliff?

The Cliff allows for tax rates to return to those Pres. Clinton approved in the early 1990’s. Most taxpayers will see their rates increase and some people who now pay no income tax will have to begin paying. In a 2007 primary debate, Pres. Obama said it was the country’s moral obligation to repeal all of the Bush tax cuts, and the OM continues to churn the notion that the Clinton tax increases caused the prosperity of the 1990’s. Now that the Democrats are in charge, most of the Clinton tax rates are unacceptable. If, as Obama now claims, the Bush tax cuts are appropriate for 98% of Americans (a fatuous figure since nearly half of Americans pay no income tax at all), does that mean Bush was 98% right in his tax policy? Does that mean Clinton was 98% wrong in his tax policy? The Cliff’s tax rates are a tool by which Obama is dividing the US along phony class lines. If everyone’s tax rates go up, Obama’s us-vs.-them, punish-our-enemies rhetoric becomes powerless.

The argument against the Bush tax cuts has always been that it lead to the budget deficit crisis. However, even Obama admits that his tax increase for 2% of Americans will not significantly reduce the deficit. Instead, the tax increase he seeks is a matter of justice, or as Warren Buffett claims, tax increases would “raise the morale of the middle class.” Obama and Buffett seem to be admitting that overall, the Bush tax cuts are not the problem they and the OM portrayed them to be, but rather the Bush tax rates only need some window dressing for “fairness” and “morale.”

The Cliff also purports to cut spending. In reality, the sequester somewhat reduces the rate of increase in spending. By any measure, all spending will remain uncut. The real-dollar per-capita budgets of all major departments will be higher than under Clinton, including Defense and HHS. In every sense the government will be better funded than under Clinton. Was Clinton an evil plutocrat who hated the poor and minorities? Further, the sequester does not address entitlements such as Medicare and Social Security. Those are the budgets whose out of control growth will destroy the US. Washington’s big spenders know they were elected to increase spending each year, and any slowdown would be against the interests of their donors.

Let the Cliff happen. Why not test the notion that Clinton’s tax rates caused prosperity? Why not see what would happen if the rate of growth in Washington’s spending was cut slightly? Why not make Obama take some responsibility for his spending habits? Why not call the OM’s bluff that the Cliff would be the end of all things? The Cliff and the negotiations surrounding it are a fabrication. The Cliff’s tax rates are Democrat tax rates, voted for by Democrats signed by a Democrat, and more recently endorsed by the Democrat Obama. The Cliff’s spending cuts are a Democrat fabrication as well. By pretending a slightly slower rate of increase in spending is a cut, Democrats built a firewall against real reform. To balance the Federal budget, spending must be cut not by $800bln over ten years, but by $10 trillion. Let the Cliff happen to deprive the Democrats of the lies they and the OM use to protect corruption, waste, and unsustainable entitlement scams.

Eliminate the Mortgage Interest Deduction Now

Shout Bits has argued that the Mortgage Interest Deduction is not so helpful to regular Americans, but with interest rates at historic lows, now is the time to eliminate this market distortion. Not only does the MID encourage buying unaffordable homes and promote market bubbles, the primary beneficiaries are wealthy individuals and large banks. Eliminating this deduction would actually help most ordinary homeowners.

For 2012, a couple filing jointly can claim an $11,900 standard deduction, even if they have no otherwise deductible expenses like mortgage interest. Therefore, the first $11,900 in mortgage interest paid by such a couple generates no tax savings for them. Today’s national average 30 year fixed mortgage coupon rate is 3.8%, which means that a mortgage smaller than $313k (11900/.038) generates no tax savings for a couple filing jointly. Now, a $300k mortgage is not unheard of, but it is clearly not for the struggling working class.

Since the first $313k of a mortgage balance is not deductible, the tax incentive is to borrow as much as possible. After all, Uncle Sam is kicking in about a third of the interest expense above $11,900. Further, the tax code discourages paying down mortgage balances, since as interest payments fall, so does that tax benefit. This perverse incentive leads to speculative bubbles which burst when incomes fall below the point where an income tax deduction is available. The MID certainly contributed to the real estate crash of 2008.

Worse still, a recent study by Andrew Hanson at Georgia State University concludes that the tax code’s reach into the mortgage market increases mortgage rates for modest homeowners. Mortgage lenders siphon off 9 to 17% of the government’s subsidy intended for homeowners (as much as $1.7bln per year) in the form of higher rates. Not only does the MID not benefit smaller borrowers at all, according to Prof. Hanson’s study, it costs them hundreds of dollars extra, even if they cannot take an interest deduction.

It is always wrong, corrupt, and perverting for the government to manipulate markets as it does with the MID, but now is the perfect storm of minimal benefits and maximum harm. Mortgage rates cannot fall much further due to structural cost limits, so the interest deduction benefit is nearly as small as it ever can be. Likewise, with tighter lending criteria, only the well-off can qualify for loans big enough to earn an interest deduction above $11,900.

With the Federal Government looking for ways to raise taxes, the very worst choice would be raise marginal rates. Instead, a flatter and broader based tax code is the answer that is more just and stable. Eliminating a deduction that only benefits the well-off, while harming modest borrowers and enriching big banks, is an obvious choice. The time is now.

What Are The States Smoking?

People sometimes convert an anticipated payment stream into cash by issuing bonds. Rocker David Bowie pioneered the practice of floating bonds financed by anticipated royalty streams; he received $55 million in exchange for his discography. Accident victims call J.G. Wentworth, the pseudo-opera singers on TV, to convert settlements into liquidity. Now, there are many good reasons to exchange future payments for cash today – uncertainty of the reliability of the payments, fear of surprise inflation surges, unexpected one time bills. A bad reason is to finance a lavish lifestyle. Floating a bond might fund the expenses for a while, but the money will run out, leaving nothing. Such is the case of states borrowing against their tobacco settlements.

In 1998, a group of Attorneys General from 46 states colluded to extract $206 billion from the tobacco industry, ostensibly to fund tobacco related Medicaid costs. A small portion of the settlement was earmarked for an education campaign to reduce tobacco consumption. None of the money went to these purposes. The State money went to fund general budget items unrelated to health, and the education campaign became an annoying series of TV commercials calling tobacco companies liars and murderers – a topic unrelated to the challenges of quitting smoking.

As governments are wont to do, they incorporated the tobacco money into their budgets, spent the payments and more. One by one, the most of the states found themselves in a budget pinch and balanced their budgets with a one-time tobacco bond sale. Last year Minnesota mortgaged its tobacco payments for $700 million. Two years ago, Illinois plugged its budget gap with a $1.5 billion tobacco bond. One time tricks do not solve long run spending problems, though, and Illinois later raised its income tax by over 60%.

Worse still, many of the state’s tobacco bonds are general obligations of their treasuries, so if the tobacco payments fall short, the states are on the hook. Of course that is exactly what is happening. The settlement payments are based on tobacco consumption, which is declining. Kids who want to look tough and women who prefer cancer to obesity still smoke, but many other people are quitting or not even taking up the habit. In several states, the settlement payments are becoming insufficient to fund the bond payments.

Despite the imprudence, Alabama just floated $93 million in new tobacco bonds. The Wall Street Journal reports that Alabama has avoided some of the risks and excesses of other states’ tobacco bonds, however they have mortgaged their future to prop-up irresponsible spending today. Separately, Jefferson County, Alabama (Birmingham) just filed the US’s largest municipal bankruptcy ever. If high finance catastrophes cannot stop politicians from borrowing to spend recklessly, perhaps nothing can.

Like underfunded pensions, tobacco bonds are an example of states’ sneaky borrowing against future revenue to fund wasteful spending today. In most states, running a state budget deficit is illegal, but the politician’s instinct to spend is too strong, so they find a way to borrow.

So, who needs people to smoke? The states that have borrowed against the smokers’ habit would be ruined if everybody quit. Irresponsible, perverse, and probably immoral, yet irresistible to politicians who are paid to spend like there is no tomorrow. The states need spending controls to solve their budget problems, not tobacco bonds to enable them.