YES, WE CAN ! ( AVOID GREECE´S FATE ) / BARRON´S MAGAZINE ( VERY HIGHLY RECOMMENDED READING )

Up and Down Wall Street

THURSDAY, NOVEMBER 11, 2010

Yes, We Can! (Avoid Greece's Fate)

By RANDALL W. FORSYTH

Deficit panel unveils true fiscal stimulus: cut spending, simplify taxes.

THE JUXTAPOSITION COULDN'T BE MORE STARK but nobody seemed to notice. On the very day that there were riots in the streets of London over the U.K. government severe spending cuts and European sovereign debt markets were roiled again with spreads on Irish and Portuguese bonds blowing out, America outlined a plan to avoid a similar fate.


Make no mistake, only the U.S. could get away with running a fiscal deficit of about 10% of gross domestic product while also running an external deficit. And all the while paying record low interest rates on its massive borrowings.

But clearly we can't live in this fool's paradise forever. As discussed here ("Why Americans Are Angry" ) previously, much of U.S. voters' ire in last week's elections could be traced to the nation's heading to a fiscal disaster worse than that of Greece.


America has been given a road map that changes its route from going over the cliff. That doesn't mean the nation will change course and actually stop driving toward the precipice or that there might be alternate routes to fiscal sustainability. But at least we've been shown an alternate path.


The nonpartisan U.S. deficit commission—formally the National Commission on Fiscal Responsibility and Reform—laid out the first draft of its proposals Wednesday. Rarely has any set of viable proposals ever emerged from a Washington panel, which a cynic might say is prima facie evidence that the commissions's ideas are dead on arrival. So much so that the commission's co-chair, Alan Simpson, the acerbic former Republican Senator from Wyoming, quipped that he and his counterpart, Erskine Bowles, the former Chief of Staff under President Clinton, would have to enter "the witness protection program."


The panel's key points are to slash spending by $200 billion by 2015, divided equally between defense and non-defense expenditures. Tax-reform proposals would help bring federal revenues and spending down to cut the deficit to 2.2% of GDP by 2015. Ultimately, the panel's proposals would result in $4 trillion less U.S. debt than the path the nation presently is on.


To be sure, this involves lots of proposals that are sure to meet opposition. My children wouldn't be able to collect full Social Security benefits until they're 68 (starting in 2050.) Their younger cousin wouldn't be able to get benefits until 69 starting in 2075.


Meantime, their mom and dad would face a thoroughly reformed tax code with popular deductions eliminated or sharply curtailed. That would include the deduction for mortgage interest, especially for second homes and home-equity loans. The federal gasoline tax would be gradually increased by 15 cents per gallon. Other popular deductions also would be curbed, including for charitable contributions. At the same time, the standard deduction would be tripled, to $30,000 per couple.


Most importantly, tax brackets would be radically reduced, perhaps to a single rate of 26% from the current 35% at the top end currently. Looking at the tax proposals from my own personal, selfish perspective, I'd be a loser. My massive New York state and local taxes probably would no longer be deductible. My mortgage deduction would be cut back. Most of the tax subsidies I get because I live in perhaps the highest-cost, most heavily taxed areas of the nation would be lost. Plus, since I have to drive at least a mile to do anything, even to get a carton of milk, the extra gasoline tax also would hit me.

In addition, the proposals also would tax dividends and capital gains at the same rate as ordinary income—higher than the current 15% but less onerous than the levy to hit dividends starting in 2011—ordinary-income tax rates, which will be as high as 39.6% unless Congress acts. While the double taxation of dividends would be more egregious, the corporate tax rate would be reduced from the current 35% to perhaps 26%.


That only scratches the surface of the deficit commission's proposals (which are outlined in full at http://www.fiscalcommission.gov/.) But I have to say these are an encouraging proposals, if for no reason my oxen would be gored by many of them.


While the commission assumes so-called static analysis, which assumes rational people don't react to incentives and disincentives, the deficit panel's proposals would collect more revenue from the government. In other words, it would get a bigger slice of the pie.


But if you make the reasonable assumption that people pay attention to incentives, not having to contrive your life to the tax code has to be liberating. How many bought houses that were more than they could afford because of the perceived tax advantages? Moreover, most of the benefits accrue to the upper crust, not the majority of tax payers who don't itemize and take the standard deduction.


While I stand to lose all sorts of tax benefits under the deficit-reduction panel's proposals, that's the best reason to support them. Instead of getting incentives to "invest" in a vacation home, I might be better off economically investing in a real-estate investment trust that owns apartment buildings that provide shelter to middle-class families. And if I want a vacation home, I'll buy it without tax incentives.


Indeed, perhaps the only person who would fare under the deficit panel's proposals would be my accountant, who not only is a CPA but also a lawyer in order to deal with the complexity of the tax code. Is there a better reason to support the commission's plan?


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