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Letter to the President, Part Five
By John Mauldin |
When
the next president of the United States walks into the Oval Office on Saturday,
January 22, after the heady experience of Inauguration Day followed by numerous
balls, he or she will be confronted with significant economic challenges. This
is the fifth and I hope final installment in a series of letters I’ve written
to the next president on those challenges. The first three letters in the
series dealt mostly with the realities of the economic landscape beyond the the
United States. The situations that most of our significant trade partners face
dictate that the next US president will have much less room to operate than the
candidates have suggested that they’d like to have.
Europe
will be struggling not to fall apart. The budgets of most European countries
are going to be even more constrained than the US budget will be. China will be
lucky to escape a hard landing within the next four years. The same can be said
for many other countries that are dependent on global trade in an era when
trade is actually slowing.
My
basic thesis is this: Without significant changes in tax and incentive
structures, the US will almost assuredly enter a recession within the next few
years. Then, if we lose tax revenues only to the extent we did in the last
couple of recessions, we’ll be saddled with a deficit of over $1.3 trillion,
and the deficit won’t fall below $1 trillion as far out as the eye can see,
according to the nonpartisan Congressional Budget Office (CBO).
It
appears to me that the CBO projection understates the real issue; in fact, the
CBO may be viewing things through rose-colored glasses. They don’t project a
recession for the next 10 years. The above chart depicts my estimate of what
would happen if we were to encounter recession two years from now. But it
doesn’t include the constant revisions upward to the cost of Medicare and
Medicaid and other entitlements. Just this week we learned that one portion of
Medicaid is going to cost well over $1 trillion more over the next 10 years
than was projected in the current budget. So add another $100 billion dollars
of deficit a year. Such revelations are constantly coming at us. My estimate
also doesn’t take into account how fragile the lower-income echelons of the US
economy are today. They will probably require even more income and healthcare
support, meaning larger deficits for the US and extremely constrained state and
local budgets.
Unless
something is done to counter these trends – and I do not mean tinkering around
the margins – this is going to be the reality that you as president will face
in the next four years. There are those who have warned for many years of a
debt crisis.
They have looked like stopped clocks. But like any stopped clock,
they are getting ready to be right this once. Paul Krugman and others who
pooh-pooh the concept that debt is a problem may soon get to see what it’s like
to deal with a true economic crisis. Of course, they will want more
quantitative easing by the Fed and federal debt issuance to relieve the
suffering; but we know now that QE does little for Main Street.
Instead, it
simply helps the rich maintain their asset prices, and deficit spending digs us
deeper into a fiscal abyss. We could of course monetize the US debt, but that
course would bring its own major negative repercussions.
My aim
with this series is to present you, as the potential new president, with a series
of options that I think will not only help us avoid the next crisis but set us
up for a decade or more of true prosperity and put us back on the path of 3% to
4% annual growth for the next 10 years. And one of the few things that Krugman
and I can agree on is that the only way to get out of this crisis is to grow
our way out.
While
this series has been more popular than I expected it to be – and even US
senators are tweeting about it – there have been those who question how
realistic it is to think that my proposal might win acceptance. And sadly, I
think they have a point. Enacting radical proposals along the lines I am
suggesting will not be politically easy. So next week – in case we don’t pull
our act together in time to avert a crisis – I’m going to outline what we can
do if we fall into recession again. I’ll also propose how we can end the
dysfunctionality in Washington DC. While I’m not advocating an actual
revolution, my proposal is quite revolutionary, and it already has a
significant movement supporting it. And, who knows, maybe in the midst of a
crisis we’ll make good on what Winston Churchill used to say about us: “You can
always count on the Americans to do the right thing – after they have tried
everything else.”
But
before we get into the heart of the letter, let me give you an update on my
Strategic Investment Conference, which will be held in Dallas this coming May
24–27.
We have been able to work out some additional space and accommodations
with the Hyatt hotel here in Dallas where the event is being held, so we have
told all those who were on the waiting list that they can now enroll. We also
have a small number of additional spaces available. Since we don’t want to find
ourselves with more attendees than we can handle, we are going to continue to
employ a waiting list.
First-come, first-served.
If you
want to attend, I suggest you go to the Strategic Investment Conference website (click
on the link) and register to have your name put on the waiting list. I can
almost guarantee that the new seats now available will disappear, as there
aren’t not that many; so don’t procrastinate. Those who wait until the last
month to register are going to be disappointed.
I
won’t even tease you with the fabulous new speakers that we are adding every
week. The lineup just keeps getting better and better.
By the
way, I was looking through the list of attendees. There are almost 100 people
from outside the US already registered. I see a lot of familiar names, and we
could easily put together a fascinating conference just from the attendees. We
are evaluating two different computer apps that will, among other things,
significantly enhance attendee networking.
One of
the comments I have heard over the years is that people would like to be able
to network more effectively with other attendees, but they do not always know
whom they want to meet. Whichever app we choose, it is going to allow you to
find and grow a network of people who share your interests. This is one time
you really want to be in the room if at all possible. Now to our letter.
Let’s
summarize where we are. Last
week I showed you where to find $2 trillion for infrastructure development
by repurposing the Federal Reserve’s balance sheet.
What I didn’t mention was
that, while the whole trillion obviously cannot be put to work the first year
(given the nature of infrastructure timelines), it is not unreasonable to
expect that $400 billion in annual expenditures could be reached within three
years. There are 122 million people working in the US today, in an economy of
roughly $20 trillion. We could easily expect that our $400 billion a year to
translate into more than two million jobs and perhaps even more, as
infrastructure development is generally more labor-intensive than many other
activities are. And these jobs would generally be higher paying than most
service jobs, so this initiative could deliver a serious stim ulus for the
economy, helping us steer clear of recession.
And if
you do the authorizing legislation correctly, it could be the gift that keeps
on giving. As these bonds are paid back to the Federal Reserve, the Fed could
use the money coming in to fund even more infrastructure construction. Your
presidential legacy might well include leaving the country’s infrastructure in
its best shape in 100 years and continuing to improve. Not a bad day at the
Oval Office.
Then I
showed you how restructuring the corporate income tax – about which there is
already quite a lot of bipartisan agreement – would offer a radical boost to US
business, especially export businesses, and generate modestly more revenue by
eliminating all deductions. Of course, a lot of K Street lobbyists would have
to look for new jobs; but they are reasonably well educated, and I’m sure they
could find something to do that would actually be more constructive .
But we
come to a real sticking point as we begin to figure out how to navigate the
budget.
Taxing foreign-earned revenue and growing the economy will only
modestly increase the revenue stream from taxes in the short term. To offset
the trillion-dollar deficits that the economy will be racking up in just a few
years, you’ll need more than modest revenue growth.
There
are really only three ways to deal with the deficit. You can increase taxes,
cut spending, or borrow money. You will notice that there is at least one party
in Congress generally opposed to two out of those three. It’s an existential
dilemma for Republicans to allow taxes to increase or for Democrats to cut spending,
especially on entitlement programs. Yes, Republicans would be willing to cut
some entitlements, and Democrats would be willing to cut some defense spending,
but both parties are just tinkering around the edges and won’t get you to where
you need to be.
One
stubborn problem is that US voters want a lot of healthcare but don’t want to
pay for it. Yet maintaining the healthcare services and entitlement programs
that we have today will require more money. There’s just no way around it.
In
order to get the revenue you need, you are going to have to convince both
parties to compromise on issues that both have sworn never to compromise on.
And proposing traditional compromises in the current political environment is
simply not going to work. You can try until you’re blue in the face, but
nothing will happen, and we’ll lurch toward a truly fundamental economic crisis
that all the infrastructure spending in the world won’t fix.
So
let’s step entirely outside the box and figure out how to give both parties
something they want so badly that to get it they’ll be willing to
compromise on what the other party wants. And we have to do this in such a way
that the bulk of the American people see a significant improvement in their
lives and in their paychecks.
To
craft a solution, let’s look first at what has happened to the average American
worker. There is a reason that large numbers of voters in both parties are
frustrated. The charts that follow tell better than 1000 words could why that
frustration is warranted. For all the crowing about how quantitative easing has
helped, it has mostly helped Wall Street and the top 20% of earners. Median
income in the United States is down 8.5% since 2000.
The
median net worth of US families has fallen sharply since 2007 and is roughly
back to where it was 24 years ago:
And
that economic malaise is affecting all education groups. Even those with advanced
degrees have seen their incomes stagnate since 2007:
And
while incomes have stagnated, the real cost of goods and services has increased
much more than the purported inflation rate suggests. The cost of housing,
utilities, and local taxes has certainly increased beyond inflation levels. And
don’t even get me started on how much has gone up, crushing families who can
least afford it.
This
next chart paints our economic situation in even starker terms. The bottom 90%
of Americans have seen their overall income drop. Low interest rates and
quantitative easing have dramatically helped the top 10%, and we could break
out the numbers to show that it’s actually the top 25% that have benefited, though
the further down the income chain you go, the less the Fed’s tinkering has
helped. The financialization of America is directly responsible for this turn
of events, and rather than helping GDP growth as it was intended to do, it has
thwarted growth.
You
need to do something, something radical, to shake up the system, to make sure
those at the bottom get an increase in income all the while making sure that
you don’t push the economy, which is already stalling, into a dive. Economics
and politics as usual simply will not cut it.
Giving Everybody Some of What They Want…
But Not Everything They
Want
Here
is the basic political reality you’re dealing with. Republicans want
supply-side tax cuts and flat taxes, spending cuts, and a balanced budget, or
some combination of all of them. Democrats want more spending for healthcare
and other consumer-related items, an agenda that means higher taxes; and many,
if not most, would at least give a nod to balancing the budget. Everyone is for
“the little guy.”
So
let’s start with the easy part. You’re going to want the Republicans to go
along with an increase in the total tax revenue. If you forget for a moment
where you want to extract that revenue from (by taxing the rich, for instance)
and just say that your goal is to get more tax revenue, then you will have a
lot more flexibility. And the reality is that you could significantly raise
taxes on the rich (and by “the rich” I mean the top 20% in income) and still
get nothing close to the amount you need. The sad reality is that you would
have to raise taxes not only on the rich but on the middle class in order to
make a difference. And I’m going to assume that raising taxes on the
beleaguered and shrinking middle class is a nonstarter for pretty much
everyone.
So to
get what you want, give the Republicans a tax cut that will get every one of
their little supply-side hearts absolutely quivering in anticipation. Give them
so much of what they want that it becomes almost impossible for them to say no.
That means you can’t be halfhearted; you’re going to have to go the whole hog.
Offer
a 20% flat tax on income over $100,000. Period. No deductions for anything.
Dividends, interest income, municipal income tax revenues, all are taxed at 20%
above the total $100,000 income level. Every
sacred cow goes. No mortgage deductions, no charitable contribution deductions,
no child tax credit, no nothing.
Every penny over $100,000 is taxed at 20%.
Now, you can make an argument that income from say $50,000–$100,000 should be
taxed at 10%, but that’s not going to give you enough money to do what you need
to do in order to be able to get the support of the Democrats. There is, on the
other hand, a case to be made that people making over $50,000 should contribute
something to the overall general welfare of the economy.
That
still gives everyone up and down the ladder a major tax cut. There is not a
supply sider in America who is not going to like that tax structure. Your
income tax filing is done on a 3”x5” card. If you made between $50,000 and
$100,000, you pay 10%. If you made more than that, you pay $10,000 plus 20% of
everything you made above $100,000. This is going to be surprisingly popular
with millennials: survey after survey shows that one of their big fears is
dealing with the IRS. In a world where 40% of America is now getting some form
of non-salaried income, dealing with the IRS is becoming more complicated.
Millennials are increasingly part of the gig economy, and a flat tax will make
their lives easier. You are going to be surprised at the level of support this
tax proposal will get from young people.
Now,
this tax structure is, of course, going to make people who want to soak the
rich unhappy, as they don’t see how the little guy benefits. So here is where
we have to get really creative. And this is why you are giving the Republicans
something that’s going to be very difficult for them to walk away from: you’re
going to combine their tax cut with two additional items.
To the
Democrats, offer to abolish the Social Security tax on both sides of the
equation, both business and personal. That means an individual making $30,000 a
year gets an approximately $2000 pay raise immediately. Every working man and
woman gets a pay increase in the form of no deductions for Social Security
taxes from their wages.
So
where do you get the money? You’re certainly not going to get the support of
senior citizens or anyone else for that matter if you start messing around with
the ability to pay Social Security benefits. So that means we have to find
another revenue source.
And
for that revenue source you need to turn to the tax that is the most efficient
in economic terms: a consumption tax. But not one that looks like a sales tax.
Rather, it should be a version of what almost every other country in the world
uses, and that is a value-added tax, or VAT. I would modify it to look more
like a business transfer tax (BTT).
Basically,
with a BTT, a company pays tax on the revenue it receives net of what it pays
for the services and products it is selling. Netflix pays on the revenue it
receives after deducting the money it sends to television and movie producers
for the rights to show their products. This is all transparent to the end user.
You
can tinker around the margins to make this tax more politically acceptable. You
can exempt groceries, but then you’re going to have to charge a higher rate on
everything else. You can exempt nonprofits, but I wouldn’t: they pay Social
Security tax on their employees now. But that may be the price of getting the
deal done.
A BTT
in the low teens (12-14%) will get you all the revenue that you need. You look
the Republicans square in the eye and say I want to get 2% of GDP more tax
revenue in the form of the BTT in return for the income flat tax on
individuals. By the way, the BTT is legally deductible by US corporations under
WTO rules when they ship products overseas – which is what every other country
does to us, and why they have a tax advantage over us when shipping products to
us. The BTT is going to be a huge boon to US producers. Talk about a cheap way
to boost the economy – this is it.
Now,
Republicans are going to push back and say, yeah, sure, you want to start this
BTT at a low rate today, but the day will come when you want to raise that
rate, just as every European and other country around the world has done. And
you’re going to want to raise those income tax rates again. Why should we give
an inch when you may take a mile in 10 years?
And
your counter to that is to offer to sign a constitutional amendment that will
require a balanced budget and a supermajority of 60% to raise taxes. In theory,
everyone is for a balanced budget (well, almost everyone), and the political
reality is that it takes 60% of the Senate to approve any major new tax revenue
source anyway.
You’re not giving up a lot. Enough Democrats will be willing to
go along, because they’re going to get the extra revenue they need for the
programs they desperately want, and they get a major boost to lower-income
America in the form of no Social Security taxes.
Now,
the hard part for Republicans is that they have to get 38 states to approve
that constitutional amendment. But they’ll just need to fight it out in about
five states (getting 33 more or less red states to approve it shouldn’t be too
hard) in order to get what they really want: certainty about the future of
taxes and the budget deficit in America. You also need to get everybody to hold
hands and sign a pledge to not raise taxes under any circumstances for 10
years. Now, we all know that inside the room a pledge like that is only worth
so much, but it’s at least a start.
Oh,
and for a sweetener, offer to sign a bill to sunset every government regulation
over the next 10 years. Do it in an orderly fashion. Maybe even something like
eliminating 20% of government regulations across the board during your first
term and not letting the absolute number of new regulations increase after
that? If you want a new regulation, get rid of an old one. Force the various
bureaucracies to clean out their attics and stop hoarding regulations that are
way out of date.
And
since I’m from the financial services industry, maybe include one little item
to help the gig economy and the upcoming generation. Make retirement plans
portable from one job to the next so that a young person has an actual
opportunity to build a tax-deferred nest egg.
Taken
together, my proposals amount to a major shift in the tax and incentive
structure of the United States. You won’t be able to implement them all
overnight. I would start with the infrastructure project and the reduction of
corporate taxes, because the former starts to stimulate the economy, the latter
is more or less revenue-neutral, and both boost employment. If part of the
compromise on the reduction of corporate taxes is some kind of lower-tax-rate
amnesty on the $2 trillion sitting outside the United States, that provision
could result in a nice one- or two-year revenue boost. If that tax rate was the
10% I proposed above, there would be $200 billion coming in, which would sure
put a dent in the deficit during the following 12 months.
But
lowering income taxes, introducing a VAT, and reducing the Social Security
burden on businesses and individuals are measures that should probably be
phased in over four years. It would take at least a year just for the various
agencies involved to change their revenue models and infrastructure.
Set a
time limit for balancing the budget. The Clinton/Gingrich budgets did not
balance the budget the first year. It took time. Figure out how much actual
infrastructure can be worked on to boost the economy in the first year, and
then begin to project how those projects will affect growth and how long it
will actually take to balance the budget. My back-of-the-napkin guess is that
4–5 years is reasonable. There is nothing like 5% nominal growth to speed the
process, and holding spending to the level of inflation will bring the budget
under control over time. It will work almost like magic. All you have to do is
make sure that the total budget doesn’t rise faster than inflation. The economy
can then take care of the rest.
The
general objection to the introduction of a VAT in the US is the political
impossibility of getting it done. It is only politically impossible if everyone
doesn’t get something they want. What I have proposed is so politically
delicious to all sides that it becomes possible.
Further,
the lead article in this weekend’s Wall
Street Journal opinion section is a full-throated endorsement of a
VAT, quoting various conservative sources. There are numerous conservative
economists who think a consumption-oriented tax is the smartest and most
economically efficient way to produce government revenue.
Everyone
agrees there are flaws in Obamacare. Depending on who the next president is,
those flaws can be fixed and their budget implications can change. But the
structure I propose above gives both sides more flexibility in getting the
changes they want. Streamlining the healthcare system and giving states more
flexibility will certainly help control costs. There have to be caps on how
much those costs can rise. The American taxpayer is not a bottomless well.
For
those under a certain age, the Social Security rules have to be changed. There
needs to be a change in the law so that the age of retirement is automatically
adjusted upward if the mortality tables show that lifespans are continuing to
increase. (You would be exempt if you were within 15 years of retirement.) This
would eliminate a political hot potato. When Roosevelt first proposed Social
Security, the average person lived only to age 58, and benefits didn’t start
until retirees were 65. Now the average person is living into his or her 80s,
and the average lifespan of those with above-average income is in the high 80s.
(Yes, there are differences in life expectancy depending on income.) Social
Security needs to be means tested.
There
are scores of other ways that savings can be found. There are over 100 agencies
with their own very expensive bureaucracies that do some type of job training.
If this were the private sector, the markets would be screaming for
consolidation.
You
have an enormously difficult task in front of you. If you do nothing but
tinker, you will have a recession on your hands in the early years of your
administration. Just yesterday, real interest rates went negative on the US
10-year bond for the first time. The yield curve is in serious danger of
becoming inverted in real terms. Your economist advisors will confirm that the
research shows the only true predictor of a US recession is a negative yield
curve.
The
research shows that if the yield curve stays inverted for 90 days, a recession
is likely to show up in 12 to 15 months. That means you are not going to have
much time after you’re inaugurated to enact a major stimulus program and
restructure the incentive structure of the US economy. If you wait until we are
already in recession to win cooperation from Congress and get legislation
passed , the negotiations will be more difficult by an order of magnitude. You
need to hit the ground running.
Therefore,
in addition to campaigning after you’re nominated at the convention, you had
better be planning to govern. The economy is not going to wait around for you
to get adjusted to your new position. But what better way to campaign than to
show the voters you are already thinking about how best to serve them?
There
are scores of other major and minor economic topics we could discuss, but these
won’t matter much if we fall back into recession. Unemployment will climb back
to double-digit levels; incomes will suffer; tax revenues will plummet; tempers
will flare and finger-pointing will increase; and you will cornered into being
merely reactive instead of proactive. Foreign policy will take a backseat if we
hit a recession, and your foreign policy choices will be far more constrained.
The first three things you need to be thinking about when you walk into the
Oval Office are the economy, the economy, and the economy. In that order. If we
go into recession on your watch, nothing else you do is going to matter all
that much in terms of the success of your presidency. You can solve the Middle
East crisis, bring peace in our time, and curb global warming. But you will
still be judged by what the economy does.
I’ve
laid out a rough plan that can certainly be adapted and changed. But if you go
with the gist of what I’ve suggested, here are the positives:
- You’re
going to add two to three million jobs during your first term as
president. Most of those jobs will be higher-paying ones, so median income
is going to rise. And because the economy will be booming, employers are
going to have to increase wages in order to attract new workers and keep
current workers. There is nothing like fatter paychecks to improve the
mood of the middle class.
- If
you add jobs and get the economy growing back at 2% to 3%, the Federal
Reserve can begin to normalize interest rates, and savers will stop being
punished. Retirees will be able to make more on their investments and be
more capable of affording a reasonable lifestyle in their retirement
years. Pension plans and insurance companies will have a better chance of
meeting their performance requirements and actually fulfilling their
obligations. I know the issue of retirement plans is not high on your
list, but there is going to be a crisis that you will have to deal with if
we go into recession. So many government pensions are drastically
underwater.
- You
will fix healthcare and entitlement programs in a bipartisan manner that
actually solves their problems rather than kicking these cans – real
toe-breakers now – down the road. You will put the country on a path to a
balanced budget.
- You
will end your first term in office as the most influential president in
terms of economic impact since Franklin Roosevelt.
- The
economy will be booming, and your reelection in 2020 will see you win
nearly as many votes as Ronald Reagan did in 1984.
These
are pretty much your choices: Herbert Hoover or Ronald Reagan?
I wish
you the best of luck, I truly do. We really are all in this together.
With
warm regards,
John
Mauldin
I know
a lot of my readers and friends think I must have gone stark raving mad. I
detoured off the deep end and kept going. I missed that turn in Albuquerque.
Whatever.
I
personally find some of the things that I have suggested to be philosophically
offensive. I can’t imagine there is anyone reading this who thinks every one of
these ideas is actually a good idea. Seriously, if I haven’t offended your
political sensibilities, you are either very flexible or I’m not trying hard
enough.
But
that is the point. We have a deeply divided country. Nearly fifty percent of
Democrats seem to be voting for a full-throated socialist. Sanders is not
socialism lite. He would take us to European socialism and keep right on going,
and there’s a significant contingent of Americans who seem to be with him.
Meanwhile, over 50% of Republicans are saying that what we need is somebody who
is way outside the “establishment,” who will shake things up and do things differently.
Forget on-the-job experience; people no longer trust the current leadership to
get the job done.
Unless
something really odd happens at the conventions, we are going to end up with a
race where the only thing the majority of Americans agree upon is that they
don’t like their choices. The unfavorable ratings of all the candidates in the
final running are extraordinarily high.
I am
seriously, deeply worried that we are going to have a recession in the next few
years. The negative impacts this time around will be every bit as drastic as
they were in 2007–08. Pensions and retirement funds will be devastated.
Unemployment will go through the roof. Monetary policy will be impotent. The
government will be all but nonfunctional, given the current players and system.
A recession this time around is actually going to feel far worse than the last
one did.
Now,
the republic will survive. We’ve actually faced far worse times and come
through them. You can go back and read about those periods – they weren’t fun.
So it’s not the end of the world, but for much of America it could end up
feeling every bit as bad as the Great Depression.
To
stave off such a serious outcome will require radical solutions; and given that
I don’t think any one party is going to have control of the process (which is
not exactly what we’d want anyway), we are going to have to choose between real
compromise and real trouble. What I have tried to do is to propose a program
that actually amounts to a workable compromise.
I
fully recognize that proposing to take another 1–2% of GDP out of the economy
and turn it into tax revenue is heresy among my more conservative friends. I
fully recognize that cutting income taxes to a 20% top rate feels like giving
the rich another get-out-of-jail-free card if you’re a liberal Democrat.
My
goal with this proposal is to create an environment in which the economy can
grow in the 3–4% range, and that rising tide really will raise all boats with
the structure I suggest. Do I think there is much chance of that growth being
achieved? That is the question we will deal with next week, when I will talk
about what we’ll need to do in case my admittedly rose-colored, optimistic
proposals never even make the desk of serious politicians, let alone the next
president.
I’m
looking at my calendar, and although I see a few one-day trips with little or
no time for anything other than meetings, my next real trip has me leaving in
the middle of the month for a short week in Abu Dhabi, then coming back for a
quick speaking gig in Raleigh, North Carolina, before I fly back to get ready
for my own investment conference here in Dallas. Which is good because the
book-writing deadline is looming in the background, along with so many
distractions and things that simply “must” be done. And it seems that most of
that stuff requires me to spend time in front of my computer. Then there are
the never-ending meetings and phone calls. I’m in the process of making
significant changes in my core investment business, and that project really
requires a great deal of personal involvement. Some things you just can’t
delegate.
If you
are still with me, you are overly patient; and so rather than conclude with a
few personal remarks, which is how I normally close the letter, I am simply
going to tell you to have a great week.
Your
concerned about his country analyst,
John Mauldin
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