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Thursday, September 9, 2010

SIX PUBLIC MONEY MISFIRES - Typical Families Face Nearly $30,000 In Fresh Annual Taxes

At the risk of sounding alarmist, the financial condition of America's government is in even worse condition than the deplorable state most people believe.

If the US attempts to restore public financial health through tax increases alone, in a few short years the odds are very high that a typical family earning $75,000 will be paying $29,000 more in taxes than that family now pays.

How is this possible? The federal budget deficit is huge, the national debt is crossing into financial no-man's land, state and local governments are on a long spending spree, government has been making "off the books" promises, and Social Security and Medicare threaten to consume enormous swaths of the economy.

First and foremost is the task of balancing the federal budget and bringing the national debt down to safer levels. Trimming the federal budget deficit by a mere 1% of GDP each year will run up the national debt because current deficits are running 9% of GDP - so deficits will continue to add to the pile of money owed for nine more years. Using conventional government economic forecasts, the country will not bring the national debt down to its current 60% of GDP for 12 more years. The debt to GDP ratio won't fall to a comfortable 30% until 2030. While this slow rate of deficit reduction is politically courageous, financially it is weak. It takes too long, risks more financial crisis, and requires taxes on a typical family to gradually increase to an additional $16,000 annually in 11 years.

And it still leaves much necessary public financial reform undone. The feds have run up another $5.7 trillion in promises for employee benefits for which nothing has been saved. Assuming no cut in benefits, that obligation will be paid off as those pension liabilities come due. If we make the simplifying assumption that taxpayers spoon that out evenly over 40 years, that will add another $2,300 dollars of annual taxes starting immediately.

There are more hidden surprises, too. State and local governments have run up big debts. If they are folded into the definition of national debt, and we pursue a limit of 60% of GDP, then this debt should be extinguished. If taxpayers pay it off over 40 years at 4% that will add another $1,000 to the typical family's annual taxes.

Fourth, like the federal government, state and local governments have also made promises to government employees beyond which they have been willing to save. This shortfall could be as high as $3 trillion. We'll use $2 trillion to err on the conservative side. Assuming this gets paid over 40 years, and is evenly spread across the country (which it is not) it adds another $800 to that $75,000-a-year family's taxes.

Fifth and sixth, Washington still has to deal with Social Security and Medicare. If we pay for the shortfalls there evenly over the next 75 years, and close that gap with tax increases, Social Security adds $2,700 and Medicare adds $7,800 in fresh taxes per family each year

To deal with these issues squarely and through tax increases alone means raising taxes on our typical US family by $14,600 next year and ramping that up to $29,000 of fresh taxes - on top of taxes already paid - by 2021.

What will this do to our typical family? Obviously, it will strangle their cash flow. Many are already dealing with mortgages they cannot afford, and retirement savings that are critically short.

Where is all this money going to come from? Ultimately, every penny comes from someone with an actual heartbeat. That narrows it down to individuals. Companies are merely paper tigers owned, worked, and supplied by live, flesh-and-blood people. The bottom line: only real people pay taxes.

The middle class and the poor will not escape lower standards of living even if politicians could stick the rich for the whole bill. Since rich people are the nation's primary savers, taxing the rich succeeds in depleting the nation's pool of capital. Without that investment, Americans will feel innovation dry up, smell the decay of slowing productivity growth, and watch the paint peel across the country.

One can safely bet that discretionary family expenditures of all kinds will feel the cleaver. Cuts will come in vacations, restaurants, clothing, cars, books, housing. More cuts will come from education, retirement and yes, maybe even medical care.

Paying those taxes will also take more sweat, more hours on the job, more output for each hour worked, more teen employment, more elderly employment, fewer stay-at-home moms. The 40 hour workweek - widely exceeded by salaried folks and nothing more than a distant dream for most small business people, is in jeopardy for hourly workers, too. And bet on a larger "under the table" economy.

For American families, it looks like the New Normal is just starting.

All numbers used in the analysis reported above are derived from government sources with the exception of state and local government unfunded liabilities.  Government does not estimate these numbers, private sources do occasionally. Contact me if you would like more detail.