A Cautionary Tale

Europe has Greece and Spain.   The United States has California and Illinois.

Fiscal wrecks.  Budget nightmares. Ticking debt bombs.

Each is a testimonial to why the tax and spend, welfare state, public union, red tape regulation form of government does not work.

Both of these states are on track towards a debt cliff that is on the horizon.  They do not seem to think of using the brakes.  It has been full speed ahead.  Their only thought seems to be to continue to feed the Democrat voting constituencies in these states of the liberal elites, labor unions, envionmental extremists and welfare state advocates.

The only good that might come out of it is the cautionary tale it should be to other states and the federal government.  This is not the way to run a railroad...or a government.  You cannot tax and spend your way to prosperity.  You cannot continually serve special interests at the expense of the public interest.  You can only get so many golden eggs out of the golden goose.

The Wall Street Journal's Allysia Finley recently interviewed Joel Kotkin, one of the nation's premier demographers and a long-time California resident, about the problems in the Golden State that are driving the middle class out of the state in "Joel Kotkin:The Great California Exodus."

Nearly four million more people have left the Golden State in the last two decades than have come from other states. This is a sharp reversal from the 1980s, when 100,000 more Americans were settling in California each year than were leaving. According to Mr. Kotkin, most of those leaving are between the ages of 5 and 14 or 34 to 45. In other words, young families.

The scruffy-looking urban studies professor at Chapman University in Orange, Calif., has been studying and writing on demographic and geographic trends for 30 years. Part of California's dysfunction, he says, stems from state and local government restrictions on development. These policies have artificially limited housing supply and put a premium on real estate in coastal regions.

"Basically, if you don't own a piece of Facebook or Google and you haven't robbed a bank and don't have rich parents, then your chances of being able to buy a house or raise a family in the Bay Area or in most of coastal California is pretty weak," says Mr. Kotkin.

While many middle-class families have moved inland, those regions don't have the same allure or amenities as the coast. People might as well move to Nevada or Texas, where housing and everything else is cheaper and there's no income tax.

In other words, the liberal elite have their place in the sun so no one else needs to be anywhere near the beach.

"The new regime"—his name for progressive apparatchiks who run California's government—"wants to destroy the essential reason why people move to California in order to protect their own lifestyles."

Kotkin also speaks about California's cap and trade law (AB 32) which will further increase energy costs while making almost no difference in carbon emissions as another middle class killer.  California's energy costs are already 50% higher than the national average and it is certain to get a lot worse.  These high energy costs will drive more middle class manufacturing jobs out of the state over the next decade.

There is also the $100 billion bullet train.  Right now a train to nowhere.

Mr. Kotkin calls the runaway-cost train "classic California." "Where [Brown] with the state going bankrupt is even thinking about an expenditure like this is beyond comprehension. When the schools are falling apart, when the roads are falling apart, the bridges are unsafe, the state economy is in free fall. We're still doing much worse than the rest of the country, we've got this growing permanent welfare class, and high-speed rail is going to solve this?"

Of course, we can't forget about taxes.  You always can use more tax revenues to feed the budget beast in California.

Meanwhile, taxes are harming the private economy. According to the Tax Foundation, California has the 48th-worst business tax climate. Its income tax is steeply progressive. Millionaires pay a top rate of 10.3%, the third-highest in the country. But middle-class workers—those who earn more than $48,000—pay a top rate of 9.3%, which is higher than what millionaires pay in 47 states.

And Democrats want to raise taxes even more. Mind you, the November ballot initiative that Mr. Brown is spearheading would primarily hit those whom Democrats call "millionaires" (i.e., people who make more than $250,000 a year). Some Republicans have warned that it will cause a millionaire march out of the state, but Mr. Kotkin says that "people who are at the very high end of the food chain, they're still going to be in Napa. They're still going to be in Silicon Valley. They're still going to be in West L.A."

However, the middle class has been (and will continue) to leave in droves.

As a result, California is turning into a two-and-a-half-class society. On top are the "entrenched incumbents" who inherited their wealth or came to California early and made their money. Then there's a shrunken middle class of public employees and, miles below, a permanent welfare class. As it stands today, about 40% of Californians don't pay any income tax and a quarter are on Medicaid.

It's "a very scary political dynamic," he says. "One day somebody's going to put on the ballot, let's take every penny over $100,000 a year, and you'll get it through because there's no real restraint. What you've done by exempting people from paying taxes is that they feel no responsibility. That's certainly a big part of it.

And the welfare recipients, he emphasizes, "aren't leaving. Why would they? They get much better benefits in California or New York than if they go to Texas. In Texas the expectation is that people work."

It is not much better in Illinois.  It actually might be worse.

Illinois raised corporate taxes 30% and individual income tax rates 67% in January, 2011 to supposedly solve a $4.6 billion deficit.  Where do things stand today?  The projected budget deficit for this year is $5 billion.  In addition, the unemployment rate increased faster in Illinois than in any other state in 2011.  This feels a lot like quicksand.

A big reason that Illinois is not making any progress on its fiscal challenges is that its public pension and retiree health program is an economic black hole.  The public sector employees have completely taken over the state.  For example, consider that the unfunded retiree health obligations for public employees averages $3,399 per person if you live in Illinois.  In neighboring Indiana, it is a mere $81 according to Steve Malanga of the Manhattan Institute.   That raises the question of who would want to move to Illinois and assume that obligation?  And if you live in Illinois, why would you not be making plans to move to Indiana if you could?

Even Rahm Emanuel, President Obama's former Chief of Staff is seeing the writing on the wall.

Chicago Mayor Rahm Emanuel recently offered a stark assessment of the threat to his state's future that is posed by mounting pension and retiree health-care bills for government workers. Unless Illinois enacts reform quickly, he said, the costs of these programs will force taxes so high that, "You won't recruit a business, you won't recruit a family to live here."

George Will writes in The Washington Post that "Illinois is running out of time and money" and cites the depth of the problems that Illinois has brought upon itself with its public employees.

The Illinois Policy Institute, a limited-government think tank, in a report cheekily titled “Another $54 Billion!?” argues that in addition to the $83 billion in pension underfunding the state acknowledges, there is $54 billion in unfunded retiree health liabilities over the next 30 years. Illinois, a stronghold of public-employees unions, “is on pace to spend nearly $1 billion on retiree health care benefits in fiscal year 2013, more than double what it spent in 2003. Worse yet, these liabilities are growing more than twice as fast as tax revenues.”

A day of reckoning is on the horizon.  The cliff draws closer.  The big question is what happens when they go over the cliff?  We have seen Wall Street bailouts.  We have seen European bailouts.  We are sure to hear calls for a California and Illinois bailout.  This may be the biggest unspoken issue that will be before us in the next four years.  Who is sitting in The White House and in Congress will make an enormous difference when the time comes.  A cautionary tale, indeed.

Disappointed, Discouraged and Disgusted

I don't know whether I am more disappointed, discouraged or disgusted when I consider the actions of the Democrats in the United States Senate.

On April 29 it will have been three years since the Democrat-let Senate last passed a budget blueprint.  This is despite the fact that this is in direct violation of the 1974 Congressional Budget and Impoundment Control Act that states,

"On of before April 15 of each year, the Congress shall complete action on a concurrent resolution on the budget for the fiscal year."

It is indeed interesting that the Senate passes laws that the rest of are required to obey, but they blatantly ignore their own legal obligations.

What do the Senate Democrat leaders have to say about the situation?

Senate Majority Leader Harry Reid(D-NV) said "We do not need to bring a budget to the floor this year.  It's done.  We don't need to do it."

Senate Budget Chairman Kent Conrad(D-ND) stated "This is the wrong time to vote on the floor.  I don't think we will be prepared to vote before the election."

I guess you can at least give Senator Conrad a couple points for honesty.  However, what a woeful excuse.  By the way, Conrad has announced that he is not seeking re-election this year so he is not protecting himself.  However, there are 23 Senate Democratic seats up for re-election this year (compared to only 10 Republican seats).  None of them want to be tied in any way to President Obama's budget plans that will soon take us over $16 trillion in total federal debt.

In order to look like he was doing something, Conrad called a Senate Budget Committee meeting last week to markup a budget that would never be voted on.  To show you how ridiculous the entire process is, this is a photograph of that meeting.  Conrad is at the head of the table with Republican ranking budget member Jeff Sessions(R-AL).  The Republican Budget Committee members are on the far side of the table hoping to get something done.  All of the empty chairs on the near side of the table are the Democrat seats.  No one showed up to do any serious work.

A picture does tell a thousand words.

As do these charts comparing President Obama's budget for 2013 with the Ryan/Republican budget.  The first shows the differences between now and 2022 with respect to federal deficits as a % of GDP.  All are compliments of Keith Hennessey.com.

The second chart shows debt as a % of GDP over the same time period.

As I have written before, despite with you hear from Democrats and in the mainstream media, the Ryan budget is not radical by any means.  It actually increases federal spending $1.3 trillion over the next ten years.  Social Security spending will increase 74%.  Medicare spending will increase 53%.  Medicaid and other health spending is slated for a 40% increase over the next decade.

What is really important is looking at the longer-term impacts of both proposals.  Quite simply, President Obama's budget is not economically sustainable over the long-term.  It relies on short-term tax increases and does nothing to address the underlying entitlement problem.  It is just a matter of time before the entire economic system will break somewhere on that path.   And when it does, there will be untold misery for millions and millions of people.

The decisions we make today will have massive compounded effects in the future.  Small changes now will save billions in future interest expenses and tax costs that will not only take money from our children but also impair future economic growth.  Entitlement reform now will save trillions in future costs while protecting the inter-generational promise made to current retirees.

The Democrats claim they want to protect those least-advantaged in our country.  Unfortunately, the budgetary and economic policies of the Obama administration are putting these people at greater risk with each succeeding day.  It will not be a pretty picture if we allow it to occur.  This picture shows that there is a different path we can still take before it is too late.

Unfortunately, the Democrats in the Senate are too worried about the next election.  After writing this, I now know how I feel.  I am disappointed, discouraged and disgusted.

Forget the RV and Hope for Change

The number of people of working age who are not in the labor force is nearly 88 million people.  This includes students, retired persons, stay-at-home parents and the unemployed.  There have never been more people not working in this country.  There are almost 8 million more people not working today than when President Obama took office in January, 2009.   This chart from Zero Hedge tells the story.

Going further back in history, there are nearly 20 million more people of working age who are not working today compared to the year 2000.  On the other hand, there are only about 5 million more people working today than in that year.  In other words, for every 1 additional worker today we now have 3 additional people who are not working compared to 12 years ago.

I have written before that I am more focused on the labor participation rate than the unemployment rate.  The unemployment rate calculation has become too subjective.  It only counts those as unemployed if they are actually looking for work.  It does not count those who become discouraged and have simply quit looking.  It does not count the teenage slacker who has dropped out of school and is living in his parent's basement playing video games.  It does not count the older worker who got laid off at age 59 and "retires" because of no decent job prospects.

In the end, every American is a mouth to feed, clothe and shelter.  If there are fewer people pulling the wagon and more people in the wagon, we have a fundamental problem.  The money gets spread around in thinner and thinner increments.  That is just basic economics.

Some people might look at the increasing numbers of persons not in the labor force and attribute it to our aging population of Baby Boomers.  However, the reality is that the percentage of the population over the age of 55 working today is greater than at any time in the last 50 years.  At the same time, there are fewer 16-24 age workers than at any time in the last 60 years.  Labor participation in this younger group has decreased by about 15 percentage points (70% to 55%) since 1990 while labor participation increased by 10 percentage points (30% to 40%) among the senior citizen cohort.  The young are getting stuck with all of the current federal debt that is being accumulated that will need to be paid off.  They also are not getting needed job experience to prepare them for the future.  When is this group going to realize that they are being taken advantage of? They really need to hope for change in the next election.

The labor participation rate for those age 55+ is growing for all senior age groups as evidenced by the chart below courtesy of Calculated Risk.  The increases are particularly apparent for those age 65 and over.  Over 30% of those 65-69 are working compared to only 20% 25 years ago.  Around 20% of those over age 70 are working. That is double what it was a quarter-century ago.  Some of this can be attributed to a healthier and more active senior population.  However, the data also suggest that many have to work to make ends meet as retirement income has deteriorated and health care costs and other expenses continue to rise.

Can a retiree even afford to gas up an RV for a sightseeing trip like they used to?  If you can't do that you might as well just keep working!  More older Americans are coming to that conclusion.  

Both young and old are paying the price in this economy.

Slip Sliding Away

I am always interested in stories that cut against the grain of conventional wisdom.

Take the question of cohabitation before marriage.  You might call it living together.  Or shacking up.

The argument for it seems to be that it is a good test run for marriage.  In a nationwide survey conducted in 2001 by the National Marriage Project, 62% of men and women in their 20's believed that living together with someone before marriage is a good way to avoid an eventual divorce.  However, that same report stated that there is no evidence to support the view that living together before marriage reduces the odds of divorce.  In fact, there is research to suggest that cohabitation before marriage (particularly before the couples are engaged) results in less fulfilling marriages and more divorces.

Why is this?

Meg Jay, a clinical psychologist, has an opinion piece in yesterday's New York Times.  And the answer again seems to revolve around one of my favorite topics-behavioral economics.

Sliding into cohabitation wouldn’t be a problem if sliding out were as easy. But it isn’t. Too often, young adults enter into what they imagine will be low-cost, low-risk living situations only to find themselves unable to get out months, even years, later. It’s like signing up for a credit card with 0 percent interest. At the end of 12 months when the interest goes up to 23 percent you feel stuck because your balance is too high to pay off. In fact, cohabitation can be exactly like that. In behavioral economics, it’s called consumer lock-in.

In effect, each step forward in living together is often incremental and evolutionary.  The decisions leading to marriage are not weighed in the larger context of the real commitment necessary for a successful union.  It becomes more the case of gradually sliding into it rather than really understanding that it is a giant leap.

Lock-in is the decreased likelihood to search for, or change to, another option once an investment in something has been made. The greater the setup costs, the less likely we are to move to another, even better, situation, especially when faced with switching costs, or the time, money and effort it requires to make a change.

Cohabitation is loaded with setup and switching costs.  Living together can be fun and economical, and the setup costs are subtly woven in. After years of living among roommates’ junky old stuff, couples happily split the rent on a nice one-bedroom apartment. They share wireless and pets and enjoy shopping for new furniture together. Later, these setup and switching costs have an impact on how likely they are to leave.

Jay speaks of a recent client, Jennifer, who came to her after having lived with her boyfriend (and eventual husband) for four years.  She was in the process of looking for a divorce lawyer having spent more time planning her wedding than she spent happily married.

As Jennifer and I worked to answer her question, “How did this happen?” we talked about how she and her boyfriend went from dating to cohabiting. Her response was consistent with studies reporting that most couples say it “just happened.” 

“We were sleeping over at each other’s places all the time,” she said. “We liked to be together, so it was cheaper and more convenient. It was a quick decision but if it didn’t work out there was a quick exit.”

She was talking about what researchers call “sliding, not deciding.” Moving from dating to sleeping over to sleeping over a lot to cohabitation can be a gradual slope, one not marked by rings or ceremonies or sometimes even a conversation. Couples bypass talking about why they want to live together and what it will mean.

 Jennifer said she never really felt that her boyfriend was committed to her.  “I felt like I was on this multiyear, never-ending audition to be his wife,” she said. “We had all this furniture. We had our dogs and all the same friends. It just made it really, really difficult to break up. Then it was like we got married because we were living together once we got into our 30s.”

I guess Simon and Garfunkel had it about right.

Slip sliding away, slip sliding away 

 You know the nearer the destination, the more you slip sliding away 

Instagram, Instabillion

You probably saw the news this week that Facebook has purchased Instagram for $1 billion in cash and stock.  Instagram is a free photo sharing program that allows users to take a photo, apply a digital filter to the photo (for example, to make it look retro) and then share it to different social networking sites.  It was founded a mere 18 months ago and has a mere 13 employees.

The principal founder, Kevin Systrom, is a 2006 Stanford grad who is 28 years old.  He will net a reported $400 million on the sale.

I thought this was an interesting story as it underscores several points that I made in earlier posts at BeeLine.

I wrote about the sad case of Eastman Kodak on January 2 of this year.  Kodak lost 88% of its stock value last year.  It was priced at 65 cents per share on December 31, 2011.  In 1997, it was trading at $95 per share.  I predicted that it would soon declare bankruptcy.  That prognostication proved accurate a couple of weeks later.

What I find interesting is that nobody knew more about photography than Kodak.  In fact, a Kodak engineer invented the first digital still camera.  However, it did little to capitalize on this expertise in the marketplace while other companies successfully undermined their film business with digital cameras.  To add insult to injury, a 20-something kid and 12 others develop a photo sharing program and net $1 billion while Kodak was on the road to bankruptcy.  What were they and all of their engineers doing?  It should be a cautionary tale to all of us.

The other interesting point in the Instagram story is the fact than so much money and wealth was created by so few.  We keep hearing about the uneven distribution of income and wealth in the world today compared to 30 years ago.  The Instagram story shows why this is occurring in the information age and the marked contrast with the manufacturing age of the past.  I wrote about this in BeeLine in 1% + 99% Should Be Greater Than 100%.

We entered the information age from a manufacturing age.  Manufacturing spreads income in a much broader swath in an economy.  You need to pay a lot of workers to build an automobile.  You only need a couple of computer programmers to develop a video game that might sell millions.  For example, the Call of Duty: Modern Warfare 3 game that was released last year grossed $1 billion in the first 16 days it was for sale. 

The Instagram story underscores the point.  In the manufacturing age you would need millions of invested capital in plant and equipment and thousands of workers to build a business worth $1 billion.  It is unlikely that it could be done in 18 months no matter what the resources were.  There is little doubt the world has changed.

This raises another question. How much should the federal government share in Mr. Systrom's good fortune?  This is a perfect example of a situation where President Obama's "Buffett Rule" would come into play.  This gain would be taxed at 15% based on current law.  The size of the gain is so large that it would dwarf any other income.  Thus, his overall effective rate is undoubtedly going to be close to that 15% rate.  President Obama's Buffett Rule would double the tax on Systrom and other entrepreneurs in similar situations to 30%.  Is that fair? You also need to keep in mind what happens to $60 million differential.  Based on past performance is that money going to be put to better use over the long term in the hands of Kevin Systrom or the federal government.  I leave that answer to you.

Tax Blood and Rich Turnips

President Obama believes that if we tax the rich more that we can make everything right in America.

We hear a constant refrain that the rich do not pay their "fair share".

Of course, the facts directly contradict these statements.  As I have written before, the United States has the most progressive tax system in the world.  The rich pay a higher share of their income in taxes in the U.S. than in any other country that you can name.  More than Australia. More than Canada. More than France. More than Sweden. More than the United Kingdom.  More than any of the European welfare states.

What is true is that there is a much greater share of income concentrated in the top 1% than was the case 30 years ago.  This is an issue I also wrote about earlier this year in my post, 1% + 99% Should Be Greater Than 100%.  The share of income of the top 1% went from 8.30% of total income in 1981 to 16.93% in 2009.  This was matched by a similar increase in the tax share-17.58% paid by the top 1% in 1981 to 36.73% in 2009 proving that the taxes on the rich grew just as much (actually a little more) over the same period.  See chart.

Phil Gramm and Steve McMillin put it all together in an op-ed in The Wall Street Journal recently with a great analysis of the reasons behind the growth in income equality and why there are real limits to how much "tax blood can be extracted from rich turnips".

Gramm and McMillin list three dynamics that have resulted in the growth in income inequality.

First, is the fact that much more business income is now reported on individual tax returns in the form of partnership and subchapter-S corporations.  In 1986, just 5.6% of income for the top 1% was from these sources.  By 2007, almost 19% of the income declared on individual returns came from business income. Similar growth has also been seen in capital gains and dividend income.  As these marginal rates have been reduced, the amount of income reported on individual returns has grown significantly.

Second, the growing participation of China, India, Brazil and other emerging countries has affected incomes in the United States.

The vast expansion of labor engaged in world commerce has raised the return on capital and reduced the relative return on labor. The share of income flowing to capital—both traditional and human capital such as education and training—has risen. 

In relative terms, the return to unskilled labor has fallen. Short of a crippling reversal in world trade, which would reduce the value of both labor and capital, this effect will dominate world markets for the foreseeable future. Since high-income Americans own more capital and have higher levels of education and training, their incomes have grown faster than everyone else's.

Third, technological advances and increased economic freedom have affected income equality.  People like Bill Gates and Steve Jobs created fantastic new products that increased both productivity and our quality of life.  However, the information age spreads money around much differently than the manufacturing age we were in 30 years ago.  As I pointed out in my 1% + 99% blog article.

Manufacturing spreads income in a much broader swath in an economy.  You need to pay a lot of workers to build an automobile.  You only need a couple of computer programmers to develop a video game that might sell millions.  For example, the Call of Duty: Modern Warfare 3 game that was released last year grossed $1 billion in the first 16 days it was for sale. 

It is understandable that many see  all of this as "unfair".  However, who determines what is "fair" and "unfair"?  That is why it seems logical to look at other countries to determine the level of taxation that our "rich" pay compared to others to get some objective measure of "fairness".

While income distribution has become a source of protest and political debate, any analysis of taxes paid in high tax-and-spend countries shows that the U.S. has the most progressive income tax system in the world. An inconvenient truth for the advocates of higher taxes on America's rich is that big governments in developed countries are funded not by taxing the rich more than the U.S. does, but by taxing everybody else more.

Gramm and McMillin provide the numbers to back it up pointing out that if the United States taxed like France and Sweden it would hardly affect the rich.  The bottom 90% would see their taxes double.

In an eternal irony unique to large welfare states, it is the expansion of government in the name of the poor and middle class that always costs poor and middle-class families the most. When the U.S. collects 16.1% of GDP in income taxes, the top 10% of taxpayers pay 7.3% and the other 90% pick up 8.9%.

In France, however, they collect 24.3% of GDP in income taxes with the top 10% paying 6.8% and the rest paying a whopping 17.5% of GDP. Sweden collects its 28.5% of GDP through income taxes by tapping the top 10% for 7.6%, but the other 90% get hit for a back-breaking 20.9% of GDP. 

If the U.S. spent and taxed like France and Sweden, it would hardly affect the top 10%, who would pay about what they pay now, but the bottom 90% would see their taxes double. 

Since OECD members have significantly higher consumption taxes on average than the U.S., the total tax burden of bigger government is even more heavily borne by lower-income citizens in developed nations than these numbers suggest.

This is a big reason why I have so much trouble with President Obama's approach.  If he wants to model the United States on the European social model then he ought to be honest about it.  Put it out there and let the people decide.  We know they like the things that government can give them.  We need to find out whether they are willing to pay for them.

President Obama's health care reform package was the perfect opportunity for him to put it to the test.  It was easier to just send the bill to the rich and put in a mandate.  He clearly could have funded the program and got everyone to pay by putting in a broad-based tax (like Social Security or Medicare).  He never even tried.

At some point, all of this government spending either needs to be paid for or we need to drastically cut back.  Either way, it is the 99% or the 90%, not the 1% of 10%, who is going to feel the most pain.  As Gramm and McMillin point out, there is only so much tax blood that can be extracted from the rich tax turnips.

Radical Ryan and Beyond Radical BeeLine

President Obama is in full attack mode.  One day he is taking on the Supreme Court.  The next day it is Paul Ryan and the House Republican budget.  

I thought that this video was particularly telling as it shows that the President's speechwriters have not even bothered to update the attacks on Ryan and the House budget since last year.   You would think that a year later that they could come up with some better talking points.  This shows that he is not only the "Teleprompter President" but he should be called the "Cut and Paste President" as well.

Keep in mind that President Obama is quick to criticize Ryan and the House Budget but the 2013 budget that he just submitted to Congress did not get one vote.  Not one Republican or Democrat voted for the Obama budget!  The final count was ZERO votes for Obama's 2013 budget plan and 414 votes AGAINST the White House plan.

This is a chart that comes directly from the Obama's 2013 Budget submission that shows the trajectory of publicly held debt under his proposal extended to the out years.

Is it any wonder he could not get even one Democrat to vote with him?

How radical is the Ryan House Budget?   After all, President Obama has described it as "a Trojan horse" that seeks to impose a radical vision" on the United States.  He called it "nothing but thinly veiled Social Darwinism" and "antithetical to our entire history as a land of opportunity and upward ability for everyone who's willing to work for it".

Hearing him speak you would think that the Ryan budget is cutting the social safety net and federal government spending with a meat cleaver.  What happens to federal spending between 2012 and 2022 under Ryan's plan?

Let's start with overall spending.

2012 Federal Outlays  $3.6 trillion

2022 Federal Outlays  $4.9 trillion

Average Annual Increase in Federal Spending +3.1%
Total Increase 2012-2022  +36.1%

What about Social Security?

2012 Federal Outlays $770 billion

2022 Federal Outlays $1.34 trillion

Average Annual Increase in Spending on Social Security +5.7%
Total Increase 2012-2022  +74.0%

What about Medicare?

2012 Federal Outlays $560 billion

2022 Federal Outlays $855 billion

Average Annual Increase in Medicare Spending +4.3%
Total Increase 2012-2022  +52.7%

What about Medicaid and Other Health Spending?

2012 Federal Outlays $287 billion

2022 Federal Outlays $402 billion

Average Annual Increase in Medicaid and Other Health Spending +3.4%
Total Increase 2012-2022  +40.1%

What about Discretionary Spending? (this includes Defense spending and most other government operational spending)

2012 Federal Outlays $1.300 trillion

2022 Federal Outlays $1.212 trillion

Average Annual Increase (Decrease) in Discretionary Spending -.7%
Total Decrease 2012-2022  -6.8%

Does this look anything like a radical plan?  It proposes overall spending restraint of slightly more than 3% per year.  That is restraint, not cuts.  The only area that real cuts are occurring (as a normal person would define it) are in the area of discretionary spending.  Bear in mind that about 2/3 of "discretionary spending" is for Defense.  

The Ryan budget actually does not balance the federal budget until 2035! Truly radical!

I proposed my 2.2.22 budget plan in an earlier post this year.  This plan simply states that we can balance the federal budget by 2022 if we constrain overall federal spending to no more than an annual 2.2% increase for the next 10 years.  This also assumes no changes in tax law using current tax revenue projections of the Congressional Budget Office.

Most people I talk to believe that providing the federal government with an additional 2.2% per year seems very reasonable.  This is particularly true when so many families are not getting close to that number in additional income increases in this economy.  If Ryan is radical then BeeLine must be beyond radical.  And I thought I was just being reasonable! 

Interest Insomnia

If there is anything that should keep you awake at night it is the ravenous need of the federal government to finance its deficit spending.

Another $1 trillion of debt must be issued this year to fund the current year's spending needs in excess of revenues.  In addition, almost $6 trillion of the federal government's debt held by the public must be refinanced in the next five years.  As of April 2, there is almost $11 trillion of debt owed to the public (that includes individuals, institutions (mutual funds, insurance companies etc) and foreign governments (China, Japan etc).  Another $4.7 trillion is composed of intragovernmental obligations to Social Security and other government entities.

This means that over the next five years the federal government will have to find a way to sell in excess of $10 trillion of debt obligations to the public. 

The current average interest rate on all federal debt right now is just 2.2%.  

Let's put that in perspective.

In fiscal 2011, the U.S. had net interest expense of $230 billion on its federal debt outstanding of almost $15 trillion.  In 1997, when federal debt was less than $5 trillion, net interest costs were $232 billion.  Therefore, despite the fact that fedeal debt has increased over 3-fold in the last 15 years, the federal government paid less in interest costs in 2011than it did in 1997 due to these extraordinarily low borrowing costs.

An increase in average interest rates to the level of 1997 (around 5.8%) would add almost $500 billion in additional interest costs to the federal budget!   To be fair, some of this would inure to the benefit of the Social Security Trust Fund and other intragovernmental funds.  However, the net cost is almost $90 billion for each 1% increase in net interest costs.

Let's put that number in perspective.

In 2011, the federal government collected just slightly over $1 trillion in indvidual income taxes.  Therefore, a $500 billion increase in the federal budget to fund increased interest costs on the federal debt would require a 50% across the board increase in income taxes.  Alternatively, if these costs had to covered by reducing spending, it would require the elimination of all Medicare spending ($555 billion in 2012) or all Discretionary Spending ($528 billion in 2012).

Why haven't we seen interest rates already start to increase?   First, Europe's problems have been receiving all of the attention so we have not had to deal with the heavy glare of the world's capital markets while the Euro debt crisis melodrama plays out.  Second, the Federal Reserve is buying up almost all of the debt by printing money.  In 2011, the Fed purchased 61% of all federal debt.  This is simply not sustainable.  Even worse, this level of debt purchased is masking the reduced demand for our debt and is also delaying the inevitable day of reckoning.  We have been getting a free ride but the day is coming where we are going to be charged the full fare (and more).

Caroline Baum, a columnist for Bloomberg News, summarizes the issue very nicely in "Four Numbers Add Up to a American Debt Disaster".

She sees a major problem with the short duration of the Treasury debt.  In fact, only 10 percent of federal debt matures beyond a decade from now.

The U.S. is more dependent on short- term funding than many of Europe’s highly indebted countries, including Greece, Spain and Portugal, according to Lawrence Goodman, president of the Center for Financial Stability, a non- partisan New York think tank focusing on financial markets.

The U.S. may have had a lot more debt in relation to the size of its economy following World War II, but the structure was much more favorable, with 41 percent maturing in less than five years, 31 percent in five-to-10 years and 21 percent in 10 years or more, according to CFS data. Today, only 10 percent of the public debt matures outside of a decade.

We hear some liberal economists argue that the current ability to borrow so much at 2 percent interest rates means that we should be doing even more stimulus spending.  However, the funny thing about the access to credit is that it can literally dry up in the blink of an eye.  There is nothing more dangerous than borrowing short term while using the money for long term commitments.  This is exactly how we are financing the federal government right now.  Baum says it succinctly.

So the next time you hear someone say the Treasury can borrow all it wants at 2 percent, tell him, that’s true -- until it can’t.

We would also be wise to consider some thoughts on debt by our first President.

"There is no practice more dangerous than that of borrowing money; for when money can be had in this way,' repayment is seldom thought of in time, the interest becomes a moth, exertions to raise it by dent of industry ceases, it comes easy and is spent freely, and many things [are] indulged in that would never be thought of if [they were] to be purchased by the sweat of the brow.... in the mean time the debt is accumulating like a snow ball in rolling."

-George Washington in a letter to his nephew, Samuel Washington, Mount Vernon, 12 July, 1797

"To contract new debts is not the way to pay old ones."

-George Washington in a letter to James Welch, Apr. 7, 1799

Thanks, George.  However, thinking about the interest costs that are building on our national debt should cause all of us a lot of insomnia.

Is It About Supply and Demand?

The U.S. Energy Information Administration released data today on total gasoline sales in January by refiners.  Sales (consumption of gasoline) continued to fall with January seeing only 28.4 million gallons/day going from refiners to gas and filling stations.  Gasoline sales are less than half of what they were 4.5 years ago (60.9 million gallons/day in July, 2007) and almost 30% below the levels of a year ago (40.3 million gallons/day last year).

I wrote about this stunning statistic last week and the possible reasons for this drastic drop.  The higher gas prices that we are all experiencing does not seem to be the total reason for the longer term trend.  The chart below shows the decline in gasoline sales since July, 2007.

Total U.S Gasoline Sales by Refiners (Millions/Gallons per Day)
Source:U.S. Energy Information Administration

A further question to ponder is if demand has dropped this dramatically since last year, how can prices continue to be climbing?  Is demand in the developing world (China, India etc) making our drop in consumption irrelevant?  Is it the uncertainty in Iran and the Middle East? Is it the speculators?  Is it the declining price of the dollar vs. gold?  Is it all of the above?

Whatever it is, it is hurting Americans in the pocketbook.  It is also another reminder of why we should be doing everything we can to take advantage of our domestic energy resources.  We need all of them-oil, gas, coal, hydro, nuclear and alternative sources.  Our economy does not go-or grow-without accessible and affordable energy.