Jun 05 2012

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An Economic “Moment of Truth”

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Denial is No Longer an Option

A fresh bucket of bad economic data and the resultant stock market swoon, which wiped out all the 2012 gains for the Dow last week, crystallizes a moment of maximum danger for the global economy. Only decisive leadership, championing fairly radical measures, can salvage the current situation.

Looking back to the aftermath of the 2008 fiscal crisis, it is now clear that policy makers in both the US and Europe focused on short-term, emergency measures to cushion the impact of recession, to the exclusion of necessary structural reforms in national tax, health and retirement programs until such time as sustained, economic growth had returned.

Politically necessary, but economically risky.

But sustained, private sector led growth did not return.

The trillions in stimulus, spent across the globe, eased the impact of the recession. But without genuine action on the fundamental issues of debt and spending, the new debt only weighed down a global financial system, which is now strained to the breaking point.

Export led economies that have been key to global economic growth – China, India and Brazil, are slowing down due to a lackluster global demand and insufficient domestic consumer demand.

In Europe, the sovereign debt crisis portends the once unthinkable collapse of the Euro as a currency and enormous economic pain and dislocation that would result, in Europe and across the globe.

In the US, economic growth has stalled. The “recovery”  that began in June 2009 has been the weakest since WWII. Unemployment, which hit 10 percent, remains over eight percent.  The dual collapse of the housing and financial markets in 2008 wiped out trillions in wealth for average Americans, impacting 401(k)s and home values. Business is gun-shy, fearful of tax and regulatory uncertainty. Consumers are gun-shy, fearful of tax, regulatory and job uncertainty, as well as flat incomes and creeping commodity inflation.

All the while,  the US government racked up a fresh $5 trillion in new debt in only four years. US government debt obligations – foreign and domestic – now account for 100 percent of the nation’s GDP. But the massive borrowing, far from catalyzing sustainable recovery, has only served as breathing space between crises.

Europe and US are at a tipping point. What to do?

As for Europe, the future of the EU and the Euro are in the hands of Angela Merkel.

The Chancellor has a ten-year plan for gradual fiscal union of EU member states.

But Europe doesn’t have ten years.

It may not have ten months.

The only real option is immediate fiscal integration. To use the power of European Central Bank (ECB) to guarantee the debt issuance of at risk countries, and equally as important, to act as an FDIC for depositors in those countries to prevent a bank run.

 In return, at risk countries must comply with existing austerity measures, and each sovereign central bank will need to be brought under de facto ECB control to provide more seamless management.

Only in this way can the erosion of confidence in Europe and the Euro be staunched.

Once the situation has stabilized,  the greater project of the EU will be the complete overhaul of the social welfare state in Europe, with the goal of bringing benefits in line with economic production. To live within their means.

Can the sovereign states of Europe acts in unison to implement unprecedented changes in their economic, social and cultural norms? To cede sovereignty? Will German voters support changes that will effectively make the nation the banker of last resort?

It won’t be long now to find the answer.  The consequences are coming.

In the US, it means and end to the half measures and political ploys that substitute for action and reform.

The US must restore certainty to its regulatory and tax structures and credibility to its budget and debt reduction efforts. Only in this way will the government win the confidence of international investors (and perhaps win back its AAA rating) and, crucially, US business, which is sitting on $2 trillion in reserves that can power an economic renaissance if provided with a secure and predictable operating environment.

1) Total Reform of the Tax Code: forget about the Bush tax cuts or the payroll tax cuts.  These are false arguments.  Start with a clean page. Swap deductions in the tax code for overall rate reductions. For politically sensitive deductions (mortgage interest, state and local taxes) phase out the deductions at higher income levels. This provides the tax fairness that Democrats seek, while ensuring the lower long term structural rates that Republicans want.  The top personal rate should be no hire than 30 percent.

a) Lower the Corporate Tax Rate:  ours is the highest in the developed world and is essentially a pass-on to consumers.  The new rate should be no higher than 25 percent.

b) Maintain Low Tax Rates on Capital Gains & Dividends: this is investment money already taxed once as income. If you want a pool of capital for business investment, keep rates lower to attract it.

2) Reform Entitlements

Social Security: the Social Security Trust Fund is filled with $2.7 trillion in IOUs from the general Treasury. The federal government hasn’t stashed that cash it borrowed in some high interest bearing account.  When the bills come due, it will either require punishing tax increases or benefit cuts. Lets get out ahead of the curve:

a) No Benefit Cuts for ANY Retiree or Those Near Retirement: everyone agrees on this. Every plan proposed stipulates this.  But the Democrats demagogue on this. End the charade.

b) Change Calculation for Inflation: all entitlement programs increase automatically each year based on a government formula for inflation. The chained-inflation index is a closer approximation of real inflation and increases more slowly. Benefits increase, but on a slower trajectory.

c) Means Test Benefits for Wealthy Retirees: if you are rich when you retire, you will get less from Social Security. Benefits paid out almost always exceed payments into the system, so no one is being taken advantage of here.

d) FICA Tax: this is a regressive tax that is capped at $107,000 in income. The least well off pay the biggest share of their income. It is inhibits small business creation where the contributions of both the employee and employer are born by the entrepreneur. Ditch it. Uncap FICA. Create a pyramid taxation system where, where the tax gradually rises to a certain income point after which, the rate begins to decline again. This provides continued incentive to earn, while maintaining collections. One percent of a million dollars is still 10k.  Create a new, blended rate for small businesses to incentivize job creation.

Reform Medicare: it is going broke with a growing number of new entrants and a fee for service model that has no correlation between taxes and benefits. See ads for the “Scooter Store” if you don’t believe it.

a) No Changes for Current or Near Current Retirees: same as above.

b) Introduce Competition for Medicare Services: similar to the very popular Medicare drug benefit, which has seen drastic reductions in anticipated government cost. Seniors are not one size fits all and neither should their health care be.  A version of Paul Ryan’s “premium support would complement this new structure and provide a foundation for decades of solvency.

c) Means Test Medicare: if you have more, you get less. Again, so long as that lower benefit is higher than the taxes paid into the system, no one should be grumbling.

3) Complete Reform of Regulatory Structure: environmental, financial and health care regulations of the Obama presidency have been a drag on the US economy, had a chilling effect on US business, and have yet to demonstrate measurable results or savings. The goal should be to promote an aggressive new domestic energy production program, financial regulations that will actually prevent a replay of 2008 and health care policy that extends quality coverage to Americans, affordably and through market competition, not government diktat.

If the federal government takes these measures, it will instill certainty and dynamically incentivize economic growth and business expansion – which will lead to job creation.

Dramatically slowing the rate of government spending in conjunction with higher economic growth rates – that produce hire government revenues – will reduce the budget deficit and stabilize the US fiscal situation so that the US can develop a longer term plan to address the national debt.

Can the US political system come together to implement these measures?  Will November be the pivot that will unlock the gridlock in Washington? Even with a new governing majority, will DC do the right thing?

It won’t be long now until we have the answer.  The consequences are coming, regardless.


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