Health of the US Economy

 

 

by John Koraska

Revision:  October 9, 2007

 

For Economic and Social Security updates please visit my new website

USPUBLICPOLICY.COM

 

“With Congress, every time they make a joke, it’s a law

And every time they make a law it’s a joke.”  Will Rogers

 

“The Road to Hell is paved with Good Intentions!” The U.S. economic super-highway now being traveled may have a similar destination. The character and moral fiber of the United States of America is crossing the threshold of an era of enormous challenges. Conflicting policies, philosophies and beliefs will be severely tested.

 

Impotence of Policy Makers

 

The prospect for future prosperity of the United States is increasingly more uncertain and depressing. The cumulative results of significant defects embedded in U S tax and welfare law are rapidly approaching an epic economic crisis.  Both the government and the banking system appear powerless to avoid an inevitable economic relapse.

 

Phony Money breeds Unjust Law

 

Real money that represents a “Store of Value” is the bedrock foundation for a healthy economy and a strong nation. During the Great Depression, “New Deal” legislation that violated constitutional restraints by creating artificial fiat money has engendered a complex array of defective laws that has robbed citizens the freedom to decide for themselves what is in their own best interests.  To preserve individual Freedom there is no more important option than the inalienable right to save money that represents a repository of wealth as a means of attending his own affairs by preserving the fruits of labor and responsible financial conduct.   

 

Since the 2001 recession there have been many economic developments in the USA that indicate economic good health. Measured by public and private statistics, indexes and surveys; the U.S. economy currently (Oct 2007) appears strong. Employment is high, business enjoys double digit profits and the economy is generally viewed as vibrant. However; beneath the “numbers”, there exists an undercurrent of public unease about the future health of the U.S. economy. That anxiety is not without merit.   

 

Revitalization of the economy is not without costs. Each cyclical recovery over the past several decades has required more stimulation than the one that preceded it. This one has taken the largest deficit spending in history, 13 successive interest rate cuts by the Federal Reserve, two massive tax cuts, three wars (War on Terrorism, Afghanistan and Iraq), establishment of another redundant bureaucracy (Homeland Security), massive tax incentives (i.e. Capital Gain and Dividend tax rate reductions to 15%), significant growth in Money Supply, short term negative interest rates, a tax induced housing ‘boom’ and a ‘low-interest’ induced mortgage refinancing ‘Boom’ to emerge from a relatively modest recession.

 

Until 2005, strong housing activity contributed significantly to national economic vigor. A prolonged reversal of this vital force (and contiguous factors) might now lead to the next recession, possibly in 2008. The cheap money to finance this ‘Boom’ has decimated savings and punished savers to a degree not seen since the early 1980s. During the 5 year period 1978 to 1982 inflation reduced purchasing power of the US Dollar by 50%.

 

The combined force of a depreciating currency, US government fiscal and Federal Reserve monetary policies have shattered incentives to save. Tax penalties combined with the inflation impact on earned interest and capital; results in negative yields on savings accounts. Further complicating matters for US savers, is the over 40% devaluation of the US Dollar against the Euro since Jan 2002. Domestic inflation coupled with global devaluation of the dollar has created a highly volatile economic environment that is neither manageable nor sustainable.  

 

Recent Fed actions, that injected billions$ into the Sub-prime mortgage market, and deeper than expected cuts in the Discount and Fed Funds (interest) rates signaled a reversal in priorities of fighting inflation and support for the US dollar.  These sudden policy changes are opposite the actions taken by Paul Volker to fight inflation and lure foreign investment by raising interest rates to historic highs in the late 1970s, early 1980s. The current Fed’s hurried preference to reinvigorate a weakening economy will have significant, inflationary impact in coming years.  

 

The US Economy is Floundering in Oceans of Debt

 

Fueled by unsustainable levels of debt and Trillions$ in unfunded social obligations, the U.S. Economic Ship of State is cruising in uncharted waters. Failure of U.S. public policy (federal, state and local) has created perilous social and economic conditions that have accelerated beyond control. Groundwork for these dire conditions has evolved with defective policies begun during the Great Depression. The age of citizen virtue has been replaced by an age of consumerism characterized by greed, manipulation and power stimulated by phony money and faulty tax and welfare laws.

This generation's buy now, pay later consumers realize and have accepted the notion that painless means of correcting flawed economic policies is impossible. The philosophy of debtism was created when the US government began to ignore Constitutional restraints on its power. Responsible citizenship was gradually replaced by consumers who, for the first time, were able to spend without benefit of savings; such was the power of the new plastic redeemable for goods and services worldwide. With this evolved the new American debt-slave. Buying things we don't need with money we don't have has become the American way of life.

Treasury Secretary Henry Paulson recently asked Congress to increase the government debt ceiling by $850 billion from $8.965 trillion to $9.82 trillion, the fifth increase since Bush took office in 2001. It took this country 205 years (1776 to 1981) to accumulate $1 trillion in government debt that is limited by "statute," often referred to as the Public or National Debt. It has taken only 26 years to exceed $9 trillion, an 800 percent increase.

 

The $9 trillion federal debt is the tip of the iceberg. Total contractual American Debt (federal/state/local plus federal debt to trust funds, business, household, domestic financial sectors) exceeds $50 trillion. The Net Present Value (projected future expenditures less future revenues, in current dollars) of under-funded U.S. government explicit and implicit obligations such as Military and Civil Service retirement programs, Social Security, Medicare, etc., add another $45 trillion to the nation's debt.

Total American debt can be conservatively estimated at no less than $100 trillion. Not included are costs of means-tested Social Insurance entitlements such as Medicaid, Supplemental Security Income, State Children's Health Insurance Program, and Veterans’ medical and pension benefits, plus discretionary government subsidies.

Also not included, above, are other discretionary government expenses (resulting

from Transfer Payments inserted in the IRS tax code) such as the Earned Income Tax Credit (EITC) that returns more than $40 billion per year of FICA and FIT taxes to

eligible, low-wage households.  Loss of revenues to the federal government because

of “interest expense deductions”, Child Tax Credits and other deductions/exemptions from gross income tax liabilities of businesses and households further compound accounting complexity to a degree that development of rational monetary and fiscal policies is a practical impossibility.

Defective public policy has created an accounting charade that is impenetrable. The bottom line is it is impossible to accurately determine the amounts of total debt and cost of future obligations being passed on to future generations. That fact will not forever escape the attention of domestic and foreign lenders or credit rating services.

 

Trust Fund Myths contribute to U.S. Budget Deceptions

 

Alleged Trust Fund surpluses are spent on other budget priorities (like the War in Iraq and an expansion of the Children’s’ Health Insurance program) and the interest to Trust Funds is paid with IOUs. If this deceitful practice was abruptly discontinued the government would be required to sell the debt to the public and pay a minimum of 5% interest on $3.9 trillion ($195 billion, annually at current debt levels) causing the US budget deficit to skyrocket. In August 2007, the Congressional Budget Office lowered its FY2007 budget deficit estimate to $158 billion, as economic growth bolsters tax revenue. Add in the $195 billion of IOUs the Government remits to “Trust Funds” and the real 2007 deficit estimate is $353 billion.
 

The U.S. government does not provide honest accounting of financial resources to pay for future Social Insurance obligations. Proper amortization of un-contracted, under-funded pension (Social Security) and health care (Medicare) benefits is not difficult. Deceptive accounting is employed simply because the government wishes to hide the truth from the general public. The truth cannot lie dormant forever. “You can fool some of the people some of the time, but you cannot fool all the people all the time!”

The dilemma facing Politicians today, is they are unable to figure out how to tell “Baby Boomers” (at the threshold of retirement) that there is no way they can get all the benefits they were promised during their working years. Political “Promises” are not “Contracts”. Unlike military retiree pay that is a contractual entitlement between the government and a service member, Social Security retiree compensation (benefit) rely on political promises that have already been compromised.

 

Social Security Trust Fund Myth

 

The Social Security Act of 1935 requires all surplus contribution amounts be invested only in US government securities or Securities guaranteed by the US government.

There is not now, nor has there ever been a surplus of Social Security Trust Funds. The so-called current "surplus" (more money coming in via the FICA tax than is paid out to beneficiaries) in the Old-Age, Survivors and Disability Insurance (OASDI) Trust Funds is grossly misleading. A review of the facts, affirm there is an actual net cash flow deficit.

See Critique of 2006 Social Security Trustee's Report for details.

 

 An examination of federal policies and accounting practices exposes disinformation that is designed to conceal government deception. The media is as guilty of covering up the truth as is the government. Current OASDI Trust Fund assets (government IOUs) are offset by an equal amount of US Treasury debt. The OASDI Trust Fund assets and projected surpluses (through 2017) reflect gross amounts of combined Federal Insurance Contributions Act (FICA) taxes reported to the Social Security Administration. These gross amounts have not been adjusted for corporate expensing of FICA taxes that significantly reduce the actual net (cash) revenue received by the U.S. Treasury. This accounting scheme is one of the most disingenuous deceptions ever perpetrated in the history of mankind.  

Social Security Act of 1935 

Established

Two Direct Income Taxes on Wage Income

 

http://www.ssa.gov/history/35acviii.html#Excise

"SECTION 801. (Paraphrasing) “In addition to other taxes, employees shall pay an income tax on 1% of wages up to $3,000 and every employer shall pay an excise tax on individuals in his employ of 1% on wages up to $3,000 on each employee...... "(Note: The initial 1% was scheduled to increase in the early years of the program.)

 

 FICA Income Tax Deduction from Gross Individual Income forbidden by Law

 

"SEC. 803. For the purposes of the income tax imposed by Title I of the Revenue Act of 1934 or by any Act of Congress in substitution therefore, the tax imposed by section 801 shall not be allowed as a deduction to the taxpayer in computing his net income for the year in which such tax is deducted from his wages.” This explicit deduction prohibition applies only to Individual Tax returns NOT Corporate Tax Returns.

 

Business Expense Deduction of FIT & FICA Income Taxes

 

 An employer may keep approximately one third of the individual Federal Income Taxes (FIT) and Federal Insurance Contributions Act (FICA) income taxes withheld from employee paychecks; although workers are lead to believe these taxes are sent to the Internal Revenue Service (IRS) or the Social Security Administration (SSA). 

 

Deduction of employee FICA and FIT Taxes as Wages

IRS Publication 535 (2004), Business Expenses

http://www.irs.gov/publications/p535/ch06.html

IRS QUOTE:  6. Taxes...  Employment Taxes:

If you have employees, you must withhold various taxes from your employees' pay. Most employers must withhold their employees' share of social security and Medicare taxes along with state and federal income taxes. You may also need to pay certain employment taxes from your own funds. These include your share of social security and Medicare taxes as an employer, along with unemployment taxes.

 

You should treat the taxes you withhold from your employees' pay as wages on your tax return. You can deduct the employment taxes you must pay from your own funds as taxes.  You pay your employee $18,000 a year. However, after you withhold various taxes, your employee receives $14,500. You also pay an additional $1,500 in employment taxes. You should deduct the full $18,000 as wages. You can deduct the $1,500 you pay from your own funds as taxes.  UNQUOTE

 

2006 Social Security Trustee Summary

 

The 2006 Social Security Trustees “Summary of 2005 Trust Fund Financial Operations” reported that “The OASDI Trust Funds received total income of 701.8 billion (Contributions 592.9, Taxation of Benefits 14.9 and Interest 94.3) and expended 529.9 billion. Assets increased by $171.8 billion in 2005 to $1.86 trillion because income to each fund exceeded expenditures."

 

Comment: The Trustee statements are misleading. The OASDI income is over stated because the “gross amounts” of IOUs deposited in the Trust Funds have not been adjusted for the Business Expense deductions. The “net” FICA taxes collected by the IRS are less than Social Security expenses. Also not shown as Trust Fund expenses are Earned Income Tax Credits (EITC) that return FICA taxes paid by eligible low wage employees.

 

The 2006 OASDI Trustees Report stated: “Under the intermediate assumptions, the OASDI cost rate is projected to decline slightly during 2006 through 2008 and then increase up to the current level within the next 2 years. It then begins to increase rapidly and first exceeds the income rate in 2017, producing cash-flow deficits thereafter. Despite these cash-flow deficits, beginning in 2017, redemption of trust fund assets will allow continuation of full benefit payments on a timely basis until 2040, when the trust funds will become exhausted.” 

 

Comment: The intermediate assumptions are also misleading because, as explained above, the gross contributions recorded in OASDI Trust funds are significantly less than the net FICA collections by the Treasury.

Why Most Americans Don't Save
 

The simple explanation of “Why Americans don’t save” is there are more incentives to borrow than to save and too often the real cost of living a middle-class, modern day life-style increases faster than real net wage income. Because of the inflation tax and large defects in socialistic tax and welfare policies based generally on fiat money and debtism; Americans are heavily influenced to spend beyond their means.

The IRS tax code is loaded with penalties on wage and interest income and incentives to buy now and pay later. Wage income is taxed twice (FIT and FICA) and interest income is taxed at nominal normal rates, unlike capital gains and dividend income which enjoy special (15%)rate preferences. Both wage and interest income is further subjected to the hidden inflation tax that is arguably the most destructive among all taxes.

Often the “take home pay” of millions of middle class workers is less than typical living expenses and they are compelled to borrow, further compounding the problem. They simply do not have a surplus of money or the will to save or invest. Those who do enjoy discretionary income for savings are penalized if they choose to do so. Interest on savings suffers from low, artificially contrived rates that are often lower than the combined effects of hidden inflation and direct income taxes.

The Federal Reserve recently lowered its prime lending rate from 5 ¼ to 4 ¾ percent, with rumors of more rate cuts to follow. Having abandoned the fight against inflation and to forestall a possible recession, those who save will be further penalized by the Fed’s rush to calm nervous financial markets. Average annual inflation (measured by the CPI-U, all items) since 1971 (when the dollar became fiat) is 4.6%.

The ultimate hypocrisy is for the U.S. Government, arguably the most wasteful dis-organization in the universe, to encourage citizens to save when the governments’ own record of piling up inestimable debt and making promises it can’t keep is a perfect model of profligacy, fraud and financial mismanagement.

As of July 31, 2007 the Total Public Debt Outstanding (Debt Held by the Public $5 trillion + Intra-governmental Holding $3.9) was $8.9 Trillion. Of the Debt Held by the Public $2.191 Trillion was held by foreigners or 43.8%. Estimated average rate of interest paid on the public debt is 5%. Percentage of the Total Debt borrowed from so-called Trust Funds is 43.8% that the Treasury doesn’t have to pay real interest on.

 

As economic reality and the truth emerge, public outrage will detonate and current politicians will be blamed for decades of cumulative government and banking  mismanagement and deception. It will not be a pleasant time for elected officials.

 

There are no economic scenarios politicians can offer that can solve this problem. Absent public outrage, that is unlikely - because of public apathy -, until the bottom falls out, the only recourse available to middle-class workers is class-action lawsuits filed in federal court across the country, demanding that government STOP misappropriating their retirement “nest eggs”. Even if unsuccessful such action will scare hell out of the politicians.

 

Savers are forced to pay income tax on actual monetary losses in terms of real purchasing power. Debtors are rewarded with tax deductions and the ability to pay loans back with cheaper money. The illusory gains stolen by inflation are subjected to income taxes, thus government is rewarded by phony money and deceptive tax and welfare laws at the expense of prudent tax-paying Americans.

 

This phony money operation could continue only as long as the US enjoyed dollar hegemony (a trading currency monopoly that the US has enjoyed since WWII). It is becoming more evident that the US$ is increasingly vulnerable to the Euro and other foreign currency and trade challenges, as chronic deficits and account imbalances persist. The perilous risks to the US economy are of our own making. Phony money and defective policies encourages Americans to live beyond their means. The heavy price that must be paid for this cumulative misbehavior is rapidly coming due. Postponing and political jaw-boning the problems will not make them disappear. Delay only increases the costs and the painful consequences.

 

Neither Democrats nor Republicans seem to grasp the enormous risks of an economy that is being driven by consumerism and funded by increasing levels of debt.  Their lack of knowledge or action is important. Without full political understanding and contentious public airing of the cause-and-effect of uncontrollable debt, there is no way to develop a consensus for confronting the problem and finding solutions. Lawmakers and bankers are more embroiled in reacting to situations beyond their control than trying to fix the underlying problems.  A solution to the national “Debt” predicament becomes even more intractable as a result of the bitter rivalry between the political parties.

 

Balancing the Rights of Employers and Workers

 

A fundamental dilemma facing the nation is how to develop policies that fairly balance the needs of workers and their employers. Workers must earn incomes that provide as a minimum, a moderate living wage with a cushion for savings, to meet future needs such as retirement. Companies must make a profit with a cushion for investments to enhance their own development. Contented employees are a company’s best assets. A worker’s best security is a good paying job.

 

When balance is biased toward one side of the competition, the other side must inevitably suffer the consequences; unless there is an intervening force. It is the function and responsibility of Government to promote the proper balance among contending forces. It is not the role of government to choose winners and losers with tax and welfare laws that are indecipherable to the public it was created to serve. It is a fact that current government tax, welfare, and immigration policies weigh heavily against workers, favoring profits over wage income.

 

Another problem facing workers is insuring adequate funds are available for retirement. Employers have over the past quarter century shifted away from Defined Benefit retirement contracts toward Defined Contributions. The value of these retirement nest-eggs are subject to the future performance of financial markets that may suffer greatly because underlying debt and unredeemable social obligations may cause a downgrade of US Credit worthiness.

 

Because of current tax laws, funds withdrawn from tax-deferred accounts are subject to tax even if losses occur within the individual accounts. Many of those who suffer losses will be further penalized because of the income tax on SS benefits. Politicians have already proven they cannot be relied upon to keep their promises.

 

After decades of political promises that benefits WOULD NEVER be taxed since income taxes had already been extracted on the contributions; in 1984 income taxes on benefits began. The tax on SS benefits is concealed under a labyrinth of complex formulas and legalese that makes it difficult to determine the amount of the tax, but the cumulative annual amounts have grown from $3 billion (1984) to $16.9 billion (2006) and is projected to go higher as inflation pushes benefits above tax thresholds (not indexed for inflation) established for this relatively new form of government confiscation.   

 

 Development of Reform Strategies

 

Unredeemable Debt and Unfunded Social obligations are like a ticking bomb hidden beneath the US Economy. The road to perpetual prosperity cannot be achieved without creating a just tax and welfare systems and a transparent means of government and business accounting. See Principles of a Fair Tax System

 

All great historic advances are surrounded in controversy. The same can be said about significant corrections to defective government social and economic policies. The test of time and wisdom is how to sustain the former while reforming government.  The current dilemma is how to change course from perpetual debt to perpetual prosperity without destroying the economy.

 

Strategies for development of fundamental reforms of federal tax, welfare and banking policies, require identification of defects in current practices that have generated the current perilous financial conditions. The seeds of ultimate economic destruction need to be uprooted and replaced by sound, sustainable, time-tested policies.

 

 For openers, a primary goal must be the dilution of powers now exercised by the central government and Federal Reserve bankers. Centralized government management of vast resources and constituencies simply do not work. Without question, defective fiscal and monetary policies have caused the U.S. to change status from Creditor to Debtor nation. Unarguably, long term economic prospects are deteriorating and future prosperity of this great nation is becoming more uncertain.  

 

Solving Trust Fund problems of compounding government debt require elimination of fundamental defects in federal accounting and tax and welfare laws. Adopting accounting procedures and Trust Fund guidelines government imposes on business would be a good place to start.  A good place to start would be to limit all Trust Fund investments to assets that may be publicly marketed.

 

One solution to the National deficit and debt problems is to change the provision that allows for business expense deduction of employee taxes (business can partially recover from this change by passing the expense on to consumers of their goods and services). Another alternative is to eliminate the corporate income tax and replace it with a 1% or 2% total business receipts tax. If compelled to make a choice, most corporations would likely opt for the former instead of the latter. Government revenues from the Corporate Income Tax are generally nullified by compliance and enforcement expenses of business and government.

 

The ultimate irony is the government is spending "gross" FICA income like it is real time deposits; but "net" FICA income after "business expensing" falls short of current Social Security expenditures. To further complicate matters, future benefits are calculated on combined "gross wage contributions" that overstate "net income" by more than a third. Why does the US Treasury owe over $2 trillion to the OASDI Trust Funds when the program has been running continuous negative net cash flows and alleged surpluses (money spent by the government that wasn’t received) have already been spent on other priorities? Can anyone offer a rational explanation for this mess? And how can future beneficiaries expect to get paid what they are being promised when it can be proven that current Social Security expenditures exceed current "tax adjusted" net income?  Ask your congressman or senator to explain it to you.

 

The public will blame the politicians and the politicians will point to each other. For most folks a more honest place to find who to blame may be in a mirror.

 

         These comments were added to the article on October 10, 2007

 

There is "NO" Social Security Surplus!

 

Even the most fiscally responsible candidate running for President of the United States , U.S. House representative, Rep Ron Paul; does not understand government accounting. In his recent “Ron Paul’s Texas Straight Talk” weekly column “Keeping Promises to Seniors” stated:

 

Quote: In reality, those dollars are just IOUs the government is writing to itself when it borrows from the fund to spend on unrelated programs.  There are no real assets in the Social Security Trust Fund.  This is similar to taking money out of your savings account, spending it, then replacing it with an IOU to yourself, and calling that IOU an asset.

 

In addition, this money we owe to our seniors is not even included in official budget deficit figures.   In fiscal year 2006 alone, $185 billion was borrowed from Social Security.  The official deficit was reported to be $248 billion.  The actual deficit for 2006 would be $433 billion when combining the two.  This sort of accounting would land private sector executives in prison for fraud. Unquote

 

The part Dr. Paul (nor any of his cohorts) seem to be unable to grasp is in 2006 there was no $185 billion to borrow from Social Security. While gross FICA tax collections reported in the OASDI (Old Age, Survivors and Dependents Insurance) Trust exceed Social Security cash benefits; the net income after the (Business Expense Deduction of FICA taxes) deposited in the U.S. Treasury was billions of dollars less than OASDI expenditures.

 

The bottom line is the US government is commingling and counting money it doesn’t receive, spending it on programs it can’t afford; and ingenuously converting the negative cash flow into imaginary surpluses. Unwarranted Treasury debt is created with IOUs to Trust Funds that are really NOT Trust Funds, but defective accounting practices that conceal a “Shell Game” used to determine under funded, future benefits. Perhaps defects in government accounting may be better explained by using an analogy:

 

EXAMPLE: John Smith is a wealthy politician in the 35% nominal tax bracket that itemizes deductions. Smith pays the School District $10,000 in taxes. He then deducts the $10,000 from his FIT tax return. The deduction reduces Smith’s income tax liability by $3,500. The net result is the school gets the gross $10,000. But the US Treasury gets $3,500 less than it would have received if the tax deduction did not exist.

 

The gross amounts of the combined FICA taxes (OASDI) based on wage income are reported by businesses to the SS administration. SS uses the gross individual wages as part of a complex formula to determine future benefits. The net amount of FICA tax cash revenue to the Treasury is approximately 35% less than that reported to SS because of the Business Expense Deduction of wages, FICA and FIT taxes). 

 

These deceptive accounting practices and other flawed policies have converted the Public Retirement program from one created to assist low income workers to one that pays the highest benefits to those with the least need and/or entitlement to, and pays the lowest benefits to those below poverty lines. 

 

 

"The opinion of 10,000 men is of no value if none of them know anything about the subject." -- Marcus Aurelius