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Leadership by Hyperbole

hyperbole – hy-PUR-bə-lee – an exaggeration to create emphasis or effect.

Washington’s latest legislation – the one extending the payroll tax cut for 2 months – could be one of the worst pieces of legislation ever passed.

Republicans supported the bill thinking they would lose votes if they didn’t support something. Democrats got their payroll tax cut and extended unemployment benefits -they will call this a “stimulus” and take credit for growing the economy.

So for once it’s not due to political party differences – democrats and republicans are working together. The House even passed this epitome of political nonsense by unanimous consent.

But when looking at the bill from an economic point of view it doesn’t make sense. Each of its five parts exposes a problem inherent with Washington, not necessarily what the bill aims to fix. Let’s look at them one by one.

The Payroll Tax Cut (Or as I like to call it, Destroying Social Security)

First, consider the false name “Payroll Tax Cut”, then consider what it does: De-fund, destroy (you pick the word) Social Security. Cutting collections that go into Social Security only accelerates the demise of this entitlement. (The original legislation caused Social Security to run a deficit of $50 Billion)

Millions of people have been erased from the income tax rolls so cutting income tax rates does nothing for them. This leaves payroll taxes as the only populist tool for politicians.

But, a 2% cut in Social Security tax rate does not boost economic output because it is not a cut in the top marginal tax rates. This means the government must make up any revenue loss by cutting spending (which it never does), borrowing more or raising taxes on someone else. But, taking money from one group to give to another is a zero sum game, at best.

In the year since the 2% tax cut was initiated in January 2011, and with the Fed’s super-easy monetary policy (near zero % interest rates), consumption increased at an annual rate of 4.3% – unchanged from the 4.2% growth rate for all of 2010, the year prior to the cut. The tax cut appears to have accomplished nothing. Potentially proof that only marginal tax rate cuts may increase economic growth.

Unemployment Benefits Extension

This is the one that always trips up politicians – no one wants to be on record against this “handout”. It is clear that two-year unemployment benefits have done little to create jobs. Extending unemployment benefits does nothing to encourage employment – in fact it can have the opposite effect, paying people to stay unemployed longer. Unemployment will likely fall when the government stops threatening to raise businesses’ costs (taxes and regulations).

Increased Fees on Fannie Mae and Freddie Mac

Every bill Congress passes is supposed to be “paid for” by offsetting cuts in spending or tax hikes. This partially explains the two-month extensions. It’s cheaper to fund a two-month holiday than a full year. The Senate simply pushed for a two-month tax bill to delay the debate until post-election.

The two-month cut needs to be paid for, so Congress levied 10 years of higher fees on Fannie Mae and Freddie Mac. But what do fees on mortgage providers have to do with de-funding social security? Nothing.

Social Security tax cuts should be paid for by cutting future benefits. If Congress was honest, Americans would probably not support a tax cut today for lower benefits tomorrow. It would be called eating our seed-corn. Unfortunately, we already ate it (we spend more than Social Security brings in). So this tax cut just makes our already underfunded plan even more underfunded. So Congress avoids this by putting more fees on home ownership!

Raising fees on Fannie and Freddie makes no sense. They’re already losing billions and Congress isn’t going to put these funds into escrow to pay for future losses. Instead it will spend the money today and taxpayers will be on the hook for losses. They should be closing down Fannie and Freddie, not making them a bigger part of government.

The “Doc Fix”

Back in 1997, Congress passed a “balanced budget act” that was supposed to control spending by holding back the growth rate of Medicare spending. Medicare payments to doctors were supposed to be held down by a formula. In the first few years, these reductions were small – Congress avoided putting these cuts into effect by passing a “doc fix” every year, or just delaying the inevitable.

In order to comply with these cuts today – which have never been allowed to happen – doctor reimbursements need to fall by a whopping 27.4%. If this were to happen, doctors who treat Medicare patients would be up in arms. No one wants that – it’s not good for business.

Congress used this bill to push off these cuts again. It also “kicked the can” on eleven other items as well. Along with the “doc fix,” Congress also made sure cuts to ambulance and mental health add-ons, bone mass measurement, outpatient treatments, and other varied items did not happen.

This behavior, which many in Washington knows happens every year, is potentially about to go into hyper-drive. President Obama promised roughly $500 billion of future Medicare cuts would help pay for Obamacare. These future cuts are based on formulas very similar in design to the 1997 bill. So why would anyone believe Congress won’t do the same thing all over again? When faced with the choice of cutting spending or making a constituent mad… Congress always choose the constituents… and not the ones who pay for it all.

But it gets even worse. Every year, the Congressional Budget Office (CBO) assumes that Congress will follow through on its 1997 agreement when it scores the budget. So the deficit forecast for the next decade assumes a cut in doctor reimbursements that everyone knows likely won’t happen. When the budget deficit rises more than expected everyone in Washington expresses amazement, regret and surprise and then blames it on the private sector and the rich for not paying enough taxes. Is this a messed up system or what?

The Keystone Pipeline

Republicans used this bill to force President Obama to make a decision within 60 days on the Keystone Pipeline extension. This project would have already been put in place if private businesses and private money were the only deciding factors. But politicians in the US are too busy subsidizing solar and wind power while delaying and penalizing traditional carbon-based fuel sources.

From an economic point of view the pipeline is a no-brainer, making this the only economically viable part of this bill. But it highlights the continued failures of Washington.

The Worst Bill in History?

Any business that ran this way may quickly be out of business. Government, because it has so much control and power, can avoid the inevitable for a little longer. But eventually the game comes to an end. It is happening in Europe right now. The Welfare State has come to its logical conclusion – bankruptcy. Greece and Spain are doing us a favor: a potential preview.

Spain, for example, just admitted its deficit is 8.5% of Gross Domestic Product, not the 6% that it was publicizing last year. So, it is proposing a package of tax hikes and spending cuts equal to 1.5% of GDP. This will leave the deficit at 7% of GDP, even though it had promised under new rules to get it down to 4.5%.

Governments seem unwilling to deal with issues that are relatively straightforward. Spending needs to be paid for by taxes, but taxes undermine the incentives to produce and invest in global business. Eventually governments spend so much the economy can’t support it (no matter how much tax rates rise) and bond buyers go on strike. Which is where many European countries are now at.

The United States is not there yet. However it is steadily approaching that day if nothing changes. Politics as usual is not working. Just as the above bill demonstrates, every piece points to a government potentially running out of self-control.

It’s always easier to keep spending… and Congress acts like no one will figure that out. It links Social Security tax cuts to mortgage fees, it ignores rules that it previously agreed to and promised to follow through on and it “stimulates” an economy that does not need to be stimulated. It continues programs that don’t work. And the entire time it is doing this it keeps telling us that “without government everything would fall apart”.

It’s a broken system and the only common theme that runs through it is a considerable effort to get re-elected. It becomes clearer by the day, all the Emperors are naked… there are no more clothes.

The good news is we the people are waking up. The European Welfare State is failing and history suggests the US will find a way to correct its course before it’s too late.

Steve Booren

Steve Booren

Steve started his investment career in 1978 with the NYSE investment firm EF Hutton, working in the environment of a large investment company. Desiring to provide clients with unbiased investment advice, he founded Prosperion Financial Advisors. Learn more about Steve here.

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Sources:
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First Trust Economics

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