The Plan...time for some rules and discipline

We're in a mess, and we're in a mess because our leaders have too much power and not enough discipline.  One of the institutional problems with both monetary and fiscal policy is that they are subject to the whims of elected officials...folks who want to stay employed more than they want to do what's best for the country as a whole.  This creates a tremendous amount of uncertainty for everybody and if there's one thing the economy can't take, it's uncertainty.  For years the 'experts' have talked about and warned us about a 'liquidity crisis'.  There is no liquidity crisis in the sense that there's plenty of available capital already in the economy.  What we have is a 'confidence crisis'...very few consumers or leaders of business have confidence that DC knows what to do, and for good reason.  The current and previous administrations have shown how inept they are at economic policy.

It's time to rein in the free-lancers with some very basic policy 'rules'.  In general both fiscal and monetary policy should be required to operate within these rules.  Doing so not only decreases the volatility of decisions made by politicians campaigning to get re-elected, it also ensures a more predictable and economically sound decision making process.

Full disclosure mandates that I admit most of these ideas aren't new and have been discussed in the geeky world of economics for years.  I've added my own perspective so if something sounds really crazy blame me.


(PS- GDP is private sector GDP = Real GDP – government spending)

Federal Government Spending

Except in times of a congressionally declared war, or with 2\3 support in both chambers, spending should be capped at 30% of total GDP and linked to GDP changes;

                                     Max spending

GDP Growth                as a % of GDP

< 1.0%                                   40%

1.1% - 2.0%                          38%

2.1% - 3.0%                          35%

3.1% - 4.0%                          33%

4.1% - 5.0%                          28%

> 5.0%                                   25%

Since government spending has bounced between 30% - 35% since the late 60’s, until 2009, there’s no reason to believe we can’t have a functioning government operating within that range.  Note that this approach does not mandate increases nor decrease in the absolute amount of government spending, it just links fiscal policy to GDP.

Monetary Policy

Force the Federal Reserve to publicly adopt the Taylor Rule (r = p + 1/2y + 1/2(p-2) + 2) in setting the Federal Funds rate.  Only through legislation would the FR be allowed to deviate from the Taylor Rule.

DoD Spending

1.  Transition from counter-insurgency in Afghanistan to counter-terrorism

2.  Look to speed up our withdrawal from Iraq under the SOFA

3.  Establish a plan to cut end strength by 5% by FY 2015 (Oct 2014)

4.  Require a 5% cut in non-Pay, Benefits & Retirement (PBR) spending in FY2012

5.  Require an additional 5% cut in non-PBR spending in FY2013

6.  Require an additional 5% cut in spending in FY2014 with up to half coming from PBR spending

7.  Reduce OCONUS headcount by 5% by FY2013.  Savings cannot be included in other budget reduction requirements.

8.  Reduce OCONUS headcount by an additional 5% in FY2014.  Savings cannot be included in other budget reduction requirements.

9.  Reduce OCONUS headcount by an additional 5% in FY2015.  Savings cannot be included in other budget reduction requirements.

(OCONUS is outside the continental US but includes HI)

US Treasury Bonds

Treasury issues 3 types of callable bonds.  The bonds pay 1% above PS-GDP with interest being tax-free at the Federal level.  Revenue generated from the bonds can only be used as directed.  Can only be redeemed when PS-GDP reaches 4% or higher annually, but they are callable after 12 months.

·      Deficit Reduction Bond

·      Stimulus Accelerator Bond

·      Iraq & Afghanistan War Bond

Personal Income Taxes

1.  Alternative Minimum Tax

a.  Recalibrate the income level at which the AMT kicks in to account for inflation since it was implemented.  This will significantly reduce the number of people inadvertently caught by the AMT…essentially a tax reduction for the upper middle-class.  When the original AMT was introduced in 1970 it was in response to less than 200 millionaires not paying any federal income tax the previous year.  An estimated 4,000,000 Americans had to pay the AMT last year.

b.  For incomes > $1,000,000 include all dividends in the AMT calculation.  Currently dividends are not included in personal income that is subject to the AMT.  This is why Warren Buffett paid such a low effective tax rate - 90% of his income is shielded from the AMT.  Including all income in the AMT is a much more effective means of ‘getting the rich to pay their fair share’ than what Buffett has suggested.  He recommended increasing the marginal tax rates on ‘the rich’.  While that will increase revenues some, it doesn’t address the core reason why Mr. Buffett is paying such a relatively low effective rate – his primary source of income, dividends, is only taxed at 15%.  It should come as no surprise that Mr. Buffett is basically recommending a solution that looks good on the Op-Ed page of the NYTs but doesn’t really impact him that much. 

2. Consumer Credit

Allow tax-payers to write off their credit card interest payments through 2012 for all purchases made prior to January 1^st, 2011.  This will serve as a motivator for consumers to ‘deleverage’ and pay off their credit cards more quickly.  Mandate that the credit card companies include this interest data on monthly statements and require filers to include it with the tax forms.

3.  Medical Bills

Decrease the threshold Adjusted Gross Income from 7.5% to 3.5 %.  Currently filers can only deduct medical expenses that exceed 7.5% of their AGI.  Lowering the thresholds increases the deductions, thereby letting folks keep more of their money during a time of higher medical bills.

Employment\Unemployment

Link the duration of federal unemployment benefits to the unemployment rate;

Unemployment Rate  Federal UIC

< 5%                                              0

5% - 6%                                  13 weeks

6% - 7%                                  26 weeks

7% - 8%                                  45 weeks

> 8%                                       52 weeks

Federal UIC should be tax-free and it should be considered an interest free loan, not a gift.  Recipients are given twice the duration of the time they received UIC to pay back half of what they received.  Half, since their compensation was reduced, or prices were raised, by their previous employer to assist in paying the UIC tax.  Recipients must pass periodic, random drug screening to ensure they are eligible to work.  This rule only applies to federal UIC, states can do as they wish with their UIC programs.

Social Security Tax

Currently workers are taxed 4.2% for Social Security income up to $106,800. 

The tax rate used to be 6.2% but was reduced last year as part of a stimulus plan.  Keep the 4.2% tax until PS-GDP reaches 4% and then raise it back to the 6.2% mark.  Maintain the $106,800 ceiling (anything over that isn’t taxed) until you reach the $1,000,000 income level.  At that level instate a universal payment of $40,000, which is the same as 4% for the $1,000,000 earner.  It doesn’t matter if they make 1 million a year or 100 million, their tax bill for Social Security is $40,000.  As a trade-off, guarantee nobody currently paying the 40k flat payment will ever be means tested beyond what is currently in place.

Corporate Taxes

Flat tax for corporations based on gross revenue, not earnings before interest and taxes (EBIT).

Tie corporate tax rates to PS-GDP.   As the PS-GDP increases, tax rates increase - as PS-GDP falls, taxes fall.

 PS - GDP                           Tax Rate

< 1.0%                                    15%

1.1% - 2.0%                            16%

2.1% - 3.0%                            17%

3.1% - 4.0%                            18%

4.1% - 5.0%                            19%

> 5.0%                                    20%

Currently corporations are taxed on their ‘profits’, which rewards them for taking advantage of the thousands of ‘loop holes’ in the tax code that reduce their balance sheet profits.  Companies spend tens of millions of dollars to figure out ways to pay less in taxes.  Congress constantly tinkers with code in an attempt to engineer a specific behavior by corporate America.

Allow for only one type of deduction – depreciation.  It can be taken annually off gross revenue using the following accelerated schedule;

                                        Depreciation

PS - GDP                  as a % of purchase price

< 1.0%                                    90%

1.1% - 2.0%                            75%

2.1% - 3.0%                            50%

3.1% - 4.0%                            25%

> 4%                                std rates apply           

An accelerated depreciation schedule encourages reinvestment in capital equipment since buyers can quickly write off the cost of the equipment against gross revenue.  This effectively decreases their tax obligation and rewards them for reinvesting during a downturn.

We can debate over the specific numbers and percentages as long as we can agree on moving away from too much discretion and towards more of a rules\disciplined approach that stabilizes policy and provides predictability.