Scoring the Fiscal Cliff Debate: Obama 0; Democrats 0; Republicans -5

It has been too easy for the fiscal cliff debate to be reduced to the narrow argument of whether Washington should raise revenues by increasing tax rates on the wealthy or by removing their tax deductions. With everyone’s attention riveted on this absurd question, their attention is diverted from the real fiscal challenges this country faces and the real math we must learn in order to make the best policy decisions. The President is right “the math doesn’t work”, but it is his and the Democrats’ math that must be examined.

The President most recently proposed raising $1.6 trillion in new tax revenue over the next 10 years by raising rates and reducing deductions for the wealthy. In addition he proposed about $600 billion in “spending savings” to quote his messenger, Secretary Geithner, and asked for control of the Federal debt limit. Each of these proposals needs careful scrutiny.

Accepting tax rate changes (raising marginal rates and reducing deductions for the wealthy) that supposedly will increase Federal tax revenues (a result that is questionable) in order to reduce the deficit and the total Federal debt implies that the deficit and debt are importantly the result of income tax shortfalls because the wealthy are not paying enough. This is not only implied in the Democrats’ message, it is explicitly stated that the Bush tax cuts favored the wealthy and hurt Federal tax revenues. We will examine the Federal tax consequences of the Bush tax cuts after we see what is really behind the mushrooming deficit and escalating total Federal debt.

The Executive Branch of government executes its responsibilities largely through a number of cabinet departments and special agencies. What has happened with the major cabinet departments’ budgets from 2007 to 2010? Hold on to your calculators -the result is astounding! On average, the 15 major cabinet departments saw a 77% increase in their budgets over this short 3-year period. That’s right -77%! The absolute dollar amount these departments spent in 2010 as compared to 2007 increased by $794 billion.

To put this in perspective, the largest single year bill for the combined Iraq-Afghanistan wars was $170 billion with the budget for 2011 at $159 billion. Ten years of this massive increase in cabinet department spending is almost $8 trillion while the total cost of the Iraq-Afghanistan wars from 2003-2011 is almost $1.3 trillion. We have a problem with runaway spending in Washington.

Pile $800 billion a year of new spending on top of $200-$400 billion in reduced revenues resulting from a stagnant economy and you end up on China’s doorstep asking for a loan. We should ask all the middle class households whose budgets have been at best flat over this prolonged economic slowdown what they think of their government’s spending growth of 77% between 2007 and 2010. (There is a fundamental flaw in how the Executive Branch manages the cabinet departments which I will address in a future blog.)

Why would the middle class, challenged to balance their own budgets, tolerate these astounding excesses of our Federal government? The answer is simple — they don’t know because the media ignores this issue and the Republicans can’t seem to articulate the compelling math. If our citizens knew and understood the math, I believe more of them would reject the path the Democrats want this country to follow. I believe they would not buy the argument that this country’s major fiscal problem is that we do not tax the wealthy enough.

But who is taking the real math to the public? The media is oblivious and the Republican leadership isn’t talking about the real numbers. This is one reason why I currently score the Republicans at -5 in the fiscal cliff debate.

The President says he needs $1.6 trillion in new tax revenue over the next 10 years. The Republicans respond by being indignant that the President asks for twice as much new tax revenue as he campaigned on. What are they thinking? The Republicans again ignore the math. They need to point out clearly that Federal tax revenues, which fell from a bit over $2 trillion in 2000 to less than $1.8 trillion in 2003, rose dramatically after the Bush tax cuts. The math, which no one can deny (although many do ignore), shows that Federal tax revenues increased by $2.6 trillion in the five years after the Bush tax cuts. Let me repeat- over a five year period after significant reductions in marginal tax rates, capital gains tax rates, dividend tax rates, and estate tax rates– tax revenues increased by $2.6 trillion!

Obama wants an average of$160 billion a year increase in Federal tax revenues and proposes to do so by increasing taxes on the wealthy while Bush’s tax cuts on everyone resulted in an average of $520 billion a year in increased tax revenues. Cutting taxes generated revenues over 3 times more than Obama proposes to generate through raising taxes on the most successful of earners. To borrow a well-known phrase “It’s the economy, stupid.” You can lower tax rates in an expanding economy and increase Federal tax revenues dramatically. Raise tax rates in a sputtering economy and look out. The President wants to protect the Bush tax cuts for the middle class (so does everyone else) but maintaining that portion of the status quo does nothing to stimulate economic growth. The message is simple -any change in tax policy needs to be clearly pro-economic growth, something which taxing the top 2% does nothing to accomplish.

Now for the third request in the President’s proposal: He wants the Executive Branch to control the limit of the U.S. Federal debt. This request was clearly articulated by Secretary Geithner who also attempted to defend it while keeping a straight face. Besides the fact that the Constitution places authority for Federal spending with the House of Representatives, why would anyone give debt limit authority to people who know no limit in spending? An analogy that illustrates the absurdity of this White House proposal goes something like this: Imagine you borrow money from your neighborhood bank. Despite your borrowing, you do not have enough money to pay your bills. So you go back to the bank and borrow more. Eventually the bank looks at your balance sheet and revenue sources and puts a limit on your borrowing. So you go to your bank and say “Guess what? I no longer want you to determine how much money I can borrow. I demand the authority to set my own borrowing limit.” No way that could ever happen in the real world and no way should it happen in Washington.

So let me summarize why I score the fiscal cliff debate at Obama 0, Democrats 0, and Republicans -5. Obama gets a zero because he keeps on misleading people with his claim that the Bush tax cuts favoring the wealthy are an important contributor to the current fiscal crisis. He also earns his zero because he can’t find more than $60 billion a year in “spending savings” when his cabinet, over a short 3-year period, increased their spending by almost $800 billion a year.

The Democrats get a zero because, to a person, they parrot, almost word-for-word, the President’s message. It appears that none of them have ideas of their own. I can’t easily get a family of 5 to agree on what restaurant to go to for dinner, while hundreds of Democrats all agree with budget-busting out-of-control spending and appear to have no interest in understanding the real math.

Finally, the Republicans, who are currently losing the debate, deserve a score of -5 because they have stupidly allowed themselves to be characterized as obstructionists because they want to protect “tax cuts for the wealthy.” Unless the Republican leaders place more emphasis on educating people with the real math and make it clear that they are protecting the country and not the wealthy, we have no hope of saving this country; not from falling off the fiscal cliff, but from falling into the abyss- the abyss of Federal bankruptcy–the abyss where our legacy to our children and grandchildren is a mortgaged country unable to pay its debts.

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Looking for Revenue in All The Wrong Places

As predicted from the Presidential campaign rhetoric, what to do with taxes has become the number one gating factor for solving the “Fiscal Cliff” challenge.  As I outlined in my recent post “The Fiscal Cliff Is Built on a Mountain of Ignorance,”  the debate is still hung up on the misperception that the Bush tax cuts reduced the Federal income tax burden of the wealthy.  Republicans talk about revenues and the Democrats talk about rates.  It seems like neither party knows of or cares about articulating the actual facts.  After marginal tax rates were reduced in 2003, Federal income tax revenues increased sharply and the wealthy once again saw an increase in their share of the total Federal income tax burden.  Those who continue to support raising marginal tax rates seem to be more concerned about how much of their income the wealthy get to keep rather than how much they send to Washington.

Over the past 80 years, despite multiple movements in marginal rates up and down, the top 1% of earners paid an ever-increasing share of the total Federal income tax burden reaching its highest point at 40% after the Bush tax cuts and most recently representing 38.7% of total Federal income tax in 2009.  Compare this to the total share of Federal income taxes paid by the 80% of tax payers who are in the 2nd through 5th quintile of earners who paid less than 6% of the total Federal income tax burden in 2009 (data from the Congressional Budget Office).  How can any rational person who knows the facts interpret that 1% paying a total of 38.7% of the income taxes and 80% paying a total of 6% of the income taxes shows that the wealthy are not paying their fair share?

Unfortunately the debate on marginal tax rates isn’t the only uninformed debate.  Another ill-conceived target of the tax rate proponents is something called “carried interest.”  Carried interest is not really interest.  It is a payment made to managers of private equity and venture capital funds (as well as certain other funds).  Managers of these funds raise money from what are called limited partners (pension funds, wealthy family offices, university and other not-for-profit endowments, etc.) and over a period of several years invest this money into privately held companies.  After about 3-5 years (sometimes up to 10 years)  if the private companies grow, they can be sold to larger companies or to larger private equity funds.  In some cases, successful companies are able to go public, creating opportunities for all types of investors to own shares of stock in such companies (Genentech, Microsoft, Apple, Google, Wal-Mart, Home Depot and on and on).  This entire process is a major economic and job-creating engine for this country.

Managers of these private equity and venture funds are compensated in two ways.  First, they receive annual management fees, usually 2% of the total dollars committed to the fund by the limited partners.  That 2% annual fee pays the salaries and overhead of the fund’s management.  All salaries paid out of this management fee are taxed as ordinary income.

When a portfolio company of the fund is sold or goes public (usually several years after the fund makes its investment) at a profit to the investors, a distribution of cash (or stock if the company goes public) takes place.  After the limited partners get back all their money that the fund invested in the company, the remaining profit is distributed 80% to the limited partners and 20% to the fund management.  Thus, the managers only share in the profit made with the limited partners’ money.  This is the “carried interest.”  Currently, this carried interest is taxed as a capital gain.  Some people assume that carried interest should be treated as salary and think it should be taxed as ordinary income.  There is no logic for this.  In essence, the fund managers are borrowing 20% of the total capital committed to the fund by the limited partners and are investing it alongside the 80% of the fund’s capital that generates the profit for the limited partners.  Several years later, when the fund’s investments in certain companies are successful and there are profits to be distributed, the managers pay back the 20% of the capital they “borrowed” from the limited partners and keep the profit generated by that 20%.  The managers, like the limited partners, are at full risk for all the investments made.  No profit – no distributions.

Just as the limited partners are taxed at capital gains rates on their profits so should the managers be taxed at the same rates.  In other words, the longer than 1-year holding period, the return of 100% of the initial capital to the limited partners, and the full and equal risk that managers take alongside their limited partners (plus it is common for the managers to put some of their own money into the fund) all justify carried interest treatment as a capital gain.  It is, in reality, no different from an investor borrowing money from a bank and making a successful investment in a company that is sold for a profit three years later.  The investor pays back the bank loan plus interest (which is tax deductible) and pays capital gains on his/her profits.  If the fund happens to lose money from its investments, management receives no distributions and the carried interest agreement does not allow management to share in the tax deductibility of the fund’s capital loss.  More importantly, when funds don’t make money, managers are out of a job.  If there is any logic in modifying the tax treatment of carried interest,  the focus should not be on the profits generated but on the portion of the limited partner’s capital that is made available to the fund managers to generate their carried interest.

In the weeks after the election, we have heard from politicians and pundits and read in the editorials that the voters spoke in the election and supported raising taxes on the wealthy.  But what do you expect when the voters have been immersed in totally misleading and non-fact-based rhetoric about who pays what in taxes and what actually happened to the distribution of income tax payments after the Bush tax cuts?  The Bush tax cuts have been described as a tax break for the wealthy.  When is paying both more and a greater share of the total income tax burden a tax break?  The poll that needs to be taken is the poll that asks the voters (and for that matter the talking heads and the press) three questions:

  1. What was happening to Federal income tax revenues in the three years before the Bush tax cuts and what happened after the cuts?
  2. What happened to the top 1% of earner’s tax bill after the Bush tax cuts (not what income did they keep but what happened to the size of the check they sent to Washington)?
  3. What happened to the top 1% of earner’s share of the total Federal income tax burden after the Bush tax cuts?  My prediction is that, over 90% of voters would get none or at best one of these answers correct.  Even worse, the large majority of members of Congress, the talking heads, and the press would do no better–an astounding and unfortunate level of ignorance.

Despite the fact that the wealthy pay much more than their fair share in taxes, most wealthy are willing to support good causes, including legitimate revenue  needs of our government – not because they feel rightly accused of not paying their fair share, but because as a group they are thankful for their success and respond with generosity.

Mounting a campaign to somehow marshal the majority of voters to think that the wealthy don’t carry their fair share is inappropriate and unnecessary.  What the wealthy (and so many others) see is enormous government waste and inefficiency.  What they see are tax proposals that pose risk to a fragile economy.  What they see is politically and ideologically driven rhetoric- not great ideas.  Norman Vincent Peale had it right when he said “Once we roared like lions for liberty.  Now we bleat like sheep for security.  The solution for America’s problem is not in terms of big government, but it is in big men (women) over whom nobody stands in control but God. ”   That was 20 years ago.  It’s time for the big men and women to step up.

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The Fiscal Cliff is Built on a Mountain of Ignorance

It is the morning after the election. The Dow is down over 300 points but I am not anxious – at least not about that. This morning I follow my usual routine. Up before 6:00 a.m., do a little work at home, and then turn on CNBC before I head off to work. I’ve heard a few sound bites from the post election concession and acceptance speeches and let a little optimism creep into my thinking. With the election battle over, maybe doing the people’s work will take center stage. Maybe our elected officials will look at history, gather the most relevant data and facts and develop the best ideas for solving our really tough challenges – our mushrooming national debt, our stagnant economy, our dysfunctional tax code, and of course, the upcoming fiscal cliff.

Today CNBC has a great line-up of guest hosts including people with experience at the highest levels of government. It is their comments that begin to reverse my optimism. First, Roger Altman, former Deputy Secretary of the Treasury, made the comment that today’s tax code is the least progressive in a very long time, at least with respect to tax rates. The fact is that today’s tax code has generated the most progressive outcomes in the distribution of income tax payments ever! This is a very important distinction as the vast majority of Americans, including unfortunately most politicians and the vast majority of the news media, equate tax rates and changes in tax rates with directionally and proportionally equal changes in tax revenues (if you are the Federal Government) and total tax payment or tax burden (if you are the tax payer).

The purpose of a progressive tax code is to reduce “the tax incidence of people with a lower ability to pay, as it shifts the incidence increasingly to those with a higher ability to pay” (Wikipedia). In other words, the relative share of the tax burden is disproportionately carried by those with higher incomes. Changes in marginal income tax rates are not accompanied by quantitatively and directionally similar changes in the distribution of income taxes paid by various income level groups. In fact, all four times in the past 80 years when marginal income tax rates were lowered, the proportion of total income taxes paid by the top 1% of earners increased, and the proportion paid by the lower 50% of income decreased. At no time was this clearer than with the so-called “Bush tax cuts.” After the 2003 changes in tax rates, the proportion of total Federal income taxes (as well as the ratio of the proportion of taxes paid to the proportion of income earned) paid by the top 1% of earners increased. The top 1% represented 13.3% of all pre-tax income and paid 38.7% of all Federal income taxes in 2009 (July 2012 CBO Report, Distribution of Household Income and Federal Taxes 2008 and 2009).

Not long after Altman’s statement, Rick Santelli joined the CNBC regulars and guest hosts and asked the question (to which he knew the answer) “When were Federal tax revenues at their highest?” Santelli quickly followed his question with the answer, “I think it was during Bush’s second term.” Guest host John Podesta, former Clinton White House Chief of Staff, quickly disagreed and said it was during Clinton’s second term. Who was right? Peak Federal tax revenue during the Clinton Presidency was $2,026 trillion in the year 2000, while peak revenues during the Bush Presidency were $2,568 trillion in the year 2007, having grown almost 45% from 2003 (the year of the Bush tax rate changes) when Federal tax revenue had fallen to $1,782 trillion.

There is an important lesson here. Altman and Podesta are smart men, experienced in government, and widely respected for their knowledge, but they were wrong and their comments went unchallenged. Today, too many smart people are willing to make statements without checking the facts – without doing their homework. Over time these statements become accepted as true by the media, the average citizen, and the politicians charged with making policy and passing important legislation targeted at fiscal issues.

There is too much opinion and ideology driving decision-making in our government and reporting by our media. We need fewer editorials and more tutorials. This country is facing major fiscal challenges and most of the people still think the Bush tax cuts reduced Federal tax revenues, that the Bush tax cuts resulted in the top 1% paying a lower share of the total tax bill, and that the only way to increase Federal tax revenue is to raise tax rates. These commonly held conclusions are all wrong and one of the most important questions we can ask is “Why?” This is not a Republican or Democratic issue, this is not a class warfare issue, this is an issue that underlines whether or not our country can maintain its greatness and make wise fiscal decisions based on data and facts. We must heed the warning of Thomas Jefferson “Educate and inform the whole mass of the people… They are the only sure reliance for the preservation of our liberty.”


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How the GOP Should Spin the Bush Economic and Tax Policies and the Auto Bailout

Much of the foundation of the Democratic presidential campaign is based on outright lies couched in what are now popular sound bites. The silence on the side of the Romney campaign is deafening. The missed opportunity by the Romney camp to reveal the truth and thus expose the opposition as ideologues willing to intentionally lie to the American people is enormous.  Let me point out three examples where the Republicans must seize the chance to uncover the Democrats’ deceit.

The first example relates to the Bush tax cuts.  How in the world can the Republicans allow themselves to be portrayed as “favoring tax cuts for the wealthy”?  The truth is that federal income tax revenue was slipping badly from 2000-2003. During the four years after the Bush tax cuts, Federal income tax revenues increased by 45%.  That’s right, revenues increased by a whopping 45% — in absolute dollars, the largest 4-year increase in Federal tax revenues ever! But here is the most important truth, the wealthy, defined as the top 1% of earners, as individuals saw their tax payments in absolute dollars go up!  Furthermore, as a group, the wealthy’s share of the overall Federal income tax brought in by the government went up while the share paid by the 99% of the remaining earners went down!  You wouldn’t know this from the Democrats, but you should know it from the Republicans if they were doing their job of telling the people the truth. Every single time a Democrat or a pundit makes the statement “the Bush tax cuts for the wealthy,” a Republican must challenge it, using the facts.

The second example of deceit is the common statement by Democrats that “we don’t want to go back to the failed policies of the Bush Administration that got us into this financial crisis.” Just what are those policies? Name five such policies, when they were implemented, whether they were presidential decrees or Bush-initiated legislation, and explain specifically how each policy led to the financial crisis of 2008. It would be entertaining and quite revealing if a Republican or a pundit actually challenged President Obama or David Axelrod or Governor Dean or any other Democratic spokesperson who makes this failed Bush policy claim with the above specific questions.  The hesitation, stammering, and lack of a coherent fact-based response would be comic, but also in a sense, tragic.

The third example of misinformation is their popular claim that Obama saved the auto industry while Romney would have let General Motors go bankrupt. Virtually every time this claim is made on national television it goes unchallenged, either by the interviewer (who is often either biased towards Democrats or ignorant of what a bankruptcy would have accomplished when compared to the actions taken by the Obama administration) or, worse yet, by a Republican (most recently the usually articulate head of the RNC who is appearing on the same national broadcast. The Romney campaign and the Republican spokespersons commonly interviewed by the national media and press must present a coherent tutorial on the side-by-side comparison of the Obama process versus the kind of bankruptcy Romney would have preferred. The impact of both the Obama action and the Romney alternative on the auto workers, the unions, the shareholders, the debt holders, the tax payors, and the future viability of the auto companies and their ability to succeed in a competitive world need to be compared.

It is frustrating to watch the American voter be fed from a vast menu of non-fact-based spin without challenge by the party that supposedly understands pro-growth tax policy and the importance of capitalism and the free markets.

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Want To Fix Medicine? Fix The Doctors First

It is interesting to see Democratic Senator Ron Wyden (OR) and Republican Congressman Paul Ryan (WI) collaborating on an approach to control future Medicare spending.  Approaches that transition Medicare to a more competitive insurance program offering premium support for various health benefit packages could be helpful – as could looking at the age of onset of benefits and means testing –  but alone these options are merely a work-around to the major problem responsible for the escalation of Medicare costs.  We cannot focus exclusively on how we pay for Medicare.  We must focus on what we are buying.

Today, Medicare, private insurers, and self-insured employers are buying healthcare services from a highly inefficient delivery system that too infrequently makes treatment decisions based on best medical evidence; has enormous variability in what care is delivered based on where beneficiaries live;  does too much (too many tests, too many procedures, and too many prescriptions); is highly fragmented such that care coordination for better outcomes and more efficient spending occurs way too infrequently; makes money by treating; and invests little money in preventing.  No matter how we pay for Medicare, we will never control its cost unless we purchase a better product.

The challenge is determining how best to transform this expensive and dysfunctional delivery system to one that delivers the right care and only the right care at the right time based on best medical evidence.  The critical error that Medicare, Medicaid and private insurance have made is to try and control medical spending by reducing reimbursement rates for each of the ingredients of care: prescription drugs, diagnostic tests, interventional procedures, hospitalization, and physician services. This approach triggers counterproductive and unintended consequences.  If you unilaterally decide to pay less for something that another’s livelihood depends on, there is a good chance you will end up paying for a higher volume of that item or services. The remarkably low Medicare reimbursement to physicians for their services is especially harmful to the intent to control healthcare spending by reducing payments for ingredients of care.  The downward pressure on physician income results in physicians seeing more patients.

But the more patients that physicians see, the less time they spend with each patient.  The unintended consequence is that physicians spend less time thinking about the best and most efficient approach to diagnosing and treating each patient’s problems.  In addition, less time is spent talking to the patient and the patient’s family (a patient’s compliance with medical directions is most influenced by speaking with the patient’s physician).  To replace the valuable, but time-consuming physician contemplation and communication with patients, physicians (not wanting to overlook any problem the patient may have) order more tests, write more prescriptions, and request more consultations by specialists.

From my experience in the Nashville healthcare market, Medicare reimbursement for physician services is often as little as 50% of the reimbursement a physician receives for providing the exact same service to a privately insured individual.  This is despite the fact that private insurers, also wanting to reduce their healthcare spending, are aggressively trying to match their reimbursement rates to Medicare levels.

The concept we must embrace, if we are to right-size Medicare spending, is that the best and quickest way to change our inefficient, highly variable, overspending  and non-evidence based healthcare system is by physicians changing the way they practice.  As I wrote in an earlier blog ( “The Doctor’s Prescription for Restoring Health to Medicare”), hospitals do not admit patients, physicians do; drug companies do not write prescriptions, physicians do; imaging centers and surgery centers do not order CT scans or perform surgery, physicians do.  We have to use appropriate reimbursement for physician services tied to better and more evidence-based physician decision-making.  It is estimated that better evidence-based health care and better managed care (fee-for-service Medicare is virtually unmanaged) can reduce Medicare spending (without sacrificing quality) by $50-125 billion/year.  Compare this to the estimated cost of increasing physician reimbursement where every 10% increase costs approximately $6-7 billion.

Physicians in this country want to take proper care of patients. Reimbursement strategies attempting to control healthcare costs are getting in the way.  We can no longer afford to ignore this as a root cause for our escalating healthcare costs.  We can also no longer wait for our highly fragmented delivery system to reorganize (if it ever will) into accountable care organizations.

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