05.27.2011 0

Dark Skies Ahead

By Bill Wilson – As Congress stands at an impasse over increasing the $14.294 trillion national debt ceiling, where Republicans are demanding trillions of dollars of spending cuts and Democrats trillions in tax increases, it is worth contemplating just how the nation’s finances have gotten so rapidly out of control.

After all, in just 2007, the total budget was just $2.728 trillion with only a $160.7 billion deficit. Now, in 2011, according to the Office of Management and Budget, the budget will be $3.771 trillion with a $1.597 trillion deficit. That’s a whopping 893 percent increase in the deficit in just four years. How can this be, when marginal tax rates are exactly the same as in 2007?

A part of the $1.436 trillion increase in the deficit has been the recession, when revenues plummeted from $2.567 trillion in 2007 to a projected $2.174 trillion for 2011. But that only accounts for $393 billion of the increased shortfall. The rest of it was $1.043 trillion in spending increases.

In other words, 72.6 percent of the problem is too much spending, meaning at least 72.6 percent of the solution must be dramatic spending reductions. In a recent piece for Forbes.com, Louis Woodhill writes that “[b]etween FY 1955 and FY 2008, federal revenues increased by 1.0 percent of GDP. However, federal spending increased by 3.4 percent, causing the federal deficit to increase by 2.4 percent of GDP.”

Specifically, the biggest driver of new spending has been “the rise of the welfare state”. As Woodhill notes, “‘Payments to Individuals’ (both direct and via grants to State and local governments) exploded from 3.6 percent of GDP to 12.7 percent of GDP.”

This puts the lie to Joe Biden’s demand that “revenues are going to have to be a part of the deal” on the debt ceiling increase. Democrats are pushing for tax increases. But as noted above, revenues have not decreased because of any lowering of tax rates. Instead, they are down because of the downed economy.

So, economic growth, not tax increases, is what needs to be part of the deal, with all due respect to Biden. And there is no question that the current economic situation is untenable, with sluggish 1.9 percent growth in the first quarter, unemployment still too high at 9 percent, and inflation creeping up again. Making matters worse, first-time jobless claims were up 424,000 the week ending May 21, and durable goods orders declined 3.6 percent in April, showing the slowdown could get worse.

That, coupled with a dire warning from Standard & Poor’s of an imminent credit downgrade on U.S. debt being significantly more likely in the next two years, plus the Medicare and Social Security Trustees reporting that the programs’ trust funds will be exhausted in 2024 and 2035, respectively, and it is clear that dark skies are on the horizon.

Already, the costs of credit default swaps on U.S. debt are increasing as the number of contracts has doubled from last year, an early sign of trouble, reports Bloomberg News. That means bondholders are increasingly insuring themselves against default, which S&P warns is becoming more likely — independent of any vote to increase the debt ceiling.

Not to mention that the European Central Bank may become insolvent if even Greece, a tiny fraction of the EU’s economy, defaults, as reported by der Spiegel.

All this may be why even New York Times economist Paul Krugman warns that we may be headed for a “Third Depression,” which he defines as a “prolonged period of economic weakness.” He notes that even during the Great Depression and the Long Depression of the 19th century, there were periods of growth, but that “these episodes of improvement were never enough to undo the damage from the original slump, and were followed by relapses.”

Krugman warns we could be in the same situation now. What’s worse, we’re only in its “early stages”. He adds, “It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.”

It is a rare moment indeed, but I agree with Krugman. We may disagree on the causes of the downturn, and what to do about it, but when he writes that “we have now gone through a year and a half of a ‘recovery’ that has failed to make any progress toward closing the gap between what the economy should be producing and what it’s actually producing” he is spot on.

The trouble is that it is no longer cost-effective to set up businesses in America, and it is costing the country millions of jobs. It is cheaper to produce things overseas, and then sell them here. That is mainly because of the weak dollar, which leads to inflation, and high taxes, which make starting a business here less attractive compared to the alternatives. We have one of the highest corporate tax rates of advanced economies, second only to Japan.

Capital creation too is hampered because of the antiquated Securities Act of 1933 and the Securities and Exchange Act of 1934, not to mention state-by-state blue sky laws, which require multiple filings, months of waiting, and hundreds of thousands dollars in legal and auditing fees — just to attempt to sell shares, interests, or any stake in new companies. Even then, there’s no guarantee new companies will succeed, so why such a high bar just to get started?

We need to start producing things, creating new businesses and jobs, and providing opportunities here in America. The job picture is dismal for new college graduates. According to the Bureau of Labor Statistics, last month youth unemployment (i.e. those under 25 years old) was 17.2 percent, rising from 13.2 percent in 2008.

These are supposed to be the labor force’s most productive, promising prospects, and they are being underutilized. If Krugman is right, and we are in the early stages of another depression, this will only get worse. Sadly, we risk raising a whole generation of government dependents if the economy does not start growing robustly soon. How will that affect the U.S. fiscal picture?

One need only look across the pond to see what the future holds. In Spain, youth unemployment has reached 43.5 percent. In Italy, it’s 28.9 percent. In the UK, it’s 20.3 percent. When the sovereign debt funding crisis hits the U.S., as surely it will, this is merely a taste of what to be prepared for: A lost generation. And national default.

We need to shrink the government, and start taking care of ourselves — before it’s too late and we’re all wards of the state.

America desperately needs new leadership to confront the twin challenges of ending the welfare state and restoring prosperity. We need to start making massive cuts to government spending and paying down the debt. And we need to make America the best place in the world to start and maintain a business by eliminating startup costs, deregulating securities laws and lessening producer costs by strengthening the dollar and slashing taxes. Because otherwise what’s ahead is an incredibly dark picture.

Bill Wilson is the President of Americans for Limited Government. You can follow Bill on Twitter at @BillWilsonALG.

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