Will America Become Detroit, Part 2: Popular Solutions That Are Bound to Fail

"For every complex problem there is an answer that is clear, simple, and wrong."
- H. L. Mencken

"In the book of life, the answers aren't in the back."
- Charlie Brown, from Peanuts by Charles M. Schulz

The U.S. government debt crisis has garnered enough attention that pundits from across the political spectrum have weighed in on the issue by proposed solutions that are pleasing to their core constituencies. As we look at these proposals, it is easy to see why they are crowd pleasers, but they all have one serious defect: they won't solve the problem.

Don't Worry, Be Happy: S&P Says We're OK

One popular solution to America's debt crisis is to contend that the problem does not really exist. CNN anchor Fareed Zakaria summarized this point of view as "America is not Greece". Debt crisis skeptics content that America is prosperous, competitive, and has a high bond rating, hence she should have no problem borrowing money at reasonable rates for the foreseeable future.

The problem with debt crisis denial should have become clear with the financial crisis of  4 years ago: bond ratings, along with other measures of credit worthiness, can change blindingly fast. Standard & Poor's rated Lehman Brothers AAA 72 hours before they filed for bankruptcy. And as late as December of 2009, Moody's rated Greek bonds a high A, only to drop that rating to Junk level in the following months. So three years ago, we could have argued that "Greece is not Greece"!

The ratings from firms such Moody's, Fitch, and S&P are merely numerical measures of human trust in the institutions being rated, hence they can change just as quickly as our emotions change. If creditors change their opinion of American credit worthiness, the ratings may change even faster than they did for Lehman Brothers and Greece, due to one disquieting fact in the back of investors' minds: the U.S. government is too big to be bailed out by anyone.

Denial of the debt problem is a temporarily comforting, but ultimately dangerous, solution. One needs to look at the Motor City to see how it plays out. America may not be Greece, but it may very well be Detroit.

Eat the Rich!

Michael Moore, among others, want us to balance the budget by raising taxes on the rich. This method has tremendous appeal, for everyone assumes that "rich" means "people who make more money than me". Wouldn't it be great if the debt could be paid off purely by stereotypical Thurston Howell III millionaires who need only sacrifice a few yachts and mansions?

Michael Moore's "Eat the Rich" solution plays well, but would it actually fix the problem? Michael Moore doesn't run the numbers, but Veronique De Rugy at George Mason university has. Her study of historical U.S. revenue data, from 1930 to 2010, shows that the government has generally has been unable to raise more than 19% of the GDP in taxes. The few times we have been able to raise 20% of the GDP in taxes has been a few years at the peaks of boom cycles. This data include the Halcyon days of the 1950's, when the highest federal tax bracket was over 90%. In short, our government is already raising close to the maximal amount of money it can raise, no matter what we do with rates.

Upping the tax rates on the highest earners can have some rather nasty negative consequences. The rich are not all Thurston Howell III clones; they also include some of the world's best developers and entrepreneurs. Excessive taxes might encourage these people to move elsewhere, and the economic activity that they would generate will move with them. This happened in 1960's Britain, where 95% tax rates caused the "brain drain", where the best British minds went overseas to protect their wealth. The "brain drain" phenomenon even inspired a Beatles song.

Well, desperate times call for desperate measures. Maybe we need to be even tougher on the rich than America was in the 1950's or Britain was in the 1960's in order to raise the money we need. Again, this scenario does not hold up once you run the numbers. Fellow blogger iowahawk computes what we could raise by the most extreme "Eat the Rich" tax schemes, including taxing 100% of all income above $250K, confiscation all the wealth of America's richest families, and all the profits of our largest companies; he finds that even these most extreme measures will just barely cover this year's budget, with no hope of covering next year's.
When you do the math, it turns out that the only way we could possibly maintain our current level of spending would be to tax the middle class so much that they would be forced to lower their standard of living. Don't hold your breath waiting for a politician to tell you that.

Next Time

In the next FatherBrain post, we look at the controversial Paul Ryan plan (I think Sen. Ryan had his first name legally changed to "controversial"). The usual complaint is that this plan cuts spending too sharply. This post will make the case that the real problem with the Ryan plan is that it does not cut enough.

Will America Become Detroit?

"Neither a borrower nor a lender be"
- Hamlet Act 1, scene 3

"You load sixteen tons, what do you get
Another day older and deeper in debt
Saint Peter don't you call me 'cause I can't go
I owe my soul to the company store"
- From "Sixteen Tons" by Merle Travis

Detroit News editorial writer Shikha Dalmia has written a sobering op-ed about my former home town's financial crisis. Detroit's leaders seem to be in a state of denial about the severity of the problem. This Op-Ed argues that bankruptcy may be the best option for Detroit, since it would force the changes needed to get the city's debt under control.

It is sad to see what has happened to this once great city, but it is hardly surprising. The city has been spending far beyond either current or projected revenue for many years now. Bowing to political pressure, the city council has been kicking the can down the road for as long as possible. But now, they have run out of road.

But those from other American cities should neither scorn nor pity the city of Detroit. The nation as a whole are following the same trajectory that Detroit followed years ago. So what prevents our country from meeting the same fate as this tragic city? Neither party has offered a serious plan for getting government debt under control. We hear a lot about climate change denialism, but this nation's undoing may well turn out to be deficit denialism.

Wait a Minute! Didn't We Fix This in the 90's?

As late as the last years of the Clinton administration, our government was not running up the deficit. Today, a third of all federal spending is borrowed. How did this our nation go so far wrong in the last 12 years? To answer this question, let us compare the year 2000 budget to this year's budget. Adjusting for inflation (2012 dollars) and population growth,

• In 2000, the government took in $2.5 trillion dollars and spent $2.0 trillion; and
• In 2012, our nation will take in $2.4 trillion dollars and spend $3.8 trillion. 

Revenue is down from 2000, but given how much weaker the economy is now, what is really surprising is that the revenue is not down even further. Spending, on the other hand, has gone out of control. Even after adjusting for population and inflation, spending has nearly doubled. If our government spent at year 2000 levels, we would still have a budget surplus.

In short, the problem is spending, not revenue. But spending cuts are more popular in the abstract than they are in practice, hence neither major party has put out serious proposals for reigning in the red ink.

Is Our Situation That Bad? No, It's Even Worse!

As the national debt clock so vividly displays, the U.S. federal deficit is rapidly approaching $16 trillion. But as stunning as that figure is, it is only a small part of our shared indebtedness. This figure does not include the unfunded liabilities of entitlement programs such as Medicare and Social Security. The unfunded liabilities of these two programs dwarf the $16 trillion figure. The 2012 Medicare trustees report estimates a shortfall of $27 trillion, and the 2012 Social Security trustees report places its unfunded liability at $8.6 trillion. And these trustees reports estimates are on the conservative side!

Another debt problem that U.S. governments, at all levels, have woefully underfunded their pension plans.We have seen the trouble this creates in California, Wisconsin, New Jersey, as well as Detroit. As the baby boom start retiring in droves, this problem will trigger more municipal bankruptcies. And the feds will not have the money to bail them out.

The Lighter Side of Default

We have general agreement that our current spending is unsustainable. Secretary of State Hillary Clinton went so far as to identify the debt crisis as the greatest threat to our nation's future. My next post will look at both party's (wholly inadequate) proposed solutions. But at this point, it is safe to say that, irrespective of who wins in November, this crisis will be dealt with the same way it was in Detroit: at the very last minute, using desperate measures. But cheer up: the impending U.S. default may be very painful in the short run, but it will force some very positive changes in our governance. Follow up posts will explain why the coming storm will be followed by brighter days. Watch this space.