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November 12, 2010

If you haven’t read all you can about the recommendations from the President’s special deficit-reduction Fiscal Commission, you should. Your kids will thank. I’ll thank you.

First off, I must commend the panel of 18–especially the co-chairs, retired Wyoming Republican senator Alan Simpson and former Clinton chief-of-staff Erskine Bowles—for their bold, realistic, actionable, and comprehensive recommendations to solve this country’s greatest threat. Our ever inflating national debt.

As a side note, I find it fascinating how bold these non-elected, politically-retired men and women are willing to be after leaving office. It’s a perfect argument for term limits, buts that’s a whole other topic for another time.

While the comprehensive report isn’t due until December 1st many of the details are being leaked. Let’s look at some of the bolder recommendations. The draft can be found at www.fiscalcommission.gov.

Defense Spending

Twenty percent (20%) of the federal budget–more than $663 billion a year–is spent protecting the American way of life at home and abroad. That’s nearly 10x the next largest “department’s” budget. It’s 14x the amount we spend on education, 11x the transportation budget, and 25x the energy department’s budget. It’s a big number that helps most Americans sleep comfortable at night. I’m all for maintaining our global military superiority, but trimming a small percentage off this figure makes a big difference in our budget. The Deficit commission is asking for a sizable $100 billion over the next five years equal to a mere 3% decrease each year. Put another way, that’s the cost of eight nuclear submarines. Every budget has room for a 3% decrease. Every budget!

Some of the specific cuts are hard to swallow such as a three year salary freeze on DOD employees and non-combat soldiers, but many are simply common sense such as integrating military schools with civilian schools ($1.1 billion in savings), replacing duplicate efforts by military personal with civilians ($5.4 billion), and my personal favorite to reduce procurement by 15% ($20 billion).

As a DOD approved contractor, I’ve seen the ridiculously inefficient bureaucracy that our military operates. I mostly blame the psychology of budget spending for this inefficiency—not the hardworking folks who are forced to follow these silly rules–but regardless of cause, there are billions in wasted spending with zero incentive to improve. The mentality goes like this: If your budget isn’t spent, it will likely be reduced the next year. Therefore capital allocators spend every last dime of their budgets and ask for more—often to inflate their perceived importance. “I’m responsible for a $150 million budget” always sounds more impressive than “I saved my department $3 million in wasted spending last year”.

Here’s a thought: let the decision makers keep 10% of the annual savings. They can doll it out to those that helped them shave the budget and all will be happy and incentivized to do what’s best for the American taxpayer! Simple.

Comprehensive Tax Overhaul

One version of the commission’s recommendation wipes out nearly all tax deductions and creates three lower tax brackets of 9%, 15%, and 24%. One version wisely left the mortgage interest deduction intact for mortgages below $500k—a brilliant political move which should help this idea gain traction.

As a side, being the financial geek that I am, I looked at my effective tax rate for the last 10 years. It averaged to 18.36% with a high of 29.65% and a low of 11.94%. In general and contrary to common sense, the lower my income, the higher my effective tax rate was. Some of that is due to my efficient tax planning and sources of income (i.e., investment income vs. earned income), but what surprised me is the average. These proposed tax rates will likely raise my effective tax rate and those of other top income earners. In other words, it will generate more revenue of the government. Meeting one of the commissions goals to reduce the national debt via revenue increases. If that’s what it takes, I’m happy to pay my fair share.

This radical change is reminiscent of the Reagan tax changes that donkeys and elephants alike agreed to in 1986. Unfortunately, we’ve added thousands of pages to IRS code since and muddied the waters, but it’s proof that miracles can happen even when Congress is in session.

I see three real benefits to this proposal. First, the simplification will allow many Americans to understand their tax liability better, resulting in wiser financial planning. As the military acronym K.I.S.S. teaches us, Keep It Simple Stupid. Second, the government will pull away from influencing individual fiscal behavior. As a libertarian, anytime the government is removed from influence, I see promise. Some have argued the government—via it’s “a house for all Americans” policy helped fuel the real estate bubble. Regardless of the cause, less artificial incentive will lead to more individualistic and fiscally sounder decisions. Third, the simplification will close the compliance gap, save billions in tax expenditures, and allow drastic cuts in the Department of Treasury’s $13B budget—most of which (>$10B) goes to the IRS. In other words, we spend more than $10B a year to collect taxes on ourselves. A simpler tax code means better compliance which leads to smaller IRS which reduces costs. Simple.

The proposed corporate tax rate of 26% is also brilliant. It brings us in line with many of our global competitors and allows U.S. based companies to repatriate foreign earned funds without negative tax consequences by replacing the extraterritorial system with a territorial system. In other words, profits are taxed where they’re earned. Corporations could do what they wish with after-tax cash. And since most of the world’s global companies are based in the U.S., it would favor us. It’s capitalism at its finest. Let capital flow to where it earns the highest return. Adam Smith would be proud.

Earmark Obliteration

Hands down my favorite provision. This non-elected commission understands the Congress’s pet projects (estimated to cost $3 billion a year) are the primary source of wasteful spending. Permanently banning earmarks will force Congress to consider the merits of a bill, not to horse trade for a handout in order to get their vote. Bravo Messrs Simpson and Bowles. Bravo. Now let’s see if Congress has the gumption to limit their own power for the better good of the nation. That’s the selfless act of real leader.

To keep this blog from running too long, I’ll leave the Healthcare and Social Security provisions for next time. Until then, be thankful we still have a few noble Americans looking after our long-term prosperity.