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American Financial Status: How Uncle Sam Can Have a Happier New Year

 Joel Redmond, CFPBy Joel Redmond, CFP

As 2012 comes upon us, one of the things we realize is that the United States government has a financial New Year’s resolution of its own to make: getting its financial house in order. We hear so many reports on the adverse financial position of the United States that we get a little numbed by them. The US…

  • Has increased its publicly-held debt from 28% of Gross Domestic Product (GDP) in 1971 to 67% of GDP in 2011 – a gain of nearly 140%
  • Has more than doubled its publicly-held debt (as a % of GDP) since 2001 – an increase of over 7.5% per year of indebtedness
  • Is expected to have publicly-held debt at 61% in 2021
  • Could see publicly-held debt at 82% of GDP by 2021 if provisions in current tax law remain unchanged
  • Has an estimated budget deficit of $1.3 trillion for 2011 – 9% of GDP, and the third highest in 65 years
  • Had higher budget deficits only in 2009 (10%) and 2010 (8.9%)

In financial planning, one thing we generally look for is discretionary income – the amount of money left in the account at the end of the month, or revenue minus expenses. Looking at the numbers above shows us that the US government has a substantial debt problem; the fifth bullet shows us that the country has no discretionary income.

US vs. Boeing

What do these numbers really mean? These debt amounts are percentages, not of the surplus wealth, but of the entire production of the country. How do they compare with private sector debt-to-income ratios? To see, let’s compare them with a public company, and look at some liability-to-asset ratios. We choose Boeing Airbus (NYSE: BA). Here are three items for 2010, according to Boeing’s SEC filings:

  • Revenue: $64.31 billion
  • Net revenue (revenue minus cost of goods sold): $12.46 billion
  • Net income: $3.31 billion

Now let’s look at the current liabilities of Boeing – what it owes in the next 12 months.

  • Current liabilities: $35.4 billion

Let’s see what the debt-to-income ratios are:

  • Current liabilities / revenue = 55.05%
  • Current liabilities / gross income = 284%
  • Current liabilities / net income = 1,069%

This is sobering. The US now has publicly-held debt that is 2/3 of the “revenue” of the US – GDP. If this is 67% of GDP, what percentage must it be of “net revenue” – all sales of US goods and services, minus their costs? If the US is comparable to Boeing (it isn’t; this is just food for thought), then the figures would look like this:

  • Publicly-held debt / US GDP = 67%
  • Publicly-held debt / US “Net revenue” = 345.65%
  • Publicly-held debt / US “net income” = 1,301.05%

Of course, the difference between Boeing and the United States is that Boeing actually turns a profit: the US has a net income, again, of negative $1.3 trillion! According to the figures above from the Congressional Budget Office, the United States has discretionary income of minus $1.3 trillion for 2011 – a deficit of $4,100 for every man, woman, and child in the country. If we express this in terms of an amount “left over at the end of the month,” we arrive at a monthly deficit of $340 or so – again, for every single person in the country. Imagine if everyone you knew carried a checking account balance of minus $340. What would they do? How would they survive? By borrowing to pay the deficit, ignoring it, or earning more money.

So what’s the point of all this? Again: this is the time of year for resolutions. Perhaps it’s time for the federal government to make the painful decision to earn more money. Three proposals might be useful:

1)      Perhaps the government should, instead of keeping the payroll tax at 4.2% for another year, double it to 8.4%. This would be painful; but doing so would keep Social Security solvent another 75 years. (At least, that’s what the OASDI 2011 Trustees Report says.) If this is too politically or even economically untenable, raise it 1% a year for the next four years.

2)      Actually allow the extended EGTRRA 2010 tax cuts to expire on 12.31.2012.

3)      Allow the estate exemptions to revert to $1MM and the 55% federal rate.

Budget Deficit Has to be Bridged

These are exceptionally unpopular courses of action. But even a cursory look at the income statement of the United States reveals that the budget deficit has to be bridged. How do you bridge a gap in discretionary income? By lowering expenses; increasing income; or both. Since US federal spending (expenses) in 2011 were 24% of GDP and federal revenues (income) were 15%, the $1.3 trillion gap is 9% of GDP. According to the Congressional Office Budget (CBO) figures, the 24% of GDP that the government spends is broken down like this:

  • Social Security – 4.8% of GDP
  • Medicaid – 1.8%
  • Medicare – 3.2%
  • Other (food stamps, unemployment, veterans’ benefits, etc.) – 3.6%
  • Net interest – 1.5%
  • Defense – 4.7%
  • Nondefense (discretionary, such as health, education) – 4.3%

It’s hard to find a substantial chunk of this to cut. Here are the revenues:

  • Payroll/social insurance taxes – 5.5% of GDP
  • Individual income taxes – 7.3%
  • Corporate income taxes – 1.2%
  • Other (customs, estate, gift taxes, etc.) – 1.4%

What impact might a 4.2% payroll tax hike have for the country? If we estimate using 2011 figures, we might deduce that the net overall rate would go from 13.3% to 17.3% (3% of additional tax to workers, and 1% to employers). Doing this creates a payroll tax surplus of $246.32 billion, or 1.65% of the gap. 9% – 1.65% = 7.35% to go. How could Uncle Sam generate this? The short answer is through individual income taxes, corporate income taxes, and other taxes. We have to generate the remaining $1.098 trillion in these three compartments. For this to occur, assuming each component maintains its estimated 2011 weighting in the federal revenue picture, we would need each tax component to increase by nearly 50%!

Raising Taxes

What does this translate to? If we merely look at individual income taxes, which are the largest component of tax revenue, we see one thing: pain. For us to close the gap, the average US effective tax rate would need to rise from about 16% to over 23%. Ouch!

These are not easy proposals to make. But we’ve had top income tax brackets over 90% of our history. It’s time we helped the US make sure it has some money left over in its account at the end of the month – even if it means less in our own. Will this happen? Probably not. But even half of these proposals would improve the US’ statements of financial position and income. Aren’t these primary financial planning goals? It doesn’t therefore seem illogical, in the case of the US, to presume that the pain of austerity, on the path to solvency, is the price of prosperity.

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