The Fiscal Cliff and the Grand Bargain   (November 28, 2012)


The Grand Bargain is unraveling, and a new arrangement will take the place of the Status Quo--whether we like it or not.

Correspondent Arnold suggested that I address the fiscal cliff, so here goes.

The first step is to set aside ideological blinders and confirmation bias, i.e. only looking for data that supports our current beliefs.

The second step is to look at the foundation of everything: household income. Household income is the foundation of taxes paid, consumption (spending) and savings/investment. If household income is declining, that means the pie of money that can be divided up into taxes paid, consumption and investment is shrinking.

If taxes go up, there is less pie left for spending or investment. And since the economy ultimately depends on private-sector spending and investment, then reducing those to fund government spending means there will be less private spending and investment.

If the government spent the taxes on investments that yielded a higher return than private investments, higher taxes would not devastate the economy. But the problem is that there are no feedbacks on government spending that favor efficiency or high yields.

Government spending decisions are made solely on the basis of constituency pain: the constituencies that create the most political pain for politicos and Upper-Caste government bureaucrats get funding. Efficiency and high-yielding investments are not in the political equation at all; there is no feedback in monopolies except those that favor expansion of budgets and constituencies.

Let's look at a chart of household income from Median Household Incomes: The "Real" Story (Doug Short). Household income has been negative since 2000 except for two brief spikes:

Here is another chart depicting the huge gap between nominal income and real income: while nominal income rose a seemingly healthy 25% since 2000, real income has declined almost 10%.

Median income doesn't tell us who is getting most of the income, so let's look at this: All the increases in income since 1970 accrued to the top 10%.

But we have to remember that median income includes all income, including the wealthy. Real income has declined by 8%-9%. The pie is smaller, period.

Some of that is due to a declining full-time workforce, which has dropped to 115 million workers:

Now let's look at the size of government spending and taxation. In terms of the overall economy (GDP), government spending's share of the economy has been rising for decades. The Internet and housing bubbles briefly "grew" the economy faster than government spending, but once these one-off expansions faded, government spending quickly returned to its trendline (ever higher).

Federal spending rose exponentially until it exceeded the carrying capacity of the economy. For context, recall that Social Security costs $817 billion, Medicare and Medicaid costs total about $800 billion annually, and the Pentagon/National Security budget is around $690 billion. Add in interest on the ballooning national debt, and the vast majority of the Federal budget goes to these four. You could eliminate all other Federal spending and these four consume all the tax revenues and then some.

Tax receipts, meanwhile, topped out at $2.4 trillion, leaving a structural gap of $1.3 trillion.

OK, so now we see why government spending can't keep following an exponential path higher: households are earning less income.

Next up: the welfare/cartel State. Some welfare flows directly to individuals ("transfer payments") and some flows to cartels: defense, sickcare, the education cartels, etc.

The problem here is the number of citizens who are dependent on government transfers and spending now exceeds the number of full-time workers. Recall (see chart above) there are 115 million full-time workers in the U.S.

Of the roughly 150 million workers in the U.S., 38 million earn less than $10,000 per year, 50 million earn less that $15,000 a year and 61 million earn less than $20,000 annually. All these numbers are drawn directly from Social Security Administration payroll data.

100 million wage earners, or 2/3 the entire workforce, earn less than $40,000 per year.

In practical terms, only the 115 million full-time workers pay significant taxes, and of those, The top 25% (those earning more than $66,193) paid 87% of the taxes. The bottom 50% of taxpayers, roughly 70 million people, earned 13% of the income and paid 2% of the income taxes collected.

(The top 1% of taxpayers reported almost 17% of all taxable income and paid 37% of all income taxes. The top 5% reported 32% of all income and paid 59% of the taxes, and the top 10% earned 43% of the income and paid 70% of the taxes. Where Do You Rank as a Taxpayer?)

The Real-World Middle Class Tax Rate: 75% (July 5, 2012)

There are roughly 127 million people dependent on government transfers: 61 million recipients of Social Security and Medicare (That Which is Unsustainable Will Go Away: Medicare May 16, 2012) (or Medicaid for the 11 million people drawing lifetime SSI Social Security disability) and 66 million people receiving welfare (SNAP food stamps, housing credits, Medicaid, etc.): When Work Is Punished: The Tragedy Of America's Welfare State (Zero Hedge)

That means there are 1.1 government dependents for every full-time worker in the U.S. Please read the linked stories above if you believe this is sustainable.

In my analysis, there has been a Grand Bargain reached by the 3.5 classes in the U.S. The Three-and-a-Half Class Society (October 22, 2012)

The top 1/2th of 1% owns most of the productive assets of the nation and most of its machinery of governance (this is the "half class"). Most of the income not siphoned off by this "we own the important stuff" class goes to the next 19.5% who pay most of the Federal taxes (class #1).

Class #2 is the dwindling "middle class" (also known as the working poor) which receives no government transfers and lives off earned income. This is perhaps 30% of the households.

Class #3 is the lower 50% who depend on transfers, subsidies, etc. because they are retired, don't make enough at their jobs to support their families or are disabled (legitimately or otherwise).

The Grand Bargain was this: we at the top will pay significant taxes as long as we get to control the levers of financial and political power. We in the top 19% will pay much of the taxes as long as we and our children can continue to live well and accumulate wealth. We in the "middle class" will continue to work hard as long as we have hope of bettering our lifestyle and the lives of our children. We in the bottom 50% and retirees agree not to threaten the top .5%'s power and the wealth of the top 19% as long as we can get by on our government transfers.

This Grand Bargain is now fraying as the promises made to everyone cannot possibly be met. Claims on welfare and disability programs are skyrocketing at the same time that the demographics of an aging populace are causing 10,000 people a day to enter Social Security and Medicare, the two costliest government programs. The triple-whammy is the upper-middle class that pays most of the taxes has been slammed with lower income and a devastating drop in their net worth.

That which is unsustainable will be replaced by another more sustainable arrangement. Everyone who slips off their ideological/self-interest blinders knows the Status Quo is unsustainable, and so everyone in the 3.5 classes is shifting nervously: will I get taxed to the point of "uncle" or will my bennies get slashed?

By heavily taxing earned income, the system extracts the highest taxes from the most productive citizens, leaving the less-productive with essentially no income taxes and the super-wealthy with the huge tax break offered to capital gains and other unearned income.

As I noted in Tyranny of the Majority, Corporate Welfare and Complicity (April 9, 2010):

In essence, this is a vote-buying scheme by the Status Quo: the top .5% control the policies of the State in alliance with the State's own Elites, and together they buy the complicity of the bottom 50% to passively accept their dominance.

In other words, the bottom 50% pay relatively modest taxes or are recipients of Central State aid and the top .5% who "own" the political process limit their taxes by favoring unearned income (what they collect from sales of securities, stock options, rents, etc.). Thus the productive quintile (top wage earners) pay the highest tax rates and most of the taxes.

It's a partnership of "Tyranny of the Majority" and "entrenched incumbents Elites." If the political Status Quo alienates the majority by making them pay more taxes, they risk losing power in the next election. If they alienate the top .5% who fund their multi-million-dollar campaigns, then they will also lose power. So they heap the tax burden on what remains of the upper-middle class.

When that 20% rebels, falters or opts out, the system collapses for want of tax revenues. Not coincidentally, that happens to fit the Pareto Distribution: the 20% "vital few" exert outsized influence on the 80%.

The Grand Bargain is unraveling, and a new arrangement will take the place of the Status Quo--whether we like it or not.




My new book Why Things Are Falling Apart and What We Can Do About It is now available in print and Kindle editions--10% to 20% discounts.



Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

go to print edition 1. Debt and financialization
2. Crony capitalism and the elimination of accountability
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

10% discount on the Kindle edition: $8.95 (retail $9.95)       print edition: $24 on Amazon.com

To receive a 20% discount on the print edition: $19.20 (retail $24), follow the link, open a Createspace account and enter discount code SJRGPLAB. (This is the only way I can offer a discount.)



     
Please click on a book cover to read sample chapters




NOTE: gifts/contributions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.

  Thank you, Robert M. ($50), for your astonishingly generous contribution to this site--I am greatly honored by your support and readership.  


"This guy is THE leading visionary on reality. He routinely discusses things which no one else has talked about, yet, turn out to be quite relevant months later."
--Walt Howard, commenting about CHS on another blog.




Or send him coins, stamps or quatloos via mail--please request P.O. Box address.

Subscribers ($5/mo) and contributors of $50 or more this year will receive a weekly email of exclusive (though not necessarily coherent) musings and amusings.

At readers' request, there is also a $10/month option.

What subscribers are saying about the Musings (Musings samples here):

The "unsubscribe" link is for when you find the usual drivel here insufferable.

 
 
Your readership is greatly appreciated with or without a donation.

All content, HTML coding, format design, design elements and images copyright © 2012 Charles Hugh Smith, All rights reserved in all media, unless otherwise credited or noted.

I am honored if you link to this essay, or print a copy for your own use.

Terms of Service:
All content on this blog is provided by Trewe LLC for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site. The owner will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, injuries, or damages from the display or use of this information. These terms and conditions of use are subject to change at anytime and without notice.


                                                                         
blog     My Books     Archives     Books/Films     home


 





Making your Amazon purchases
through this Search Box helps
support oftwominds.com
at no cost to you:


Add oftwominds.com
to your reader:


Free Page Rank Tool

Oftwominds.com #7 in CNBC's
top alternative financial sites