The tough facts about the U.S.' finances
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The tough facts about the U.S.' finances

In continuing my discussion on this topic from a few weeks ago, I now turn to a look at government revenue and economic growth. The average income tax rate for an American citizen is approximately 13 percent. In order to cover current government expenses this tax rate would have had to double – without even including the negative effects that higher tax rates would likely have on GDP growth. Is a doubling of income tax rates realistic and/or politically palatable? Absolutely not. Are higher tax rates not only likely but also necessary? Most likely, yes. A political compromise will most likely come in the form of Republicans agreeing to raise income tax rates and Democrats accepting a reform of Social Security, Medicare, and Medicaid. Will this occur? History has shown that America has overcome and become stronger despite persistent challenges throughout the past 236 years.

  • Since World War II tax receipts have averaged around 18.1 percent of GDP. In the past year revenue was slightly north of 15 percent of GDP. Is 15-16 percent of GDP the new normal? Probably not. Tax receipts are driven by two things: the economy and the level of tax rates. Therefore, tax receipts are cyclical and the low level of receipts over the past few years is directly related to the poor economy. By this token, it would seem that the answer to the low level of receipts would be to focus on economic growth. This should be done through long-term investments in education, infrastructure and technology. However, by decreasing marginal income tax rates, economic growth and tax rates over the past few decades have shown not to increase government revenue to more than prior to the tax cuts. In order for the government to break even at current rates, real GDP would have to grow at a rate of almost 8 percent per year – a number attained only 6 times in the 20th century.
  • Economic growth is a function of population growth and productivity growth. Population growth has slowed to 0.7 percent per year from an average of 1.3 percent over the 20th century. Immigration reform focused on bringing the brightest individuals from other countries could do wonders for the U.S. over the long term. With the deceleration in population growth, the bulk of current real GDP growth lands on productivity growth. Since that has also slowed to approximately 1 percent, it is easy to fathom real GDP growth of approximately 2 percent over the past 2 years. 
  • In order for the private sector to make investments, individuals have to be given a larger incentive to save. The average U.S. savings rate is 3.4 percent. In China the average savings rate is 36 percent. While the U.S. financial markets are still the premier place to invest one’s savings, the U.S. markets have also become too short-sighted. How could individuals be encouraged to save for a longer time horizon? Perhaps a capital gains tax could be enacted that decreased over time. For example, for capital gains realized within one year, the tax rate could be one’s marginal income tax rate. For gains realized between one and two years, the tax rate could be 20 percent. For gains realized between two and three years, the tax rate could be 15 percent. This could continue until the tax rate could be 0 percent for gains on investments held over five years. By helping encourage long term savings, there is a higher probability that more capital would flow to industries that could obtain high returns on assets.

 

*The opinions and forecasts expressed are for informational purposes only and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. The representative does not guarantee the accuracy and completeness, nor assume liability for loss that may result from the reliance by any person upon such information or opinions. All investments involve the risk of potential investment losses and no strategy can assure a profit. Past performance is not indicative of future results.

Securities offered through Securities America Inc., Member FINRA/SIPC and advisory services offered through Securities America Advisors, Inc. Armstrong Advisory Group, WRKO and the Securities America companies are unaffiliated. Barry Armstrong is a Representative of Securities America. Representatives of Securities America, Inc. do not provide legal or tax advice. Please consult with a local attorney or tax advisor who is familiar with the particular laws of your state. 12/12

 

Tax Receipts Return to Historical Average. The Heritage Foundation. 25 Nov. 2012.