Columns

The Real 'Truth' About Debt and Taxes


The debate around the key contributors to the federal budget deficit—government spending, tax policy, and the national debt—has had more in common with a schoolyard brawl than a rational discussion of critical financial and economic issues. The non-stop nature of the U.S. election cycle unfortunately means that any attempt to address these issues is more infused with political posturing than with attempts at realistic problem-solving.

President Barack Obama's bi-partisan blue-ribbon panel on the deficit did an admirable job in attempting to develop viable solutions to our fiscal problems. But an admirable job is not enough for a report compellingly titled "The Moment of Truth." In that sense, the report from the National Commission on Fiscal Responsibility and Reform comes up short. On the one hand, the Commission was not bi-partisan enough and did not challenge many costly "sacred cows." On the other, it may have been too bi-partisan in presenting a plan that is largely dead on arrival along both sides of the aisle.

Key principles in this debate are conveniently ignored by pundits and politicians from all points on the political spectrum:

• Taxes are a necessary evil: Short of selling all natural resources, only taxes can provide the revenue needed to run the government.

• Taxes restrain, rather than promote, economic growth: taxes are a transfer from the private sector to the public sector. While government spending does add to gross domestic product, private spending adds more to national wealth and long-term growth.

• Cutting discretionary government spending alone is not enough to eliminate the deficit: Entitlement programs such as Social Security, military spending, and interest on the national debt create an enormous burden on the national treasury.

• Not all government spending is wasteful: Whether its purpose is critical infrastructure, education, or border control, certain government spending adds to and protects our national wealth.

Open Discussion, Not Sports Rhetoric

Given the depth of our current financial problems, politicians who are raising campaigns funds while looking to avoid proverbial political "third rails " will not lead us to productive or permanent solutions. Any hope of cutting the mounting government deficits requires an open discussion of common national priorities and the fiscal facts of life.

Whatever our view of government and its priorities, we all must acknowledge that this is an era in which fiscal limitations require that only essential government spending can be tolerated. We also need to put aside class warfare when it comes to our debate regarding tax policy. In recent decades, decisions to increase or cut taxes have been mired in the rhetoric of winners and losers.

While it is easy to appear on Sunday morning talk shows to denounce "tax cuts for billionaires," it is far harder to understand the artificial incentives and uneconomic impediments that poor tax policy imposes on an economy struggling to create jobs and reduce federal debt. With an aging population that will require greater funding for Social Security and Medicare, today's budget deficit could appear downright small in just a few years if we do not make the right decisions now. This truly is "the moment of truth."

First, Washington needs to recognize that economic growth—not higher taxes—is the driver that increases government revenues. Second, plans to cut the deficit must not reduce future economic growth. In the same way that increasing tax rates can cut tax revenues, cutting spending in the wrong places will limit growth and ultimately increase budget deficits. As Alice Rivlin, former director of the Office of Management and Budget and former Vice-Chairman of the Federal Reserve, recently noted: "We can put money in people's pockets in the short-term and trim government spending in the long run." The equation is simple: Smart tax policy + intelligent government spending = growth.

Smarter Spending and Tax Reform

While cutting government waste must be a priority, discretionary government spending should be focused on education, research and development, building critical national infrastructure, and other projects that promote growth and create national wealth. While cutting taxes may be an anathema to many on the left, current U.S. tax policy is riddled with tax provisions designed to promote special interests. Tax reform, with lower nominal rates and few deductions, will promote rational financial decisions.

Smart spending and a straightforward tax regime will make America more competitive and better able to pay down its national debt. Much of the angst expressed by the American electorate in November comes from our collective concerns about our future. Economic growth and unsustainable national debt are at the core of those concerns.

In 1994 the Democratic Party was handed a similarly monumental loss in that year's midterm elections. President Bill Clinton had a tough choice to make. He opted to work with Republicans in Congress and in doing so, achieved more than anyone could have predicted in the next election.

President Obama has a similar choice now. He can be the spokesperson-in-chief for a legislative agenda that has no chance of success on Capitol Hill or he can seek to work with moderate Democrats and Republicans to forge solutions to these vital fiscal issues. If he does so, not only will Barack Obama earn a second term, but he will also earn his place among our great Presidents. If he does not, we need only look across the Atlantic to glimpse our future.

Frank_aquila
Aquila is a partner in the Mergers & Acquisitions Group of Sullivan & Cromwell LLP.

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