Nation faces historic crossroad regarding fiscal policy

August 9, 2009
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The recent reported success of the Cash Allowance Refund System (CARS, commonly referred to as Cash for Clunkers) supports the position that stimulus incentives need to be targeted, direct and provide immediate payback to those participating to bring about desired results in a timely manner. Many have argued that if there had been a similar program earlier, perhaps the course Chrysler and GM have taken and the amount of government funds needed in the bail-outs may have been different.

Hopefully for Michigan businesses and taxpayers, the CARS program will help the state economy to start running on all cylinders.

The CARS results came in the same week as the release of the gross domestic product numbers for the second quarter. The release on July 31 indicates the tide may be turning on the recession. Though a contraction in the economy still occurred in the second quarter ending June 30, the size was considerably smaller than the decline reported for the previous two quarters. Many economists found a silver lining in the GDP numbers. Business inventories continued to have a large contraction in the second quarter. Just to restock the inventory levels, a considerable build-up will be needed in the months ahead.

Another positive business development in July was the stock market advance of nearly 10 percent. The stock market typically is treated as a leading indicator of business activity in most recessions and recoveries. The July advance may be partially attributable to the better-than-expected reports of the quarterly earnings of the public companies. The earnings increases were reported as being largely attributable to the aggressive cost-cutting undertaken in recent months. The cash representing the earnings is likely to provide some of the necessary capital to restock inventories and begin embarking on modest capital expenditure projects, as well as currency for merger and acquisition opportunities.

All this news may mean we can again open the statements for our 401(k) and IRA accounts.

The other economic item of note in July was the repayment by many banks of TARP funds, indicating that some of the banks have positioned themselves and their capital structures in a post-meltdown environment. Many banks and financial institutions may still have some rough times, although perhaps the worst news is behind us.

The only notable item that may impact the economy that still seems a bit murky is the exact size and scale of the health care reforms and their debate in Washington, D.C. Some pundits argue the best plan is getting workers back to work, so more families are covered under employer-based health plans. The proposals will be front and center for the members of Congress upon their return from the August recess. The discussions regarding the design of any mandate, the size of any required tax increases on business and employees, and the revisions possible in the levels and types of benefits and care under the legislation have underscored the fact that changes to a segment that represents as much as 1/6 of the total economy cannot be rushed and require some reflection.

The risk, as we saw at the start of the second Bush term when there was an initiative to reform Social Security, is that political rhetoric and pandering to special interest groups occurs and nothing happens. Then, years later, the same problems continue and the cost and scale of reform only grows.

There is some thought that increasing taxes on the wealthiest 5 or 10 percent of the taxpayer base can help offset the cost of the various initiatives. Granted, there may be some ability for some income tax increases to be absorbed by the highest income earners, but the plain fact is that a good share of that additional tax will be borne by the owners of small businesses — the same small businesses that are significant creators of new jobs. This is the result of the fact that most small business tax liability is paid by the owners since most of the firms are structured as S corporations, limited liability companies or partnerships, and sole proprietorships. The top 5 percent or 10 percent of taxpayers already pay a majority of the individual income taxes collected in the United States. There may be a limit on how much a small proportion of the population can shoulder the additional tax burden.

As I have mentioned in past columns, a significant overhaul of the tax system may be required at some point. My prediction is that a more broad-based tax system will need to be put in place to handle some of the commitments we have made to the current and future taxpayers and citizens of the U.S. An argument raised in the health care debate is that the U.S. is the only major industrialized country without a nationally sponsored or mandated health care system. At the same time, the U.S. is the only country without a national sales tax or value added tax (VAT). In time, the VAT may show up in the U.S. In Europe, the average VAT rate is approximately 15 to 20 percent, well in excess of the state sales tax rates in the U.S. Generally, VAT taxes also apply on services as well as goods, so the tax base for a VAT will likely be larger than the current state sales tax base. There is a significant compliance cost in administering and tracking VAT payments and credits, so it will add to the cost of doing business, in addition to the actual increased tax cost of the VAT itself.

The recent spending and fiscal initiatives raise some interesting issues related to the longer term stability and financial success of the country. I have young children who are years away from joining the labor force, and I have concerns about what liabilities we, as a country, are leaving them. Many I know: Social Security retirement benefits, Medicare and the large annual federal government budget deficit. The excesses created in the mortgage and consumer spending binge of recent years are being repeated in the current environment, in which the bank TARP program, the 2009 stimulus package and impending health care reform all are large drains on the federal budget. One wonders if the result will be that the impact of government spending excesses will dwarf the carnage of the home mortgage crisis.

Some lessons may have been learned in recent months. It has been reported that the household savings rates have grown to levels we haven’t seen in years. This comes as we see the reports of annual Federal budget deficits of nearly $1.5 trillion. This level of deficits seems incomprehensible when barely a year ago the political debate was how the country could survive with $400 billion annual federal budget deficits. To date we have been lucky in that many of our trading partners have agreed to purchase U.S. Treasury securities to help finance the deficits. At some point, the piper will need to be paid. There are no easy answers. We may literally be at a historic crossroad where our decisions and actions have lasting impact on our children and grandchildren. The year 2009 may indeed be a monumental year in the annals of U.S. history.

William F. Roth III is a tax partner with BDO Seidman LLP. The views and opinions expressed above are those of the author and not necessarily those of BDO Seidman.

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