By John Mauldin
Sooner or later, the US will enter a recession. My best guess is it will happen sometime in 2020. I may be off (early) by a year or two, but it’s coming.
We know two things will happen.
- Tax revenues will fall as people’s income drops.
- Federal spending will rise as safety-net entitlement claims go up.
The result will be higher deficits.
Keynesian economics says we should run deficits in recessions and surpluses the rest of the time.
That’s not what we did.
Last year the “official” budget deficit was $779 billion. The national debt went up $1.2 trillion. The “small” $421-billion difference was more than half the official budget deficit.
Budget deficits are projected to reach $1.1 trillion in 2020. Now, add another $400 million to each of those numbers. What is called the “unified budget” is now $1.5 trillion.
Next, let’s go to a very handy website called The US Debt Clock. We see that halfway through fiscal year 2019, the debt is already well over $22 trillion. It will be $23 trillion before the end of this year.
By the end of 2020, it will be approaching $25 trillion. And that doesn’t include state and local debt of $3 trillion plus their $6-trillion unfunded pension liabilities.
Note that all that is without a recession.
The unified deficit will easily hit $2 trillion and approach $2.5 trillion in the next recession. Within 2 to 3 years later, the total US debt will be at least $30 trillion.
Not including state and local debt or unfunded pension obligations.
Wealth Taxes Won’t Help
There are calls for a 70% tax rate on incomes over $10 million.
Experts quoted in The Washington Post estimated it would produce about $72 billion a year. And you can guarantee that people will work their income statements to get below that.
And in the face of a $2.5-trillion deficit? It doesn’t do very much, let alone pay for any new programs.
The simple fact is that raising income taxes on whatever we think of as the wealthy doesn’t get us close to a balanced budget.
But what about actually doing a wealth tax? Like 1% of total net worth on the 1% wealthiest in America? Helpfully, The Washington Post article calculates that for us (my emphasis):
Slemrod, of the University of Michigan, said in an email that the wealthiest 1 percent of Americans own roughly one-third of the $107 trillion in wealth in America. This group collectively holds about $20 trillion in wealth above $10 million per household.
From there the calculation of wealth tax is simple: a 1 percent wealth tax on the wealthiest 1 percent of households above $10 million could raise about $200 billion a year, or $2 trillion over 10 years. Tedeschi, the former Obama official, found a 0.5 percent wealth tax on the top 1 percent could raise at most $3 trillion over 10 years.
But this, too, would probably change Americans’ behavior and perhaps lead them to try shifting their wealth overseas, and the economists say the actual amount of revenue is likely lower than their estimates suggest. And this is assuming there are no exemptions to what is considered wealth, such as housing assets.
Again, a few hundred billion a year is nothing to sneeze at. But at this rate, it would make only a small dent in the deficit.
The Real Problem
It’s entitlement spending. The CBO is projecting literally trillion-dollar deficits at the end of the next decade simply because of unfunded entitlement spending.
And then there’s the pesky little fact that we spent $500+ billion last year on interest payments.
In a recession and bear market, the $6 trillion of unfunded pension liabilities on state and local balance sheets could easily rise to $9 trillion, a number most cannot meet.
Either firefighters, police officers, teachers, former government workers, etc., would not get their agreed-upon pensions. State and local taxes would have to suddenly rise, or the federal government will have to step in.
All of this will happen in an environment in which the Federal Reserve will be fighting a recession and a slow-growth economy. They will try to move those asset prices back up to help the pension funds.
As such, the Fed’s balance sheet could grow to $10 trillion by the mid-next decade… and $20 trillion by the end of the decade.
When I write about such controversial topics, people often call me out as a permabear. I’m not being bearish or pessimistic here.
I’m simply looking at the numbers, doing the arithmetic, and observing that we’ll have to borrow a great deal of money to meet our obligations.
I might be wrong if politicians from either party run and win with a platform of, “I’m going to cut your Social Security and Medicare, slash the defense budget, and zero out a lot of little other pesky expenditures that you probably like.”
I feel sure that won’t happen.
The Rules Will Change
The massive increase in debt and huge quantitative programs will change the rules of investing we have lived under for the last 50 years.
It is going to be difficult, more difficult than now, to get a positive return on your bonds without taking significant risk. And your returns are going to be lower. Think Japan. Think Europe. For that matter, think the US.
Is there a way out of all of this? Absolutely. We can overhaul the tax system, actually balance the budget, fund all the entitlement spending, and watch GDP growth once again become part of our national conversation.
But it will take a crisis before we consider that. In the meantime, let’s pay attention to how the rules are changing and adapt.
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