For renewed prosperity, we need to balance the budget by 2015

Posted by Shyam Moondra

Since President Bill Clinton balanced the budget during his second term, the federal budget deficit has steadily grown during the last decade. President George W. Bush scaled up defense expenditures to finance twin wars in Iraq and Afghanistan and to deal with the financial crisis via Troubled Asset Relief Program (TARP). President Barack Obama piled on by undertaking a huge stimulus program to revitalize the economy and a comprehensive health care program that will provide subsidized health care (at a cost of $1 trillion over ten years) to millions of people who couldn't afford to buy health insurance. Today, our national debt stands at $14.2 trillion ($46,000 per American), which is roughly 96.3% of the present GDP. The interest on the debt alone is around $420 billion a year. The current federal budget deficit is running at around $1.4 trillion. Clearly, these levels of debt and budget deficit are unsustainable. Recently, President Obama proposed his budget for the 2012 fiscal year that envisions the budget to be balanced in ten years.

High-levels of deficits and debt are big obstacles in achieving full economic recovery because they will propel the interest rates to elevated levels for an extended period of time and thus have negative effect on economy. Also, they would weaken the dollar currency that will make imports expensive and thus fuel an inflationary spiral. Some extreme economists even predict that the U.S. government may be headed to bankruptcy or at a minimum faces a possible downgrade of its debt rating that will further increase the interest to be paid on the national debt. There is a general agreement among Democrats, Republicans, and Independents that projected debt and budget deficit are dangerously high and they must be brought down or else younger generations will face declining living standards. However, philosophically, they disagree on how to bring the debt and deficit down and how quickly. Liberals believe that rich people should be asked to pay more in taxes, conservatives believe that the government has grown uncontrollably big and it's time to cut spending, and then there are moderates, who believe that any viable political solution would have to incorporate both spending cuts and tax increases. Recently, a bi-partisan Presidential Debt Commission recommended a wide range of options that included both spending cuts and tax increases. However, the commission got bogged down with disagreements among the members based on their political party affiliation and different ideologies.

Here are some general observations:

· Morally, it's wrong for the government to year after year spend more than tax revenues. It's like living a good life with money borrowed from the future generations.

· The problem is urgent; we cannot wait for ten years, as President Obama has proposed. The ten-year target may have been an opening tactical move by President Obama just as Republicans have thrown out an opening gambit of balancing the budget immediately. Rather than engaging in a political brinkmanship, President Obama needs to provide leadership on this issue and strive for a compromise that would balance the budget in 3-4 years.

· The budget deficit is too large to be balanced strictly based on spending cuts. Besides, sharp spending cuts would undoubtedly hurt the low-income and middle-class people disproportionately more than the rich people.

· Some conservatives want a constitutional amendment that would put an absolute limit to national debt. That's a bad idea. The government needs the flexibility to raise money at a fast clip if some unforeseen national emergency arises caused by natural disasters or man-made disasters such as nuclear accidents or catastrophic situations similar to the recent financial meltdown that required the federal government to bailout major financial institutions.

· If our national finances continue to deteriorate, our military power would also erode over time and we will be put on the same path of decline as the former Soviet Union. Strong national finances are a must for us to remain strong militarily. If we continue with a policy of high deficit and debt, in a short period of a few years, we wouldn't be able to finance unexpected national security campaigns such as the current military action against Libya.

· Social Security and Medicare programs are like insurance policies for which the participants pay premiums in the form of payroll taxes. As such, they are entitled to the benefits provided under those plans. Therefore, any reforms with respect to these programs should not contemplate reducing the benefits. If any changes are made to these plans, they should be limited to the revenue side of the equation.

· While we look for ways to cut government expenditures, it's important that we also continue to invest in the future, especially in the areas of alternative energy sources, infrastructure improvements including high-speed transportation, and education in which we are losing ground fast (in a recent college entrance test, the U.S. students ranked near the bottom of top 25 countries).

Below are some suggestions on how to raise tax revenues and cut spending to balance the budget and reduce debt.

Tax Reforms:

· We need to enhance tax revenues by increasing the federal income tax rates on the rich people, who benefited the most under the Bush administration. In fact, even rich people like Warren Buffet have said that their tax rates are too low. Recently, President Obama agreed to extend Bush-tax cuts for two years for everyone. When this extension has run its course, the tax rates for the rich should go back to where they were before President Bush cut those rates while the cuts for the rest of the people should be made permanent.

· We need to close the corporate tax loopholes; when GE pays zero income taxes or Google pays only 2% of income in taxes or Goldman Sachs pays only 10% in taxes, something is very wrong with the tax code. We need to simplify the tax code by eliminating most special-interest deductions accompanied by reduction in the overall tax rate for all businesses.

· The current Social Security tax rate is 6.2% and Medicare tax rate is 1.45% of incomes of up to $106,800. The income limit should be gradually increased to at least $150,000, while keeping the percent rates at the current level. Also, many rich people who do not receive salary (and thus do not get any W-2 forms) should still be levied Social Security and Medicare taxes at the highest limit level (e.g., $150,000) because taking care of the elderly in the society should be considered as a collective responsibility; of course, these rich people without W-2 forms should also be entitled to the Social Security and Medicare benefits if they so desire. No change should be made in the retirement age and the benefits.

Spending Cuts:

· A serious consideration should be given to completely eliminating certain departments such as Commerce, Energy, EPA, HUD, etc. Some of their functions could be absorbed by the other departments. For example, we could combine Commerce and Labor into one department representing businesses and unions, and Energy, EPA, and Interior could become one department.

· We need to look at government employee benefit costs, especially the retirement and health care benefits. Many of these plans offer better benefits than those of the private sector. For example, members of Congress enjoy very generous retirement and health care benefits. I think time has come for the government to follow suit the private sector and reduce benefits and make government employees pay more for those benefits.

· The government procurement procedures should be tightened up to reduce fraud and corruption. The Defense procurement process could be improved to save billions of dollars a year.

· The government should eliminate or sharply curtail "free" programs such as Medicaid that suffer from widespread fraud. The eligibility requirements should be made more stringent and benefits should be reduced (impose a maximum for the year and life-time benefit, start collecting deductibles, etc.). We also need to increase resources for catching and prosecuting criminals engaged in fraud.

· Financial and military foreign aid programs should be reformed. We should cut back on who receives such aid and for how long (aid to Pakistan is a sheer waste of tax dollars and Israel has become a permanent recipient even though Israelis' living standard has vastly improved in recent years). A chunk of this aid ends up in secret Swiss bank accounts of the leaders of these countries. Rather than giving cash, we should give them material and provide services procured from American companies that will minimize the opportunity for the leaders of the receiving countries to embezzle the aid money; also, this approach will help American businesses and possibly create more jobs for Americans.

· The budget should be thoroughly reviewed and all programs that are deemed ineffective should be eliminated altogether. When Congress approves a new program, the legislation should also require periodic mandatory evaluations and specify under what conditions the newly enacted program could be phased out.

We are in a secular bull market - DJIA headed to 18,000

Posted by Shyam Moondra

The economy has been steadily picking up with industrial production, retail sales, consumer confidence, productivity, and GDP, all gradually increasing. Even unemployment has begun to decline, albeit slowly. The housing market continues to be a laggard, however. The corporate profit margin is at 18-year high and the corporate balance sheets show a record cash hoard of close to $2 trillion.

The revolution sweeping the North African region has reduced the oil output, especially in Libya, pushing the oil prices to $105 per barrel. However, the oil-rich countries need the oil revenues to keep the services in high gear to appease the raged population. Regardless of who is in control in many of these countries, oil will continue to flow and oil prices will eventually come down. In Japan, earthquake and tsunami devastated the eastern part of the country, but the disaster spared the major industrial cities and thus any harm to Japan's overall economy will be short-lived.

Much has been made of the record appreciation in the stock prices over a short period since it hit the bottom in March of 2009. However, what is not receiving much attention is the fact that in 2009 with the demise of Lehman Brothers, takeover of Bear Stearns and Merrill Lynch, and rumored bankruptcies of major banks, the market went down precipitously more than it should have. When it became clear that the major banks wouldn't go bankrupt after all (thanks to TARP), the market bounced back. The market would not have gone down as much as it did, had the investors not panicked. Therefore, the 30-40% appreciation from the bottom should not even be counted as appreciation; it was simply backtracking of an overreaction.

Today, the market is hardly overvalued, as some analysts suggest. The trailing PE of S&P 500 is only 17 and forward PE is under 15. There is no euphoria in the market as we usually see when the market is overvalued. The trading volume continues to be sluggish. During the financial crisis, corporations did an outstanding job in improving their cost-structures that made it possible for them to reap record profit margins and accumulate cash of the order of $2 trillion. The corporate world has never been more financially stronger. The companies are very well positioned to increase dividends and undertake major share buy-back programs that will be a big boon to the current investors. Also, relatively low PE levels will fire-up the mergers and acquisitions market, further boosting the stock prices.

What will help the economy is a bi-partisan effort to reduce federal budget deficit and national debt. President Obama's proposed budget is utterly inadequate. We need a 3-4 year plan to balance the budget and not a 10-year plan. A serious effort by the Congress and the Obama administration to reduce the budget deficit is a pre-requisite for sustained recovery and long-term prosperity.

Any talk of big market correction is pre-matured. The market has a long way to go before we see irrational exuberance. If the housing market turns around and a plan is adopted to reduce the budget deficit in a meaningful way, the DJIA could top the old high of 14,198 by next year. We might see intermittent small corrections caused by profit taking, but we are in a secular bull market, which may last for several years until S&P 500 PE reaches to high-20's and DJIA hits 18,000. Warren Buffet recently said that he is itching to buy; his purchase of Lubrizol for $9 billion is just the beginning. When Buffet is bullish on America, any talk of a major market meltdown is pure nonsense.