Wednesday, November 17, 2010

U.S. Federal Debt, Part II, Incentives

In Part I I laid out our debt problem. The short story: $13.7 trillion and growing fast. In that piece, I noted that all the major players: powerful people, Congress, federal managers, taxpayers, federal employees etc. all have strong incentives to increase the debt. Part II, this essay, is devoted to exploring ways to change that.

Let's start with an easy one: Congressional earmarks. For many years, each Congressman has been given a quota of money that they can spend in their district more-or-less as they please. Congressmen use these funds to get votes by giving voters stuff. Consider a new rule: earmarks are only allowed if total federal debt shrank the previous year. This would give each Congressman a powerful incentive to stop borrowing.

Now the hard one: a debt tax. This is an additional graduated tax on all income with most of the burden falling on the wealthiest (1), who are generally the most powerful and thus in a position to affect the debt. This tax is cut in half when we stop borrowing, and goes away entirely when the government has a surplus rather than a debt. The exact percentage is not critical, so long as it is too small to sink the poor and big enough to really matter to the rich. I suggest the following rates by income:

  • 1% $0-50,000 (55% of taxpayers)
  • 2% $50,001-100,000 (30%)
  • 3% $100,001-150,000 (10%)
  • 4% $150,001-200,000 (3%)
  • 5% $200,001-250,000 (1%)
  • 6% $250,001-500,000 (all others combined 1.5%)
  • 7% $500,001-1,000,000
  • 8% $1,000,001-10,000,000
  • 10% $10,000,001-100,000,000
  • 15% $100,000,001-1,000,000,000
  • 20% $1,000,000,001 and above.
This would give a strong incentive to the most powerful people in the country to have the federal government stop borrowing and pay off the debt. Yet even at the highest level, total tax when combined with current income tax would still be far less than the top tax rate of the 1950s and 60s; which was 91%. If the debt tax creates too much government income, damaging the economy, then other taxes can be reduced. I prefer taking people on the bottom off the tax roles entirely but there are other sensible approaches. For example, for the vast majority of Americans -- those earning less than $250K -- reduce the current income tax by the amount of the debt tax leaving taxation levels the same.

Right now federal managers are severely punished when they do not spend all the money they are responsible for by the end of the fiscal year (October 1). This is why the government goes on a buying spree every September -- managers are desperately trying to spend all their money. Instead of punishing managers who are fiscally responsible they should get awards, their projects should keep at least some of the money, and their budgets should not be cut. Those who over-spend should be cut. This could make a very big difference.

Finally, consider rank and file government employees. Their incentive is to increase their pay, which increases government spending. There is no way around this. However, federal employees are civil servants. Civil servants have strong job protection. Before the civil service was established it was normal for a new president to fire the entire government and replace them with campaign supporters. Laws to prevent this require a RIFF (reduction in force) to fire civil servants in any significant numbers. Usually the firing is by seniority -- the youngest, least expensive employees get canned. Civil servants could be given an incentive to reduce the debt if RIFFs were only allowed when the debt is increasing. As a general rule civil servants make less than those in private industry doing the same job, but they are compensated by job security. This would make job security contingent on reducing federal debt, a powerful incentive.

There you have it, ways to give the major players significant incentives to reduce rather than increase the federal debt. There may be better ways, but these would almost certainly work. It's also safe to say that as long as the incentives stay the same, and all the incentives are to borrow more rather than pay off the debt, the debt will increase until default and disaster (see Part I for details).

Part III: reducing government size and expenditures is next. Stay tuned.


  1. Small states, such as New Jersey, have raised taxes on the wealthy only to see them leave the state. However, leaving the U.S. is a much bigger step than moving from New Jersey to New York, and the U.S. has low levels of taxation compared to other industrialized countries. Not only are income taxes at the top brackets generally higher elsewhere, there is often a very large VAT (Value Added Tax) on everything purchased. Thus, flight of the wealthy to avoid the tax is unlikely.

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