As the current impasse concerning the raising of the debt limit has grabbed the attention of everyone in the United States, we need to examine the salient aspects of the issues that are getting lost in the fog of the political discourse. Firstly, the major determinant of the need to raise the debt limit resolves around the fact that the United States government has been running huge budget deficits for well over a decade with expenditures exceeding income by 1.1% of Gross National Product. In terms of the percentage of GNP, the US government spends 23.7% of GNP and collects revenues of 22.6% of GNP. The debt limit will need to be raised immediately because US government operations need to be funded in the short to medium term, but the legislative and executive branches will need to agree on a time frame to discuss changes to be made in both revenues and expenditures, to place the fiscal house of the United States in good order over the longer term period. When such a review is undertaken it will need to not only examine the quantity and type of government direct spending but will also need to focus on the levels of government spending done indirectly through the tax code in the form of tax preferences (tax expenditures). These tax preferences fall into one of five categories.
1. Credits which directly reduce your tax liability dollar for dollar. This would be the earned income tax credit and the child tax credit.
2. Deductions which reduce the amount of income subject to tax. Examples are the mortgage interest and charitable contributions for individuals and accelerated depreciation for businesses.
3. Deferrals which postpone the date at which income gets taxed. Examples are 401 (k) and IRA’s.
4. Exclusions and exemptions which allow certain types of income to avoid taxation entirely. Example is interest on municipal bonds.
5. Preferential tax rates for certain classes of income such as dividends and capital gains.
Based on 2010 data, the estimates of revenue foregone through these tax preferences amount to 1.1 trillion dollars annually. As a consequence any meaningful attempt to restructure the size of government finances over the longer term, would entail not only spending considerations but a major review and changes to the system of taxation in the United States to ensure it is both fair, equitable and positions the country to achieve sustained longer term economic growth and for the private sector to be competitive in the new realty of the global marketplace.
