A National Recovery Alternative That Will Work.
Henry K. Hebeler, www.analyzenow.com
For two terms of three years each in my working career at Boeing, I was responsible for long range planning, reporting to the chairman. In between I was president of three of Boeing’s companies including the Boeing Aerospace Company which was responsible for Boeing’s space activities and most of the military work. Boeing’s airplanes, space and military products had life cycles that were measured in decades, not a two or four year political term. This paper is written from the perspective of a long range planner and someone who has experienced what a company has to do to survive in difficult times. Sometimes you have to really suck it in—starting from the top. I believe that the nation has a survival problem right now and needs a different course of action to protect our long-term future. It’s time to suck it in!
Part 1. The problems:
Personal savings are far too little to support retirement or emergencies. It takes between $150,000 and $200,000 for each $10,000 of annual pre tax retirement income. Those who are between 55 and 65 have an average of only about $50 thousand in their 401(k)s. At best, that will only provide about $3,000 a year (inflation adjusted) if none has to be used for emergencies. This is a consequence of savings shortfalls that began in 1985 and gradually went down to zero almost twenty years later. To recoup these savings losses and return to historical savings rates, it would take over 20% savings rate at 8% return for the next 20 years. Only in World War II did the nation have that much savings. This was in large part because people had nothing to spend it on, and it was patriotic to invest in Savings Bonds. The government and financial industry minimized the need to save saying that new savings weren’t necessary because of huge increase in stock values, home values and forthcoming large inheritances. (For more details, see Getting Started in a Financially Secure Retirement, John Wiley & Sons, 2007.)
The stock market has recently seen another major decline. In 1999, the Dow peaked at $13,700 in 2007 dollar values. On Oct. 9, 2007, the Dow peaked at $14,165. That was less than a $500 gain in about eight years. Both peaks were followed by precipitous declines. Now it’s about half peak values. This is far from the 10% per year growth people were led to believe they would get from their stock investments.
A market decline amplifies the problems from saving too little and will be particularly hard on the 76 million baby boomers who have very little time to recover. This will almost certainly push people towards retirement at 70 as well as part-time jobs in retirement. The financial industry misled people by advocating portfolios with high stock allocations for two reasons. (1) The industry relied too heavily on historical statistics to predict the future. (2) Stock transactions brought in more fees for brokers and mutual funds.
That said, the stock market will continue to go up and down. Unfortunately, when the market is down, people tend to sell stocks and when it is up, people tend to buy. They do just the opposite of what they should, thereby further damaging their existing savings growth. Thus individual investors’ portfolio performance falls far short of the market as a whole. The average person who buys and holds does much better than those who chase the market.
A large part of population can’t afford to own their homes. We have a mortgage problem now mainly because too many people bought homes with very little down and did not have the income to support the mortgage payments. The majority of these would have been better off renting, not just because it is often the best financial option, but also because home ownership thwarts job mobility.
Greedy financial institutions started making large bets using high risk mortgages as collateral. AIG and others facilitated these bets by insuring them. Hedge funds got into the act and used borrowed money to leverage the bets. This structure collapsed, and the government took the position that it had to step in and save the U.S. financial industry. The government has assumed much of this risk now. That will lead to more financial problems and additional national debt as these poor credit risks default on their payments.
More and more people are losing their jobs. This trend will continue even with government sponsored employment. The reason is that the economy will continue to decline until industry and commerce reaches lower levels of consumption and defense spending. Government itself will continue to expand. It may be the only significant labor growth market around, but it has a terrible hazard because it increases the number of entitlements which further burdens future generations.
There is great hope that the government stimulus will bring quick job growth, particularly in “shovel ready” projects that state and local governments have in their plans. Unfortunately, a lot has changed over the years that will not make quick implementation possible. For example, transportation departments have established processes that break jobs down in small increments for many reasons including an apparent (not necessarily real) view of performance to budget, making opportunities for small and minority businesses to do the work and, not the least important, preserving jobs within the transportation departments. When Salt Lake City was preparing for the 2002 Olympics, the city recognized that it needed massive changes in its highways through the city. It abandoned the bit-by-bit process, accomplished the work on a short schedule, and saved a bundle of money. That’s an unlikely change in most of the “shovel ready” projects now in the government plans.
Taxpayers are facing increasing debt. Debts have been building unconscionably for more than two decades. We are headed to more than $12 trillion federal debt. That represents about $150,000 debt per income tax payer. (See Math Lesson below.) Even if none is paid back, the interest burden will be over $6,000 per taxpayer annually forever. Falling income tax and sales tax receipts will starve federal, state and local governments, increasing their necessity to borrow.
Private sector debt is out of control. The problems are not limited to the government. Much of the merger boom was debt financed. The result was larger executive bonuses, reduced competition and increased corporate debt. Auto and credit card liabilities far exceed the national debt and carry much higher interest rates. Widespread mortgage abuse has left both the residential and commercial real estate markets in a shambles. Domestic corporations are burdened with a multiplicity of taxes. This burden increases domestic product prices, making imports relatively more attractive.
We suffer from the increasing financial burden of entitlement liabilities. The burden we all have is paying for Social Security, Medicare, Medicaid, unemployment compensation as well as government pensions and medical benefits far exceeding even those of the auto industry. With each new piece of legislation, the government becomes more bloated with administrative staff and additional jobs. The stimulus bills will add many government employees during the next two years along with their health care and retirement entitlements. In the years that follow, those jobs will be extended because no politician will dare suggest that we need fewer people in “critical services.”
National debt and entitlement obligations are so high that it is literally impossible to pay them. The total of federal debts and entitlement obligations is now over $60 trillion and fast increasing. To evaluate this, one needs to take a very long term look because these numbers reflect entitlement payments out as far as the lives of our children. If the population and the number of taxpayers stay the same over that period, and we do not pay off the debt nor change entitlements, this means that the per capita share of the next generation will reach $220,000 (today’s dollar values) for every man, woman and child or roughly $800,000 per tax payer as these “obligations” turn into real debt.
Relieving a large part of the population from income taxes is a huge step toward socialization. If 40% of the working population pays no income tax, and many don’t even pay payroll taxes, there’s a massive voting block that cries for more benefits, thereby increasing the taxes on the other 60%. Without any stake in tax payments, the non-tax payers are saying give us a free law and order, free defense of our country, free education, free highways, free medical help, free Social Security, etc. Even a very small income tax would serve to represent some stake in our country. Instead we’re giving “refundable tax credits,” a pure welfare payment.
States and local governments are struggling to balance budgets. The states and local governments have their own problems of remaining solvent. They are cutting staff, wages and projects in an effort to balance their budgets, something the Federal government should but does not do. On 3/19/09 Steve Steckler of the Infrastructure Management Group reported that California has $200 billion of pension and retirement health care benefits not reported in the state’s $50 billion deficits. He said the problems will grow as, for example, New York employees can retire after 20 years with a full pension, so a person who started work at age 20 could retire at age 40 with no age reduction. Few in private industry could get a pension until in their sixties and even fewer would get health benefits.
Medicare and Medicaid pose some of our worst problems. Not only is Medicare one of the largest entitlements, it is getting hard to find doctors who will take Medicare patients—largely because of the financial constraints on medical facilities and doctors. Besides low Medicare compensation for doctors and hospitals, the payments can take years to reach the doctors and others. Furthermore, the number of geriatric doctors in practice and in medical schools is reducing while the number of patients is increasing. The addition of children and undocumented (read illegal) immigrants to Medicare and Medicaid rolls adds to the government costs. The government has increased the monthly cost of Medicare Part B to over $300 per month per person for those with higher incomes. At some point, it will be cheaper for people to buy private insurance thus further reducing Medicare Part B tax collections.
Demographic changes will increase the financial burdens of entitlements. It’s a well known fact that our nation’s population is aging, but the implications are often hidden. It is inescapable that the demands on Medicare resources will increase. Within our children’s lifetimes, the ratio of workers to retired people will fall from 3 workers for every retired person to only 2 workers—if the general population can still retire at roughly 65. Even if many can’t retire, the tax burden on the working part of the population will still increase because the elderly need the most medical care.
There is no leadership nor audience for realistic plans that might turn this calamity around. The government doesn’t want to hear it or take action because they are afraid to cut the size of their organizations, and it is political suicide to advocate benefit cuts and increased taxes. The finance industry thrives on growth and good news and delights with people borrowing more. Industry and commerce want to see people spending money even if they have to borrow it. Individuals have become so used to having a comfortable life with every gadget imaginable that they don’t want to hear they will have to cut back and save, not spend.
Likely outcome of current course: What will happen: First we’ll see depression as people buy less and save more. When people stop spending, then government tax receipts, industry, commerce, the economy and stock markets degrade rapidly. People lose jobs thereby exacerbating the situation. This will be followed by hyper-inflation as the government has to make our ever increasing debt more attractive with high interest rates.
We already have more government commitments than our incomes can support. The stimulus creates numerous costly government jobs to administer public projects. These increase entitlements that go on for decades. The government jobs have little multiplying effect on the economy, and they also add to our taxes for decades to the point where the generations that follow us won’t be able to afford to pay the resulting tax bills. The result will be collapse of economy and government unable to pay debts and obligations. This is no different than telling a person who already can’t pay his debts to both take on more debt and increase spending.
A large part of our national debt is held by foreigners. Foreigners will have to rollover our government bonds when the bonds mature. The resulting market rates of interest have to be competitive with many other investment opportunities. Funding the higher costs of this debt will increase future tax rates. Look for interest rates to increase everywhere. If foreigners don’t take our debt, our government will have to print more money resulting in hyper-inflation after the depression.
The Federal government is now buying debt and adding over a trillion dollars of printed money. This is being done to provide early interest rate reductions, but it comes at a high price later by increasing the opportunity for hyper-inflation.
The government will, at some point, have to include entitlement obligations in their budgets. Currently, the future payments for entitlements are excluded from the Congressional budget because Congress says it may change the rules for entitlements so that the obligations may not be so burdensome. May change the rules? It must change the rules. Congress will have to do some long-range planning, just as those in the private sector must do.
Part 2. An alternative solution:
At the onset, let me say that there is no way to stop a good deal of the government’s actions which are already underway. Hopefully, some of the spending will leave us with much needed maintenance of our transportation and transmission infrastructure. The alternatives below are something that can follow to help recover from our current course. The following steps can ameliorate depression and hyperinflation if the public starts to recognize that the majority of current actions are doing nothing but making the problem worse. These steps will require a new generation of politicians who can face up to the truth and forsake traditional promises of more benefits to sustain their offices.
I well remember T. A. Wilson, then chairman of Boeing, calling us in to a meeting where he announced that we were going to take severe cost cuts so that the company could survive. He painted the picture very colorfully including a statement I’ll never forget. “Either we do this ourselves, or the board will get someone with pince-nez glasses and ice-water in his veins to do it for us.” Then we started cutting executive wages, eliminating executive cars, speaker telephones, and other perks to set an example followed by very large percentage cuts in manpower. You may remember the Seattle billboard saying, “Will the last man out, please turn off the lights?” In one of the numerous ups and downs we had, my organization had an extraordinarily gifted chief engineer who had great difficulty laying off people because he knew them all so well. I had to reassign him and put in someone who could accomplish this very unpleasant task. I’ve never seen anything like these actions in the government.
Congress and the administration should lead by example with reduction of staff, benefits, and perks. Then Congress should start working with each department. For example, Congress could greatly simplify our tax returns thereby eliminating a large part of the IRS and reducing the time required to prepare tax returns by more than 20 hours per person. The major opposition to this is likely to come from those who want to use the tax code for social engineering as well as those who have gained great benefits by preferential treatment. Hard-nosed leadership could eliminate whole departments and get major concessions from government unions.
One obvious part of an alternative course is to cut entitlements (especially Social Security, Medicare, Medicaid, and government retirement benefits), reduce government employment and raise both payroll and income taxes as well as to build real “Entitlement Trusts” just as industry is required to have trusts for pensions with numerous rules for their implementation and management.
Crucial steps for Social Security and Medicare include increasing the full retirement age for Social Security to 70, increasing the age to start Medicare to 70, increasing payroll taxes (particularly the payroll tax for Medicare), and instituting more stringent eligibility rules , particularly for Medicare. The Medicare tax on working wages has remained at only1.45% (2.9% if we include the employer contribution) as long as I can remember. Yet Medicare incurs far greater costs than Social Security which has a larger payroll tax of 6.2% (12.4% with employer contribution). Obviously the payroll tax for Medicare should be higher, not lower than for the Social Security tax.
If the number and size of government employee pensions and retirement health care benefits don’t come down, tax rates will have to go up appreciably both at Federal and State levels. The increasing proportion of elderly people not paying income tax will exacerbate the problem.
It’s important to reduce corporate taxes. Corporate taxes are just another cost that has to be added to the price of a product in order to maintain profits and keep stock attractive. “Carbon credits” will further amplify product costs. Both corporate taxes and carbon credits are an equivalent of a national sales tax. Higher prices reduce the competitiveness of U.S. products on world markets thereby encouraging both more foreign imports as well as the use of foreign suppliers for parts, materials and services. Hence more jobs go abroad.
Other government actions should include securing the border and promoting furloughs and 4 day weeks in the government and private sector so more people can keep jobs and some income. Then encourage people to adopt the personal measures outlined below.
Personal measures: There are lots of things we, as individuals, can do to protect ourselves from everything but complete collapse of the economy. Here is a list that might be helpful:
· Reduce personal debts. (Credit card debt is probably the highest priority for reduction. A low interest mortgage may be OK.)
· Consider refinancing your mortgage if interest rates now significantly lower.
· Agree on a lower family budget and stay within it.
· Sell things you don’t really need anymore on the Net or elsewhere.
· Increase savings contributions.
· Use FDIC insured accounts for immediate cash needs.
· Buy bonds, not bond funds. (Increasing interest rates will destroy bond fund principal.)
· Consider Savings I bonds for the entire family. They are available from local banks and treasurydirect.gov.
· Invest in certificates of deposits (CDs). (Available from many sources. See bankrate.com)
· Buy Treasury Inflation Protected Securities (TIPS) in self directed IRAs or from treasurydirect.gov.
· Change to mutual funds with low upfront costs, low management fees and no kickbacks to advisors.
· Use financial advisors with low fees and no commissions.
· Downsize your home or rent. Renting provides mobility to get jobs elsewhere in the country.
· Rent out a room in your house, or stay with relatives or friends.
· Grow your own vegetables.
· Buy items with cash, not with loans.
· Get a second career as backup. Broaden your skills. Perhaps teach, start delivery service, tutor, etc.
· See about part or full time employment for an unemployed spouse.
· Rule out cars, cell phones or IPods for children--or even for yourselves.
· Make do with old computers, and software. Use no downloads requiring payments.
· May be able to get lower cost TV, internet and telephone services.
· Turn down the thermostat and wear sweaters.
· Encourage teenagers to work on weekends.
· Take advantage of tax deductions, Roth IRAs and 401(k)s and tax-exempt bonds if you are in a higher income bracket.
· Older people may not need life insurance or long-term-care insurance.
One of the most important personal items: Eat only healthy foods, exercise and keep weight under control. Take care of your teeth, eyes and ears. Neither Medicare nor most Medigap insurance policies cover teeth, sight and hearing. Good health is the best medical and long-term-care insurance you can buy.
This alternative to our current actions is a scenario that will work. It’s impossible to put numbers to our current course that will work within our lives or even generations that follow. The alternative course will let us survive, but almost everyone will be poorer. Our generation will take much of the blame because we're the ones who caused the problem with consumerism, corporate greed, politicians offering programs that we can't afford, dependence on the government and virtually everyone’s desire to own a house or McMansion.
Individuals do have two options as well: (1) Depend on government entitlements; (2) Try to become more financially independent and stay healthy. Dependence on the government offers no opportunity to improve personal conditions or that of a family. On the other hand, becoming financially independent and healthy will give blessings that few of us, our children and grandchildren could otherwise enjoy.
Thanks to the many people who helped with the material, especially Dr. John Broyles, Associate Fellow in Finance at the University of Warwick, U.K., who helped edit the material above and added this comment:
“An important perspective that we haven't discussed concerns the way all governments do their accounting. Whereas companies use conventional accrual accounting, governments use cash flow accounting. As you know people are extremely motivated by accounting performance measures, so the method of accounting affects decision making behavior.
“With accrual accounting, companies attempt to make a clear distinction between capital and income. For example, large cash flows going into real investments are charged to earnings gradually via depreciation. This encourages investment. By contrast virtually all governments use cash flow accounting. Tax money comes in and expenditure goes out. If more money goes out then comes in for a given year, there is a "deficit". The deficit gets funded by more taxes or by borrowing. As a result, investment orientation is not a feature of the system.
“The importance of the distinction is that cash flow accounting is the direct cause of the "Ponzi scheme funding" of the entitlements crisis you discuss [above].
“So it is not just political foolishness and "short termism". The problem is built into the financial accountability process. We cannot solve the long term financial problem while lumbered with archaic, intrinsically short-term cash flow accounting systems in government. So we have another option that the government is unlikely to adopt: Introduce accounting systems that recognize long term investment.”
A Math Lesson
So many people don’t know how to deal with numbers like trillions or billions or millions that the government easily pulls the wool over their eyes.
1,000,000 = one million
1,000,000,000 = one billion
1,000,000,000,000 = one trillion
So $12 trillion national debt divided by 80 million people who actually pay income tax =
$12,000,000,000,000 equals $1200000 equals $150,000 per taxpayer.
4% interest on $150,000 = 0.04 x $150,000 = $6,000.