“Irresponsible.”
That’s the word that some politicians in the United States Congress have been using this week to describe their opponents’ demands to balance the federal budget.
Just imagine what that says about the state of US public finances: that even the mere thought of having a balanced budget… of living within your means… is “irresponsible”.
What’s really sad, though, is that even the politicians who want to balance the budget don’t seem to have a firm grasp of the facts.
Consider that, in fiscal year 2022, the federal government brought in $4.9 trillion dollars of tax revenue.
That is an insane, record amount of money. With nearly $5 trillion in tax revenue, you should be able to do anything you want and still have plenty of money left over.
In fact even as recently as 2019, $5 trillion in tax revenue would have easily covered the entire federal budget, with about half a trillion dollars left over to start paying down the debt.
So if the government had just kept the budget steady, last year it could have paid off $500 billion of its $31.5 trillion national debt.
Instead, last year the government opted to ADD $1.375 trillion to the debt by spending $6.27 trillion in FY2022.
Now politicians insist on raising the debt ceiling, so that the government can once again borrow to overspend its revenue by more than a trillion dollars.
The obvious solution is to slash spending. But this is a lot more complicated than most people realize.
In FY2022, for example, the government spent $706 billion just to pay the interest on the national debt. In other words, they had to borrow money just to pay interest on money they have already borrowed.
And if rates keep rising, the government’s annual interest bill will quickly reach $1 trillion or more.
Then there’s the obvious problem of entitlements, like Social Security… and the spending that is considered ‘sacrosanct’, like defense spending.
These components of federal spending are so vast, in fact, that if you take Defense, Veterans Affairs, Social Security, and Medicare off the table for cuts, you would have to cut 85% of all other federal spending in order to balance the budget.
National parks. The electric bill at the White House. John Kerry’s private jet travel to Davos. Highway spending. Thousands of federal agencies that most of us have never heard of, like the Office of Human Research Protection.
85% of all of that would need to be eliminated in order to balance the budget… and few politicians have the courage to make such deep cuts.
Compounding the problem is that tax revenue could easily fall if there is a recession.
During recessions, consumer spending slows, company profits shrink, unemployment increases, and incomes contract. That means the government will not collect as much money from corporate taxes, income taxes, and capital gains taxes.
A recession probably also means more federal stimulus, i.e. higher spending. So the deficit would increase even more.
Another major issue, of course, is that Social Security is set to run out of money in the early 2030s. And this is not some wild conspiracy theory.
As I’ve pointed out on many occasions, the Social Security Administration admits every year in its annual report that Social Security will be insolvent within a decade or so.
This is most certainly going to require a multi-trillion dollar bailout… which is going to put even more extreme pressure on public finances.
It also practically guarantees higher taxes, especially payroll taxes.
In the United States, federal payroll taxes currently take 15.3% of each paycheck when you add up both the employer and employee contributions to Social Security and Medicare.
15.3% is actually quite low when compared to other countries internationally. For example, after recent increases, the combined employee and employer payroll taxes in the UK have reached 28.3% of each paycheck (with certain exclusions).
Even Estonia, which is generally considered a low-tax country because of its flat 20% corporate income tax rate, charges a 33% payroll tax.
So the US has a LONG WAY up on its payroll tax before getting anywhere close to international averages.
And there are already calls for higher individual income tax rates, wealth taxes, higher capital gains taxes, and more.
Most likely this is going to be part of the “solution”, i.e. the grand bargain that politicians will finally be forced to make a few years down the road.
On one hand, they will agree to deep cuts to countless government programs. They’ll also likely roll back the retirement age on Social Security, which essentially constitutes a default on the promises they’ve made to millions of Americans.
So instead of retiring at 62 or 65, it will be increased to more like 72 or 75.
But in exchange, politicians will also agree to radically increase taxes…
Naturally, the guy who shakes hands with thin air won’t say any of this in his State of the Disunion address tonight. But realistically it’s the only path forward over the next few years.
There are a few key implications here:
One, don’t rely on Social Security to fund your retirement.
Two, take steps now to reduce your tax rate.
You can actually do both of these things in one step by using tax advantaged retirement accounts.
For example, if you contribute an extra $5,000 per year to your 401(k), that reduces your current taxable income by the same amount…
PLUS that $5,000 invested through your retirement account will grow tax free.
If you do that every year, and it compounds at a rate of 9%, you are talking about an extra $461,000 saved for retirement after 25 years.
Meanwhile, you contributed $125,000 that you didn’t have to pay taxes on.
Sure, you’ll have to pay taxes when you collect distributions. But FIRST it will grow tax free for 25 years.
And that makes a huge difference. (You’d earn about $111,000 LESS over 25 years if you first paid a 24% tax on each $5,000 BEFORE investing it.)
This is just one example to highlight the fact that while these problems are unlikely to be solved by the government, you can make sure that they don’t destroy your retirement.
And you can make sure you don’t get left holding the bag by paying higher tax rates than necessary.
That’s the whole point of a Plan B — to take control of your own circumstances, so your future is not a gamble left up to politicians.
