3 Big Myths About the US Debt Crisis

UPDATED at 11 p.m. EDT September 8

Despite all the polarizing political commentary, the plain fact is we owe a staggering amount, mostly to ourselves...and it doesn’t help that our revenue base is smaller than ever, writes MoneyShow.com editor-at-large Howard R. Gold.

President Obama will ask for a much bigger payroll tax cut than expected in new legislation he previewed in his speech to a joint session of Congress Thursday night.

The American Jobs Act will include some old and new ideas that the president claims are acceptable to both Republicans and Democrats.

We'll see about that, but one thing was striking: The president asked the special committee of Congress charged with finding over $1 trillion of new spending cuts to come up with still more reductions to cover the ambitious $447 billion in new tax cuts and spending he’s requesting.

“Everything in this bill will be paid for,” he declared.

It was a stark admission of how limited his options are because of the debt crisis that’s likely to haunt the US and world economy for years to come.

But unfortunately there’s a lot of confusion about our debt problem. So, consider this column an effort to correct that by addressing three big myths about the national debt.

Big Myth No. 1: It’s Only a Spending Problem
Some claim that if you just cut spending, all the US debt problems will be solved. But, at least in the short run, it’s as much a revenue problem as it is a spending problem. (Entitlements are another story, and we’ll deal with it in a moment.)

Since World War II, the revenues the federal government took in from taxes and other sources averaged roughly 18% of gross domestic product, while spending (outlays) averaged about 20%. That’s not ideal, of course, but it's manageable. It stayed pretty close to that under President Bush after the four surplus years of fiscal 1998-2001 came to an end.

The roof fell in during fiscal 2009 (beginning in October 2008). To be sure, spending grew dramatically as the Great Recession bit deep. Some of it was automatic (more people became eligible for food stamps and unemployment insurance), and some of the increase was a result of new policies.

• Read about how President Obama and Gov. Romney are taking on the Tea Party on The Independent Agenda.

But even more astonishingly, tax revenues dropped to an appalling 14.9% of GDP in fiscal 2009 and 2010, and they’re forecast to rise to only 15.5% of GDP in fiscal 2011, which ends next month.

We haven’t seen those percentages since 1949 and 1950, and we didn’t come close to them in the nine recessions between then and now.

What happened? I asked David Walker, former US comptroller general and founder and chief executive officer of the Comeback America Initiative, who’s as knowledgeable on these matters as anyone.

“First, on the revenue side, we had a financial crisis,” he told me. “The financial crisis resulted in dramatic declines in the stock market, dramatic declines in home values, [and a recession that caused] a lot higher unemployment and a lot higher underemployment. People retired early.”

So, from an average of $2.5 trillion annually from fiscal 2006-2008, revenues plummeted about $350 to $400 billion per annum in the next three fiscal years. That added around $1 trillion to the debt during that time.

And without a big recovery, don’t expect to see revenues rebound soon, so the deep hole will remain.

Big Myth No. 2: Corporate Taxes Have Been Onerous Lately
To listen to some Republican presidential candidates, you’d think companies are carrying a ball and chain of a tax burden that’s holding them back from creating jobs in the US.

And the official tax rate of 35% of corporate income is among the highest in the developed world. Even the percentage of income companies effectively paid in taxes—nearly 28% between 2006 and 2008—is high compared with other countries.

Next: Myths About Corporate Taxes and Medicare

But lately it’s been a different story.

From a healthy $475 billion in 2006 (29% of profits), revenues from corporate income taxes plummeted to a rock-bottom low of $272.4 billion in 2009, a mere 20% of total profits.

And though corporate tax receipts rebounded strongly last year—up 50%, to $411.1 billion—soaring corporate profits (a record $1.8 trillion) kept the percentage of profits companies actually paid in federal taxes down to 22.8%.

Why? Because, ironically, the losses companies suffered during the recession actually helped them in the recovery.

“There’s a lot more aggressive tax planning going on in corporate America,” said Walker. One example: net operating loss carry-forwards, in which companies use past losses to offset gains, and reduce the amount of income on which they’re taxed.

The sheer volume of companies’ profitability has caused tax receipts to rebound somewhat—but not yet to their 2006 peak—and they may not get back there for a while.

Big Myth No. 3: I Paid for My Medicare, So I'm Entitled to Every Penny
Yes, you are entitled to it, but you didn’t pay in anywhere near what you’re going to take out.

Recent surveys show that 60% to 80% of Americans think they’re paying enough in payroll taxes to cover all their Medicare and Social Security benefits in retirement.

Yet economists Eugene Steuerle and Stephanie Rennane of the Urban Institute found that “upon retiring in 2011, [a couple earning $89,000 a year] would have paid $114,000 in Medicare payroll taxes during their careers. But they can expect to receive medical services—including prescriptions and hospital care—worth $355,000, or about three times what they put in,” the Washington Post reported.

The same couple, the researchers estimated, “will have paid $614,000 in Social Security taxes, and can expect to collect $555,000 in benefits. They will have paid about 10% more into the system than they are likely to get back.”

Of course, as more and more baby boomers retire, that’s almost certain to change.

If you account for these unfunded obligations the way companies have to estimate future claims for pension benefits or retiree health care costs, the amount we owe is staggering.

Are you sitting down? The Comeback America Initiative and USA Today crunched the numbers somewhat differently, but they came up with the same total: $61.6 trillion. Medicare will take the biggest bite of that—$35.1 trillion in CAI’s estimates and $24.1 trillion by USA Today’s count.

This is as radioactive as plutonium for politicians, and Democrats especially are in complete denial about it. But the failure to address entitlements was a big factor in Standard & Poor’s decision to downgrade US sovereign debt from AAA last month.

• Read Howard’s column predicting the US’s loss of AAA status.

The $2.1 trillion in spending cuts Congress and the president mandated to prevent default sounds like a big number, but it’s a joke compared with that $61.6 trillion in long-term obligations.

“They punted on entitlement reform and they punted on comprehensive tax reform,” said Walker.

According to AARP, 7,000 baby boomers turn 65 every day, "and we’re just on the leading edge,” said Walker.

In fact, they start being eligible for Medicare en masse this year. The long procession of 70 million boomers with their hands out ready to collect the Social Security and Medicare they “paid for” will go on for almost the next two decades—and many will live for years after that.

Who said what doesn’t destroy me makes me stronger? We’ll find out whether that is another big myth.

Howard R. Gold is editor at large for MoneyShow.com and a columnist for MarketWatch. You can read more of his commentary at www.howardrgold.com, and check out his political blog at www.independentagenda.com.