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Cutting Taxes

Will It Mean Smaller Government or Bigger Deficits?

Mary-Jo Kranacher, MBA, CPA/CFF, CFE

Our nation's presidential election is quickly approaching. According to most polls, the candidates are running neck and neck, seeking to boost their popularity by promising to cut taxes; however, they differ sharply in just whose taxes they want to cut. But how can either party do this without jeopardizing an already fragile economic recovery, risking the fiscal well-being of future generations, or digging our nation into a deeper financial hole?

The Democrats propose paying for middle-class tax cuts, in part, by allowing the 2001 and 2003 Bush-era tax cuts (i.e., the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003) to expire for individuals who earn more than $200,000 (single) or $250,000 (married), establishing a cap on itemized deductions for high-income individuals, increasing the preferential tax rate on capital gains and dividend income from 15% to 20%, and reforming the corporate tax structure to eliminate many existing loopholes. If the Bush-era tax cuts are allowed to expire at the end of 2012, high-income earners will see their current marginal tax rates of 33% and 35% increase to 36% and 39.6%, respectively.

The Republicans have advocated a one-year extension of the Bush-era tax cuts—including the preferential rates on capital gains and dividend income—for all taxpayers, while letting the tax breaks created by the American Recovery and Reinvestment Act of 2009 expire. Intended to stimulate the economy, these provisions—the expanded earned income tax credit, child tax credit, and tax credits for higher education costs—have primarily benefitted low- and middle-income taxpayers.

Federal Spending

According to the Congressional Budget Office (CBO), more than 80% of the federal government's revenue comes from individual income taxes and payroll taxes. (See the 2011 report, Reducing the Deficit: Spending and Revenue Options, www.cbo.gov/sites/default/files/cbofiles/ftpdocs/120xx/doc12085/03-10-reducingthed-eficit.pdf). Regardless of which party wins the election, a decrease in revenue—a result of the proposed tax cuts—will require some tough choices.

As financial experts, CPAs know the details of budgeting better than most people. So let's look at what we have to work with: Mandatory spending currently accounts for more than half (55%) of all federal expenditures. Entitlement programs—such as Social Security, Medicare, and Medicaid—represent approximately three-quarters of mandatory spending, and spending on these large programs will continue to increase as our population ages, unless modifications are made soon. Furthermore, Social Security's dwindling cash surpluses will remove the cushion the federal budget has enjoyed in the past. Legislators can change eligibility requirements, adjust benefit formulas, or modify other factors on the margins to impact spending on mandatory programs. But unless our country's leaders are able to make fundamental changes to the social safety net—the kind of changes that voters have traditionally opposed—we're doomed to lose the battle of our bulging budget.

According to the CBO report, interest expense consumed 6% of federal spending for 2010, leaving 39% to discretionary spending—split almost equally between defense and nondefense spending. The U.S. Government Accountability Office has been unable to render an opinion on the federal government's consolidated financial statements for years, largely because of “serious financial management problems at the Department of Defense” (http://www.gao.gov/products/GAO-12-444T). Intervention or investigation into this part of the government's finances is not allowed, ostensibly for national security reasons—or, as some have jokingly quipped, “if they allowed you to access this information, they'd have to kill you.” So, unfortunately, an informed decision on cutting defense spending and finding savings in this part of the budget is unlikely to be part of the national debate.

The nondefense portion of discretionary spending pays for emergency functions (i.e., homeland security, disaster relief, foreign aid), transportation (e.g., bridges, highways, other infrastructure), recreation (e.g., national parks), and public education programs (e.g., Title I grants for disadvantaged students). For better or worse, these areas are likely to see cuts, however minimal they might be in the grand scheme of things.

Some might call me a skeptic, but I don't see our representatives in Washington mustering up the political courage to make the hard choices needed to prevent further deficits. Perhaps we should remind them that external forces are not the only threat to our country's security. Consider a quote often attributed to John Adams: “There are two ways to conquer and enslave a nation. One is by the sword. The other is by debt.”

As always, I welcome your comments.

The opinions expressed here are my own and do not reflect those of the NYSSCPA, its management, or its staff.

Mary-Jo Kranacher, MBA, CPA/CFF, CFE. Editor-in-Chief. ACFE Endowed Professor of Fraud Examination, York College, The City University of New York (CUNY), mkranacher@nysscpa.org.

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