Red Ink (13 page)

The result is an industry of middlemen devoted to helping people find property to buy and sell, and matching the transactions in ways that the IRS considers like-kind. One twelve-year-old outfit, Accruit LLC of Denver, secured a patent in 2008 on its method of matching buyers and sellers to assure that their exchanges comply with the tax rules. (In September 2011, Congress said no more patents could be issued for “
any strategy for reducing, avoiding or deferring tax liability.”)
There are even “reverse exchanges” where—as one 1031 broker describes it on its website—“
you can make a new purchase prior to selling the current asset, allowing you to continue generating revenue from your original asset.”

Real estate, cable television, and other industries argue that if investors had to pay capital gains taxes, they wouldn’t swap one property for another even when the trade made sense, such as for consolidating adjacent cable franchises. Perhaps. But consider this example Accruit posted on its website:
Joe and Marilynn Croydon (not their real names) collected and restored vintage cars. A buyer was interested in several of their Formula 1 race cars to the tune of $2.5 million. “After going through countless part orders, mechanic expenses and original purchase prices,” the couple figured they would turn a $1.97 million profit—which at the current capital gains tax rate on collectibles meant a tax bill of $552,440. Their accountant recommended a 1031 exchange, and the couple began looking for other cars to buy with the proceeds of the sale.

Eventually they found four of them—a 2008 Lamborghini Reventon ($1.2 million), a 1969 Yenko Camaro ($180,000), a 1981 BMW M1 ($133,500), and a 1933 Duesenberg Model J ($1 million). That more than covered the $2.5 million proceeds. They didn’t have to pay the $542,400 in capital gains taxes immediately. And with smart accountants and careful planning, a tax deferred can become a tax never paid. Accruit said in its account that the gains might escape taxation altogether if the cars were bequeathed to the Croydon children.

The tax code has few defenders these days. It’s criticized for being too complicated and too onerous, for pushing companies overseas and rewarding them for going abroad, for discouraging saving and restraining growth. In concept, tax reform is popular. But ultimately reforming the tax code turns on some big, contentious issues. Will Congress actually force
anyone
to surrender a cherished provision of the tax code? Will it raise anyone’s taxes, even if only to come up with the money to lower taxes for everyone else? Can Republicans and Democrats resolve their standoff over whether the tax code should bring more money to the Treasury in the future than the unreformed tax code would?

A
lthough it is said that the most important things in life cannot be measured, American presidents are judged in real time by numbers, particularly when it comes to the economy. There’s the unemployment rate, the one economic statistic everyone instantly understands. And the price of gasoline, the largest price tag on anything sold in the entire country. And the stock market, an instant barometer of the mood of the business and investing class.

Then there’s the budget, the national credit card bill. By that metric, where did the United States stand in the fourth year of Barack Obama’s presidency? Four years older, and deeper in debt. “
We’re driving seventy miles an hour toward a cliff,” says Bob Reischauer, the former CBO director. “And when we reach that cliff will be determined by events over which we have very little control. The path we’re on can’t go on for fifteen years. Whether it can go on for two, three, four years, I have no idea.”

In Washington, where no one seems to agree on anything these days, substantial agreement actually exists on this assertion. Problem is, there’s next to no agreement on
what
to do about it and
when
.

The debate over how to steer the budget has produced a multiact Washington drama for the past couple of years. Act One was the rush to rescue a collapsing economy in 2009 with fiscal stimulus, and the bitterness over bank bailouts. Act Two featured tension among Obama’s brainy, big-ego economic advisers about whether to pump more money into the economy and when to shift to worrying about deficits. In Act Three, a procession of bipartisan blue-ribbon groups assembled to seek compromise, none of which forged a consensus broad enough to produce action. Act Four involved a confidence-shaking showdown in August 2011 between the White House and congressional Republicans over raising the ceiling on federal borrowing. And then came Act Five, the legislation that emerged from the showdown that threatens deep, across-the-board spending cuts at the beginning of 2013 unless some deficit-reducing alternative passes before then. In classical tragedy, this is known as the denouement. In Washington, it could be just farce.

Each episode had political consequences, ripples that almost surely will influence the outcome of the 2012 presidential and congressional elections. But in the midst of the political jockeying and brinkmanship, the relevant
economic
consequences
of the past four years can be summed up in two fiscal facts. Everything else is pretty much detail.

The first fiscal fact is this:

A running argument among Obama advisers early in the administration—one that has continued in the after-action books—involves whether the Obama fiscal stimulus
should
or, given political realities,
could
have been bigger than the $787 billion initially approved by Congress in February 2009. There were unending debates about whether the mix of spending increases and tax cuts in that package was optimal: Too much in tax cuts or too little? Too much spending that went instantly into consumers’ hands or too much on “shovel-ready” construction projects that took years to launch? The 2012 presidential campaign has homed in on whether the fiscal stimulus did any good at all. Barack Obama said it helped save the United States from repeating the Great Depression. Mitt Romney called it a failure that amounted to “
throwing $800 billion out the window.”

The fiscal response was big by the standards of history, but then so was the recession. The first shots were fired by what are
known in budgetspeak as “automatic stabilizers,” the built-in features of the budget that resulted in more spending (because more people were unemployed or eligible for food stamps, for instance) and lower tax receipts (because few people had income on which to pay taxes). These added up to well over $300 billion a year for 2009, 2010, and 2011, CBO estimated. Then came the Obama fiscal stimulus—or, as he prefers, “the Recovery Act.”
CBO’s latest price tag on that: $831 billion over a few years, more than initially estimated because the economy was worse, so more were eligible for aid. And then, with the economy still languishing, came the $100-billion-a-year payroll tax holiday for 2011 and 2012, temporarily reducing the payroll taxes workers pay by 2 percentage points.

The argument that such massive spending had
no
impact on the economy at all hasn’t much merit. It isn’t possible to throw that much money out of the window without someone getting a job and someone spending more than he or she otherwise would. Even Obama critic Douglas Holtz-Eakin, a former McCain adviser who now heads his own center-right think tank, allows, “
No one would argue that the stimulus has done nothing.” (Never mind that Republican candidates routinely argue just that.)

Yet it’s easy to understand why many ordinary citizens see the stimulus as a failure, given how poorly the economy did after the money began to flow. Gauging the impact, measuring the bang for the billions of bucks, requires an exercise
with which economists are comfortable and the public isn’t—comparing today’s economic conditions to what they would have been without the spending increases and tax cuts. “
Suppose a patient has been in a terrible accident and has massive internal bleeding,” Christina Romer of the University of California at Berkeley told a League of Women Voters audience in August 2011, a year after leaving her post as chair of Obama’s White House Council of Economic Advisers. “After life-saving surgery to stop the bleeding, the patient is likely to still feel pretty awful.… But that doesn’t mean the surgery didn’t work.… Without the surgery the patient would have died. Well, the same is true of the economy back in 2008 and 2009.”

Economists like Romer who believe that fiscal stimulus is a potent weapon against unusually severe recessions use economic models and rules of thumb that kick out big beneficial impacts. Witness
Harvard’s Larry Summers, adviser to Clinton and Obama: “Do you really believe if we had done nothing in response to the crisis in 2008, it would have been a good idea?” But other economists have less faith in fiscal potency, and they produce models that reveal smaller impacts—or even none at all. Witness Stanford’s John Taylor, adviser to both Bushes: “They [tax cuts and spending increases of stimulus] wither and they don’t give you a lasting recovery,” he said. “It goes away and we are even weaker than before.”

Though the debate over the efficacy of fiscal stimulus will go on, the consensus among
economists
is that the spending
and tax cuts did more than a little good.
A February 2012 survey of forty of the biggest names in academic economics (“the world’s best economics department,” the organizers at the University of Chicago Booth School of Business call it), for instance, found near-unanimity on one point: 90 percent said that unemployment was lower in 2010 than it would have been had there been no stimulus.

Bob Reischauer, seventy, is with the consensus. The physically towering economist, son of prominent Japan scholar Edwin Reischauer, is one of the wise men of budgeting in Washington. Recently retired as head of the Urban Institute think tank, he spent his entire career at CBO—he was one of Alice Rivlin’s lieutenants in the agency’s infancy—and at Democratic-leaning think tanks in Washington. Reischauer’s influence is amplified by his unusual combination of hard-nosed political realism with trenchant economic insight and by reporters’ affection for his pithy sound bites. “
I’m a believer that Obama saved us from a world depression,” he said. “And the American people give him zero credit for that—99 percent of the population has no appreciation for what kind of threat it was.” That’s an overstatement: the public has warmed to the stimulus as time has passed and the economy has perked up.
In a February 2012 Pew poll, 61 percent said it was “mostly good” for the economy, substantially more than the 38 percent who voiced approval two years earlier.

Whatever the merits, that money has been borrowed, and it has been spent—which leads to the second fact:

On the day Obama took the oath of office, January 20, 2009, the U.S. government owed $6.3 trillion to others—$6,307,310,739,681.66 to be precise, according to the Treasury’s “
Debt to the Penny” website. That works out to $54,000 per household or 45 percent of GDP, the yardstick that measures the debt against the size of the whole U.S. economy.

On February 13, 2012, when Obama sent his budget to Congress, the government owed $10.6 trillion—$10,596,768,009,341.49. That’s $90,000 per household, or nearly 70 percent of GDP, higher than at any time in the past sixty years.

The real problem lies ahead, as Reischauer suggested with his car-at-the-cliff analogy. Obama said as much the day his February 2012 budget was released: “
[T]ruth is we’re going to have to make some tough choices in order to put this country back on a more sustainable fiscal path. By reducing our deficit in the long term, what that allows us to do is to invest in the things that will help grow our economy right now. We can’t cut back on those things that are important for us to grow. We can’t just cut our way into growth. We can cut back on the things that we
don’t need, but we also have to make sure that everyone is paying their fair share for the things that we do need.”

But Obama’s latest budget showed that even if Congress accepted every one of his money-saving and tax-increasing proposals and even if his health care law worked as hoped and even if the economy steadily improved, the government would still need to borrow another $4 trillion over the next four years, and the ratio of debt to GDP would keep climbing. And that
doesn’t
count trillions more in unfunded promises to pay benefits in the future, which are not formally recorded on the government’s books.

For most of recent American history, most U.S. government borrowing was domestic—the Liberty Bonds sold during World War I, War Bonds sold during World War II, the savings bonds that generations of grandparents gave at graduation time, the U.S. Treasury bonds held in Americans’ trust accounts and pension funds. “We owe it to ourselves” was the comforting mantra. No longer.
Back in 1955, when the federal debt was much smaller, less than 5 percent was held by foreigners. Foreign holdings began to climb in 1970 and surged in the 2000s. Today, foreign governments and private investors hold nearly half of all the U.S. government debt outstanding. A big chunk of this lending is from China and Japan. They have been big
savers, so they have a lot of money to lend to foreigners. And they export a lot more to the United States (when dollars flow into China) than they import (when dollars flow out of China), which leaves them with a growing stockpile of dollars that has to be invested somewhere. The U.S. Treasury bond is still the safest place to put them.