By John Mauldin

The payroll tax, as a way to pay for Social Security, has been 12.4% since 1990, with half paid by workers and half paid by business. Late last year a temporary payroll tax cut of 2% was enacted. This saved an average family of four about $1,000 per year and affected 160 million taxpayers. It is not peanuts. It also "cost" about $120 billion in revenue (best estimates). This is about 0.8% of GDP. Remember that number.

Let's review the economic implications of tax policy. Depending on which academic study you want to use, tax increases or cuts have a "multiplier" effect of anywhere from 1 times (Harvard and Italy) to 3 times, the latter from Obama's former head of the council of Economic Advisors, Christina Romer, and her husband, both at the University of California Berkeley (not a hotbed of conservatism). Let's use 2 times as an average for our discussion, but you can adjust to suit your favorite academic study (you have read all those papers, haven't you?). Various studies show that spending cuts exert an effect for about 1 year before they are "absorbed" into the economy, and tax cuts take a little longer to have their full effect.

I think it likely that we will see that the US economy grew less than 2% in 2011, and probably closer to 1.5%. If there is a 2 times multiple on tax cuts, then the stimulus was worth anywhere from 1% to 1.6% of growth in 2011 (depending on your favorite academic paper), which is much of (and maybe most of) the growth we had in the US this last year.

As I write early Saturday morning, it looks like the payroll tax cut extension will only be for two months. This would mean that taxpayers may see a roughly $100 per month cut in take-home pay, starting in March. This means that the economy will take a growth hit starting in March. So why not extend it for a year? Or even two? Why not wait until the economy is stronger?

The problem is that the US fiscal deficit is about 8% of GDP. We already have a debt-to-GDP ratio of between 80% to 98%, depending on how you count intergovernmental debt and nonfederal debt. But let's use the lower number.

That means, if we do nothing about the deficit, in three years we are over 100%. We know (Rogoff and Reinhart and the BIS studies) that potential growth decreases above the level of 90% debt-to-GDP. We also know that as the debt grows, so does the cost of interest to pay the debt.

Let's run a thought experiment (for the purposes of simplification) on a country with a large debt of, say, 80% of debt-to-GDP and a deficit of 8%, with interest costs of about 2%. Revenues are 16% from taxes, and expenses are 24%.

First, that means that the debt carries an interest rate cost of about 1.6% of GDP, or around 10% of revenues. If the debt rises to 100% of GDP, then the interest costs will rise to about 2% of GDP, or about 12.5% of revenues. This will force spending cuts or tax increases if the deficit is not allowed to rise.

But wait. If we cut spending (also known in Europe as austerity), then we will see a negative tax multiplier of about 1.5% of GDP over that time period. That means it will be harder to grow our way out of the problem, especially if the economy is growing at less than 2% annually. Debt at the levels we are talking about makes it much harder to grow yourself out of debt.

Part 2

Let's look at a paragraph from a very recent paper by the Boston Consulting Group entitled "What Next? Where Next?":

"The inability to grow out of the problem is bad news for debtors. Look at Italy, for example: Italian government debt is 120 percent of GDP. The current interest rate for new issues of ten year bonds is 7%, up from 4.7% in April 2011. If Italy had to pay 6% on its outstanding debt , such a high rate would materially increase the primary surplus (That is, the current account surplus before interest expense) that Italy would need to run in order to stabilize its debt level.

"If we assume that Italy's economy grows at a nominal rate of 2% per year, the government would need to run a primary surplus of 4.8% a year of GDP just to stabilize its debt levels; the latest forecast show only a 0.5% surplus for 2011. Any effort to increase the primary surplus through austerity and tax increases runs the risk of creating a downward spiral. When investors start doubting the ability of the debtor to serve its obligations, interest rates rise even further, leading to a vicious circle of austerity, lower growth and rising interest rates."

What if interest costs in our hypothetical country rose to 4%? That would mean that 25% of tax revenues (over time) would be consumed by interest. (Yes, I know, there is a lag effect. I am trying to keep it simple.) That means either further spending cuts or tax increases. Which leads to the vicious circle of austerity that the BCG writes about

This is why Nouriel Roubini says that Italy is better off simply defaulting on its debt and reducing the overall debt by about 20%. The arithmetic says that Italy would be better off, as the hope of using spending cuts and tax increases (austerity) as their way out of the current problem is rather bleak.

And while we deal with the European problem in Endgame, we also note that the US risks becoming like Italy in a few short years.

Sounds extreme? Here's my reasoning. If you invest in developed-market sovereign debt, it is because you are seeking as close to risk-free returns as you can get. Who buys US debt looking for risk?

The bond market is going to watch the train wreck that is European sovereign debt, and the soon-to-be train wreck that is Japanese debt, and if the US does not show a clear path to a sustainable deficit by 2013, at which time our debt-to-GDP will be closing in on 100% (however you want to calculate it), and then I think the bond market will say, "We have seen how this movie ends in Europe and Japan. We are now watching the same movie in the US. If you don't mind, we'll leave at intermission."

Once rates start to rise, the options faced by the US are not good. Real spending cuts and tax increases in the midst of a crisis? Allowing the Fed (or essentially forcing it) to monetize the debt? There will be no good choices if we do not act.

Whenever the payroll tax cut extension goes away, it will mean an effective tax increase of the same magnitude of the tax cut. In our example, about a 1% to 1.6% hit to GDP. Think the economy is strong enough to handle that without going back perilously close to recession? As states and local governments are raising taxes by about 1% of GDP? As Europe implodes?

These are the headwinds I keep writing about. These tax cuts and increases make a difference in the short, 1-2 year term. Big time difference! Do you in effect hit the economy going into an election? But if not now, when? If we fail to get the deficit under control, we soon become Italy. Can we go another year? Sure. But the longer we wait, the fewer options we have. We are going to have to face the music at some point. Better to control it now!

The only way to do this is an economically rational way is wholesale restructuring of the tax code and restructuring of entitlements. We should consider replacing the payroll tax completely.

No room today to go into these solutions tonight (but we will later!) There are tax cuts and increases that have better multipliers. If you combine or substitute taxes that have bad multiples with those that have benefits, you can partially offset the effect of the spending cuts and tax increases.

There is a way. It will take a level of cooperation we have yet to see, or one party in total control of the process. And then it will take courage.

The US has no easy choices. Our choices now are merely very difficult. If we delay much longer, past 2013, our choices go to bad or very bad. Different in kind from those of Europe but not in difficulty or the quality of outcomes. We are edging closer to the Endgame.

We must combine the above with policies that create jobs. We must have growth as part of the solution. We can get through this in the US if we choose to. But the sense of urgency needs to get turned up.

Glad to see you post something that calls austerity for the economic BS it is :tro:

And part two calls for tax increases! Well done!

Now, his proffered solution : "The only way to do this is an economically rational way is wholesale restructuring of the tax code and restructuring of entitlements. We should consider replacing the payroll tax completely."

doesn't even fit with the proofs of the arguments he himself made, but that's SQUIRREL! lovers for ya. They have never been known for logic.

That is what you got out of that? lol

I'm really not sure what to say...

You might try reading it more objectively. But I don't hold much hope.

Nice opinion column. Lots of assumptions and illogical leaps there, so it's basically nonsense, but thanks for posting it.

if you want to see nonsense check out post 39

Oh, snap! You nailed me! You are so powerful! :D

John Maudlin: "Guru Accuracy Rating 40% This is below average (current guru average is 48%".)

Seems the writer hasn't been proven to have a reliable opinion, especially for a "renowed financial expert"

http://www.cxoadvisory.com/3338/indi.../john-mauldin/

"We're not broke..... we have Laser Printers!!!"

1. You are the least objective poster here
2. It is an attempt to in fairly plain terms explaining why what you wrote before is complete bullshit
3. When attempting to forecast something you must make a few assumptions, all of which were clearly explained.
4. When it comes to economics how exactly would you know what is illogical?
5. For a better version of nonsense refer to your typical prattle from mother jones and daily kos

It is a basic overview of some current economic issues. What points are you not in agreement with? Oh that's right you are clueless so you choose to come up with bullshit about the writer?

Oh thats right his explaination makes your dissertation laughably wrong.

But do you have any opinion on the drivel opinion column you posted? How does what that writer says relate to what I wrote? Are you saying the writer speaks for you? A guy that's wrong about the financial world 60% of the time?

Or can't you do anything more than ad hominem?

Again: nice of you to post an opinion column filled with assumptions and guesses by a self-employed "economist" with a 60% economic prediction error rate. It was interesting.

What do YOU think, for example, about the vote being taken this evening in the House. Do YOU think the vote should be yes or no?

I would discuss it with you if you understood what he was talking about which you clearly dont.

Well, that makes it easy. Ad hominem only it is :tro: Too bad. In your desperation to use bad logic to prove that the deficit is the biggest problem in this country, I'd like to know what you think about the Fed giving Europe $1 trillion? Because, you know, we are so broke and all.

after post 39 in this thread, you should be forced to retire. Blame it on a bowed brain tendon.

lol keep talking and proving my point...

Be sure to give your Social Security money to that economic guru you quote.

The funny thing is that I used that article because it pretty reasonably explains the issue of national debt in terms most reasonable people can understand. It isnt political in nature, explains its assumptions and why it is making them and more or less shows that the best answer in the long term is to change the system as opposed to what the politicians will do which is try to manage it in short term (for political gain). Naturally Riot (mostly because she doesnt understand economics at all) finds things like Austerity is bs, the writer is an idiot, I'm using "bad logic" whatever that means, etc.

Keep talking...

Well, not exactly, but don't let that stop you from falsely characterizing.

Look: whenever you don't like what someone posts, you pull out some obscure opinion piece and present it as inalienable fact. It's what you do.

As I said: Nice opinion column. Lots of assumptions and illogical leaps there, so it's basically nonsense, but thanks for posting it.

Go ahead and tell me what you didnt agree with.

And lets be serious, on a regular basis you post inane bullshit from daily kos and motherjones which is mostly outright lies and voodoo bs appealing to the morons that follow those sites as actual news or analysis.