The sky is falling; California might have to pay with IOU's...again.

As federal and state regulators shut down four banks Friday, the State of California is not looking so good either.

This week the California Supreme Court allowed the Gubernator to order 144,000 state workers to take three days of unpaid furloughs each month. State Controller John Chiang said that the state is running out of cash and might begin issuing IOUs within two weeks because the Legislature has not adopted a budget for the fiscal year that began July 1.


"I must be clear that this year's looming cash crisis is fundamentally different than last year's," Chiang explained in aa speech Wednesday. "Importantly, the fiscal crisis we face this year is 100 percent political, and the only thing standing in our way is the absence of leadership."

Uh, someone should have commented it's always been political, John. We have a mostly inexperienced Legislature because of voter mandated term limits and the voters mandated a two-thirds vote in both the Senate and Assembly to approve a budget knowing the Republicans would likely always hold slightly more than a third of the seats in each house. It's an election year. It's politics. We don't have a State budget and we probably won't have one until after November.

That's the situation in Sacramento. Meanwhile, back in reality the federal survey data for July came in and according to it, we lost 25,102 jobs and added 89,916 to the workforce showing a "seasonally unadjusted" unemployment rate of 12.8%. During the four weeks of July, the Employment Development Department reported that 314,142 initial unemployment claims were filed compared to the 155,188 filed during the same four weeks in 2006.

Looking at the actual number of people who have jobs as indicated by the federal survey and the EDD report, we can establish that the job loss since the 3rd quarter of 2008 looks something like this and we can project a trend (click on the graph to see a larger version):

Unfortunately, the state's economy has bottomed out which means State General Fund revenue hasn't bottomed out.

It appears we will have lost 1.3 million jobs by June 2011 resulting in further loss of income and sales tax revenue. So what on Earth makes anyone think they can project a budget that doesn't involve "slash and burn" cuts to schools, welfare, and health care and significant tax increases?

Or is the plan just to sit back and run out of money? Like we have in prior years.

Taxing the "rich" and "not-rich"

The airwaves and blogosphere are filled with a deluge opinion flowing around the expiration of "The Bush Tax Cuts for the Rich." Either we need that tax money to reduce the deficit or we need the rich to keep the money so their investments will help the economy will recover. We are assured the sky will fall if the tax code returns to the way it was in the 1990's.

The debate around this subject seemed too much like specious campaign rhetoric to ignore. Most certainly, how the federal income tax is structured will be of importance to everyone. But what are the facts underlying this rhetoric? And if there is a problem, how would I solve it?

The Expiring Tax Policies

Of course, the facts are very different from the debate. A number of elements are involved in the tax code changes that expire December 31, 2010. The most obvious involves the rate tables published in the press and online as follows:

Table 1

If the rate tables in Table 1 by themselves don't confuse you, nothing will and you don't need any help with the issue. Since income steps are not the same on each table, I don't know how you could not be confused.

Beyond the differences in income steps between plans, the "taxable income" brackets shown are not your income. Even if all your income is taxed normally (for instance you don't get any capital gains tax breaks), at a minimum you can take the standard deduction and get the per person exemptions. The total of those on your return represent tax free income as follows (ignore the "My Plan" line, we'll deal with that later):

Table 2

Ok, so the confusing tax rates in Table 1 aren't applied until the income shown in Table 2 is deducted. Then, if you add in the fact that there is a Child Tax Credit which you can deduct from the taxes you owe but which will drop from $1,000 per child to $500 per child if the 2011 plan goes into effect, things get even more confusing.

I had to spend time with a spreadsheet to do a little comparison. I assumed certain levels of taxed income, which is gross income less all those deductions, adjustments and exemptions and I ignored the many special rules that apply to some people. I then determined the tax due and deducted the applicable "Child Tax Credit." I discovered this (again ignore "My Plan" which will be discussed below):

Table 3

If the "Bush tax cuts" 2010 Plan expire at the end of this year, the effective tax rate for a couple who are taxed on $1,000,000 of annual income will jump from 32% to 36% and the rate applied on more taxable income above that will be 39.6%. On the other hand, a couple with two children who are taxed on $20,000 of annual income will see their effective tax rate jump from 0.8% to 10.0%, something not regularly pointed out in the noise in the press and on the web!

Let's deal with the truth here. No one is going to be convinced that the loss to taxes of $153 a month would not be a problem for a couple trying to support two kids on $3,875 a month (remember one must add $26,000 in standard deduction and exemptions to that $20,000 taxed income). And I doubt that one is going to be convinced that a family taxed on $85,500 a month (yes, I know they would have had itemized deductions far in excess of the standard deduction, but this is just an example) would suffer from the loss to taxes of $3,285 a month.

There is a dilemma facing Congress. Simply allowing the "Bush Tax Cuts" to expire is not the best policy option, nor is it even rational, as it would:

• increase the rate structure in a recession,
• reduce the Child Tax Credit by $500, and
• restore the marriage penalty.

On the other hand, it would be nearly impossible to get enough votes to adopt the Obama plan because of the reluctance to let the tax rate increase on the wealthy. "My Plan" would be politically feasible.

My Plan

"My Plan" would be to let the old rate table return and let the extra $500 child tax credit go away. In other words, let the "Bush Tax Cuts" expire.

Instead of arguing over those rate policies, let's triple the exemption for the filer (the "Yourself" box on the 1040 form) from $3,650 to $10,950, double the exemption per additional person ("Spouse" and dependents) from $3,650 to $7,300, and index that credit to the CPI for the future, a policy that has been needed for years.

Yes, "My Plan" would increase the tax due from $14 a month to $22 a month on the lower income family with two kids. But keep in mind that they have to earn more than $51,550 a year to have any taxed income. It seems like $8 a month is a reasonable amount to collect from such a family to help pay for the wars in Afghanistan and Iraq. The family of four taxed on $1,000,000 would have to pay an increase of $2,683 a month.

"My Plan" would, however, actually drop the taxes paid by the hurting middle-class taxpayer who pays taxes on about $60,000 a year (again that family of four must earn more than $51,550 a year to have any taxed income, so we're talking about a family that makes $111,550 a year). This economic group would gain $150 to $180 a month to spend or save beginning in 2011. Likely they will spend at least two-thirds of that gain. Increased spending will boost our economy.

Every member of Congress should be able to vote in favor of it, unlike requiring a vote on a new tax table. What's not to vote for, since the option of doing nothing will represent higher taxes. Well, yes, we do have the deficit and economy problems. Fortunately "My Plan" has a second part to do more than stimulate increased consumer spending.

My Plan Part 2: Tax Credits

If we want to use tax policy to deal with the American economy, deficit,  and that high tax rate on those with higher incomes, let's consider instituting three tax credits:

1. Institute for businesses an Investment Tax Credit for tax years 2011 and 2012 with a carry over of unused credits into 2013 and 2014, up to a maximum total of $120,000, and only on purchases of new business equipment and rolling stock manufactured in the United States.
2. Institute for businesses an Employee Expansion Tax Credit for tax years 2011, 2012, and 2013 equal to the amount paid on the employers' share of Social Security (FICA) on jobs newly created and continuously filled for more than six months (compared to the September 2010 reported positions).
3. Institute for businesses and individuals a Newly Constructed Building Purchase Tax Credit  for tax years 2011 and 2012 of $5,000, allowable on purchases of residential and commercial buildings constructed during the period of 2008-2011.

We are constantly hearing from the right that those with the higher incomes invest in our economy and increasing the upper bracket tax rate by 4.6% will discourage investment. If those paying taxes in the highest income tax bracket are providing capital for investment in the American economy, they will be the beneficiaries of all three credits as they are passed through to investors. If they aren't actually investing in the American economy, they'll just have to forgo what most Americans would think are luxuries.

Even workers will benefit from the jobs created as a result of these credits and some will benefit from the Newly Constructed Building Purchase Tax Credit on homes they purchase.

On the other hand, the tax credits do represent a loss of tax income which increases the deficit. However, the right would argue that in the long term they will produce more economic activity which would result in increased tax income which would reduce the deficit.

 Growing Our Economy

While I believe my proposals would speed up our economic recovery, that would only be in the short term. As I've posted before, Americans will still need to address what they expect out of their economy.

Between outsourcing and automation we have used our American ingenuity and initiative to put ourselves out of work. We need to find a way to use all our human energy - mental and physical - to create wealth that returns back to each of us to meet our material needs - not just basic needs but a level of "middle-classness" needs, whatever that means.

The economic model of the second half of the 20th Century isn't going to work in the future in my opinion. Being constantly at war from 1947 to today isn't a sustainable pattern to follow. Relying unnecessarily on other nations' natural and human resources is foolishness. Allowing a few to divide our energies into squabbles over meaningless economic and social ideologies just diverts attention away from problem solving.

If my granddaughters are to be assured that the energetic use of their skills and talents will give them that middle class economic status that I "enjoyed," Americans must be even more socially aware, economically innovative, collectively creative, and individually adaptable during the next 60 years than we were from 1947 to 2007.

That shouldn't be a problem for Americans as we transition from the Information Age to whatever "Age" the future brings. Right?