Taxes: The Myth of “Deficit Neutral” Spending

Obama likes to say that new spending should be “deficit neutral”.  That sounds like a great idea!  After all, nobody wants to be financially irresponsible, right? The idea that we account for new spending is a good one, and it is better than not accounting for new spending.  But, it’s yet another politician’s con job.

Let’s use a simpler example.  Let’s say you have a monthly income of $1,000.  And let’s say you’re carrying a debt of $100,000 for your mortgage, for which you pay $537 per month.  You also tend to spend about $500 on your other living expenses, so all in all you’re losing money each month.  Since a tax-hike is like a giving the government a raise, let’s say that one day, you get a raise of $200 per month.  You could decide to save that money.  Or, you could decide to go buy a car (healthcare) for $20,000 and a $200 per month payment.  All-in-all, you convince yourself, you are “deficit neutral”.

Here is how it looks:

As you can see, although we decided buy a car, we are still “deficit neutral”.   Our income has gone up, but our incremental losses each month have not.

But what happens 5 years down the line?

After time passes, we now see that “deficit neutral” does not mean we didn’t create a more dire financial picture.  Sure, we are now the proud owners of a 5 year old car.  But to do so, we’ve amassed 17% more debt, and have nothing in the bank.  Ironically, of the 3 financial outcomes, you can easily argue that we would be better off to never even get the raise than to buy the car.  Can you imagine saying to your boss, “Please don’t give me a raise – it will send me into more debt!”?

Finally, how often do you get a large raise?  Can the government give itself a raise any time it wants to?  The answer is – not very often.  Sure, the government can give itself a raise by way of more taxes, each time we do so, we decrease economic growth.  As such, the government needs to choose very wisely when it does tax and for what purpose.  By having increased our taxes to pay for healthcare, Obama will need to raise even more taxes to pay off our debt.

So now the question is – what is Obama’s plan to get to financial responsibility?  He seems to think “deficit neutral” is responsible.  But, as you can see, that’s not the whole picture.   I know this is obvious to most readers of this blog – sorry for being pedantic.

** The numbers above are all based on values I picked for interest, periods, etc.  I chose reasonable numbers – 5% interest, a little more for the car, only 10% for credit card debt, etc.  This was just the first set of numbers I used.  Regardless of the numbers you use, realistic-ish scenarios yield similar results.