I think most Americans would agree taxes are heading higher. Yet, curiously, most may not care. (A Gallup survey shows 45% of Americans are happy with their tax rates and 3% believe them to be too low.) In fact, I suspect a significant portion of the population may welcome the tax increases with hardly concealed joy.

How is that possible, you ask?

The explanation is as simple as it is disturbing. For nearly half of US households taxes are simply somebody else’s problem. Approximately 47% pay no federal income taxes at all! (Data from Tax Policy Center for 2009.)

That’s right: nearly half of Americans qualified for enough credits and deductions to fully eliminate their tax liability, or had too low incomes to start with. (According to Deloitte, credits for low- and middle-income families have risen so much that a family with two children making $50,000 a year will owe no federal income tax.)

Half the country is happy with tax policies… well, they should be if they pay no taxes in the first place! These are the people who, more often than not, support higher marginal tax rates, for that simply means someone else will have to pay for their ever growing entitlements.

It is a sign of our hypocritical era that the cry of making taxes more ‘fair’ – meaning of course robbing higher earners blind so that lower earners need to pay nothing – has now been almost universally accepted.

But how on earth can one talk of fairness?

Consider this: the top 1% of Americans pay 40% of federal income taxes, the top 5% pay over 60%… while the bottom 50% pay less than 3%! (Data from the Congressional Budget Office, latest available tax burden release, 2006.)

Half the population is getting something for nothing, and they call this fairness?

As is always the case with expanding welfare states, generous entitlements are paid for by everyone except the actual beneficiaries.

There is nothing fair about redistributing incomes, much less on such a massive scale. There is no fairness in the government penalizing someone for working harder than others. (Not to mention it is unsustainable over a longer term – you will run out of wealthy people to tax.)

Now can you see the fundamental problem here? 40% of American households paid 86% of total federal tax liabilities. However, when it comes to deciding how the government should spend that money, they are outnumbered by the 60% who paid just 14% of taxes.

Is it any wonder that government spending is out of control and the US is coming close to fully adopting European-style socialism? The majority of voters decide on how to use other people’s money – why would they want any spending cuts?

The Congressional Budget Office data also shows that higher earners are paying a larger share of total federal taxes than ever before (as far back as tax burden data goes, to 1979).  

According to the IRS, in 1987 the top 5% of earners paid 43.26% of all federal income taxes; today, that group pays more than 60% of the tax burden – despite bringing in just 37% of the income. By contrast, the share of taxes paid by the bottom 50% of taxpayers – who bring home 12% of the income – has gradually fallen to less than 3%.

Higher earners have, over time, been forced to fund an increasing share of the federal government and fast growing entitlement programs. Meanwhile, according to the Tax Foundation, 60% of Americans consume more in government services than they pay in taxes, and the benefits extended to this group have been steadily increasing.

And yet the likes of Mr. Obama continue to tell us the wealthy aren’t paying their ‘fair share’!

Hence the $650 billion or so in tax hikes and new taxes that will be imposed on higher earners over the next decade will hardly be of concern to the vast majority of Americans. This is a short-sighted view, but then most people aren’t programmed to think of long term consequences. Given the immediate benefits for oneself, who will spare any thought on the negative impact on the economy and future job creation?

Which of course explains the shift toward statism and socialism at a certain stage of mass democracy. (Not for nothing did John Adams, the 2nd President of the USA, say that “there never was a democracy yet that did not commit suicide”, and did James Madison and other Founding Fathers believe that individual rights must be protected from the “tyranny of the majority”. They understood that without checks and balances the propertyless majority would tyrannically tax away the property of the minority.)

The state has clearly become far too big and in the process has made the majority of the electorate dependent on hand-outs, with the result that voting for the necessary medicine will now be virtually impossible.

The massive deficits, unprecedented debts and out of control entitlement programs (as well as demographic trends) leave few options – drastic spending cuts or significant tax hikes (or a combination of the two).

According to a recent Goldman Sachs study (based on budgetary data for 24 OECD economies covering 35 years from 1975), there is only one effective way to reduce debt and sustain future economic growth: imposing budget expenditure cuts across the board. On the other hand, increasing taxes to compensate for a higher budget has proved very damaging to future growth.

While cutting spending would be of most benefit to the country’s prosperity and future, it simply won’t happen on any meaningful scale. When the majority of the electorate has no interest in giving up their entitlements, political leaders will always take the path of least resistance and penalize those voters who, being a minority, don’t present a sufficient threat to their political careers.

And so, on top of all the existing, technically bankrupt federal programs, the Obama administration created a new health care entitlement, to be paid for, as usual, by everyone except those who will benefit. (Detailed overview of associated taxes further below.)

The problem is the US – along with much of Europe – is on a wholly unsustainable budget path, with unprecedented public spending (largely paid for by borrowing and money printing). In the absence of Americans rejecting the expanding welfare and entitlement state, taxes will have to rise much beyond the scheduled increases. Unless, that is, the administration finds some other – miraculous – way to reduce the enormous amounts of debt it continues to pile up.

A recent study by the nonpartisan Tax Policy Center calculated that to reduce the federal budget deficit to a sustainable 3% of GDP, the government would have to find some $500 billion each year – in new revenue (or spending cuts). To get that amount via tax increases on the top two brackets (families with over $209,000 in taxable income) the rates would have to go from the current 33% and 35% to 72.4% and 76.8%.

You didn’t think socialism comes cheaply, did you?

The truth is, no matter how much marginal income tax rates will rise, they cannot realistically be taken high enough to fill the fiscal hole. A broader based tax or a consumption tax is therefore likely to be on the horizon in the coming years.

Speculation about a value-added-tax (VAT) is already ripe. Former Fed Chairman Paul Volcker, among others, has called for VAT to be considered in light of the massive deficits. VAT is a national sales tax applied at each stage of production and collected by businesses (meaning additional bookkeeping and costs). It’s difficult for anyone to escape the tax since it’s included in the price of products and services you buy. (In Europe VAT rates range from 15-22%.)

VAT, apart from being a convenient way to pay for ObamaCare, has other advantages as well. It would allow (via increasing rates) for funding of a continued expansion of government, and as such would undoubtedly permanently open up the floodgates of public spending.

But while VAT is (for now) just a speculation, the tax increases starting next year are very real. Below you’ll find an overview of tax hikes and new taxes to be imposed on (better-off) Americans in 2011-2018.

2011 – tax hikes (tax cuts expiry) on higher income and capital income

First there is the expiry of the Bush tax cuts at the beginning of next year. The highest tax bracket will move from 35% to 39.6% and the 33% bracket will rise to 36%. The estate tax will also revert to 55%, with an exemption of $1 million (unless Congress reinstates the 2009 rules of 45% federal rate and $3.5 million exemption).

Importantly for investors, the capital gains rate is set to rise to 20%, up from 15% now. Dividends, currently taxed at 15%, will be taxed as ordinary income, with the top rate scheduled to rise to 39.6% (unless Congress enacts a proposal for a top dividend tax rate of 20%).

While most of these increases appear to only target wealthier Americans, they are also damaging to small businesses. (According to IRS data, some 26 million small business employers file under the individual income tax code and so will be subjected to much higher taxation.) This, along with the onerous new health care burdens, will certainly not help small businesses hire more people.

On top of the tax cuts reversal, Obama’s health care ‘reform’ brings a number of new taxes and tax increases (2011-18) aimed at financing part of the new spending. For obvious reasons most of the tax hikes will start in 2013, after the election year. (Some ObamaCare related taxes go into effect in 2011, however, these will affect drug makers and importers.)

2013 – increase in payroll tax + new tax on investment income

From the beginning of 2013 higher-income taxpayers will be hit with a tax increase on wages as well as an entirely new levy on investments.

Medicare payroll tax will rise by 0.9% from 1.45% to 2.35% – a gigantic 62% increase – on wages above $200,000 for individuals and $250,000 for married couples filing jointly.

In addition to that, and for the first time ever, Medicare taxes will be extended to investment income. A brand new 3.8% tax will be imposed on the falsely called ‘unearned’ income – dividends, capital gains, interest, rents and other investment income – for individuals making more than $200,000 a year and couples making more than $250,000.

(A 2.3% excise tax on sale of medical devices also goes into effect in 2013.)

2014 – penalties for lack of insurance

2014 is when the health coverage goes into effect, and the requirement begins for everyone to have health insurance. (The government will provide subsidies for lower and middle income groups.) If you don’t want health insurance, tough; you’ll pay penalties – $695/p.a., further rising in 2016.

Medicaid (the federal-state program for the poor) will expand to all Americans with incomes of up to 133% of federal poverty level; since this could bankrupt the states they might start electing out of Medicaid. (More than a dozen states have already filed lawsuits over the constitutionality of the burden imposed by Obama’s bill.)

Subsidies (tax credits of up to 50% of employer’s contribution) for small businesses (up to 10 employees) will provide for coverage increase. Penalties will be imposed on employers with over 50 employees who don’t provide ‘affordable’ coverage (note – affordable as deemed by government bureaucrats); they will be fined $2,000 a year per employee, excluding the first 30.

(The health insurance industry will also start paying annual fees; $8 billion in 2014, rising in subsequent years.)

2016 – steep rise in penalties for uninsured

Penalties for those who don’t carry coverage will rise to 2.5% of their taxable income or $695/p.a. – whichever is higher.

Not to mention, a mammoth bureaucracy will be created thanks to ObamaCare (see here the astonishing list of all the new boards, commissions and agencies the bill gave birth to). The government will also hire an estimated 16,000 IRS agents to harass and audit individuals and individual businesses to check for compliance. (I suppose Mr. Obama would expect us to applaud this convenient new job creation scheme?!)

2018 – tax on high value plans

An excise tax of 40% will be imposed on health care plans with premiums exceeding $10,200 (individual coverage) and $27,500 (family coverage).

Investors hardest hit

Apart from higher-income taxpayers being disproportionately targeted as a revenue source, policy is now clearly taking the path of increased taxation of passive income. In fact investors and higher earners will bear all the burden of ObamaCare (without getting any of the benefits).

Let’s look again at the massive new taxes Obama assaulted investors with, as well as the likely impact.

Those with income from stocks, real estate or other investments are expected to contribute a giant share of the costs of health care expansion. (I suppose we’re seeing a theme here… from the continuing witch-hunt on the financial sector to the increasingly investor-hostile environment.)

Aside of the income tax and payroll tax hikes detailed above, there are three specific developments penalizing investors: increase in capital gains tax from 15% to 20% (2011), increase in dividend tax (to either 20% or as high as 39.6% – see further below; 2011), and the new additional 3.8% tax on all ‘unearned’ income (2013).

What exactly will be subject to the 3.8% tax? Dividends, interest, annuities, royalties, rents, as well as capital gains (minus deductions properly allocatable to such income). Basically, all income and gains derived from a ‘passive activity’ count as investment income. (Note that income and gains from an investment fund, even if the fund is classified as a ‘trader’ for tax purposes, will be subject to the tax.) Tax-exempt interest income and distributions from tax-qualified retirement plans, including IRAs and Roth IRAs, are not to be included in investment income.

Capital gains, currently taxed at 15%, will therefore be subject to a 23.8% tax (20% after expiry of the Bush tax cuts + 3.8% in new tax).

Dividend income (currently taxed at 15%) will be particularly hard hit. In 2011 dividends will be taxed as ordinary income, with the top rate scheduled to rise to 39.6% from 35%. With the additional 3.8% Medicare tax dividend tax will go as high as 43.4% in 2013. Obama has proposed a top dividend tax rate of 20%; if Congress enacts the proposal, the top tax rate for dividends would rise to ‘only’ 23.8% at the beginning of 2013.

Impact on investment and investors’ behavior

Overall, some $409 billion in additional taxes will be snatched from investors in order to pay for big government socialism. What will be the likely impact on investment?

Essentially, investment income (capital gains, dividends) will be worth less to investors once the tax hikes/new taxes go into force than it is today. It is feasible that it could revalue the entire stock market lower.

Credit Suisse in a recent (April 2010) report estimates that a 10% rise in dividend and capital gains tax in the US would take about 7% off the fair value of the equity markets (assuming that 30% of the market is owned by tax-exempt funds and foreigners and the higher tax rates will apply for 15 years).

The 2011 capital gains tax increase could also prompt investors to liquidate holdings this year, ahead of the increase.

In addition, we may see shifts in investors’ behavior, in particular if dividend tax goes up by nearly 200%. Investors will certainly take that into consideration when making decisions; as a result they could shy away from dividend stocks and focus on those they perceive as having greater potential to appreciate.

More generally, the new taxes will discourage investment, making it more difficult for companies to bounce back after the recession. On top of that, as noted earlier, most small businesses pay the individual income tax, and the rate hike will have a negative impact on expansion and hiring. (Mr. Obama of course sees small business owners not as job and wealth creators but as rich exploiters who must pay yet more onerous taxes so that those who don’t pay any can enjoy still further entitlements.)

Add higher income taxes for the most productive Americans and higher payroll taxes, and it becomes clear that the Obama administration is penalizing those who have worked hard, saved, and invested, while rewarding and indulging the less able, unproductive and lazy. Classic Marxist class warfare… blaming the productive and enterprising for all of society’s ills, which can naturally only be ‘fixed’ by redistribution of unprecedented scale.

We will not need to wait too long to see the outcome. Significant tax increases can only reduce economic growth, for they take away people’s incentives to work, save, and invest. (They also encourage tax avoidance, thereby defeating the purpose of the tax increases.) Capital will be allocated to where it can avoid (some of) the taxes instead of where it would be most productive for the economy.

“When people who earn more than the average have their ‘surplus’ or the greater part of it seized from them in taxes, and when people who earn less than the average have the deficiency, or the greater part of it, turned over to them in hand-outs and doles, the production of all must sharply decline, for the energetic and able lose their incentive to produce more than the average and the slothful and unskilled lose their incentive to improve their condition.”

(Henry Hazlitt)

I will not even take into consideration increases in other taxes at federal, state and city levels, including corporate tax hike proposals, a likely consumption tax on energy (as part of climate change legislation) and possibly a value added tax.

And in the unlikely case you still believe Mr. Obama’s socialist propaganda on how the ‘rich’ aren’t paying their ‘fair share’, please review the statistical data at the beginning of this article. Not only do higher-earners pay a fair share, they are being robbed blind. (Brief recap – the top 5% earn 37% of income yet pay nearly 61% of all federal income taxes, while the lower 50% earn 12% of income and pay less than 3% of taxes. And that is before any of the coming tax hikes on the better-off!)

How did we get to this sorry state?

Consider that in 1913 the top rate of income tax was just 7%! Not only have taxes gotten more progressive and excessive, there has also been a staggering increase in related bureaucracy. The number of pages in the tax code has increased by 16,775% in the past century.

Taxes are, however, only a side issue. What should really concern us is how, within a relatively short period of time, the US went from a limited government, free enterprise, individual liberty valuing regime (of the Founders) to big government statism and finally the progressive socialism of today. The people, once freedom loving and self-reliant, have carelessly traded their liberties and responsibilities for entitlements and handouts.

Government programs and welfare only make people less reliant on themselves and more dependent on the state, which in turn prompts an ever increasing size of government, until one inevitably ends up with socialism.

The dependency mindset is now almost as prevalent among Americans as has long been the case in much of Europe. The productive sector that adds value to society is sucked dry by the parasitic state bureaucracy, the able and hard working are penalized for their success; as a result the whole society ends up much poorer. (Not to mention the terrifying and impoverishing public debt burden left to the next generations.)

Of course all this happens in the name of ‘fairness’ and ‘equality’.

Yet redistribution has nothing to do with fairness and everything to do with envy and theft. Such action gains, thanks to majority rule, a seal of legitimacy, but it really is no better than common robbery.

The fact is today the vast majority of people feel entitled to the property of others. They demand that it be taken away from them through taxation, so that (some of) it can be given to those they deem to be ‘in need’ – i.e. those who have less but of course feel entitled to have more.

Forcibly taking other people’s money would in other circumstances be considered criminal, yet this mass criminality is rationalized on the grounds of democracy, will of the people, political mandates, etc. Progressive taxation appeals to the masses who, more often than not, have a desire to pull down the minority of the most productive, talented, enterprising (and as a result more successful). Progressive policies in general are just a mean to an end; the end being an envy-based redistribution.

Unfortunately once a certain stage of statism or progressive socialism is reached it is nearly impossible to reverse. Once a voting majority pays no income tax and benefits from entitlements, the productive and enterprising minority is doomed. The majority will continue to vote away the rights of others, and call it the will of the people.

This is the tyranny of democracy the Founding Fathers had warned against. They did not intend for the state to guarantee everyone’s well-being and provide support against every possible obstacle. They would be horrified at the idea of divesting some people of their properties for the advancement of others in society. And yet today that is exactly what much of the population expects – to be taken care of by the government, be given something for nothing – all at the expense of those who stand on their own two feet and attain things by hard work.

One can work and produce goods or services that others want to pay for, or one can steal (or give the government a mandate to loot on their behalf). It is human nature to take the path of least resistance, which explains why most believe it is perfectly acceptable to plunder others rather than obtain what they desire by their own efforts and sweat. Naturally they will always find a justification for such action; hence it is deemed a matter of fairness for a minority to subsidize the majority who are perceived as disadvantaged in one way or the other (never less apt, less willing or simply lazy).

This socialist disease has now infected much of the fabric of the society. And it’s not just the liberals who prefer the state to make life-governing decisions for them. According to information from the 2008 American National Election Study about spending priorities, the majority of self-identified conservatives isn’t really in favor of cutting spending on most government programs either.

Of course anyone who disagrees with this entitlement mentality is labeled uncaring, uncharitable, lacking social conscience, or worse. The notion that unless we let the state do everything for us we are ‘bad’ persons is now so prevalent that few dare to mention the choices that must be made. How many in public office take up the cause for limited government and hence severe cuts to welfare and the public sector (including eliminating millions of counterproductive public jobs, bureaucracies, regulations, entitlement programs, etc)?

And yet far from unfair or uncaring, that is the only viable path to safeguarding America’s economic future.

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The Dubai and Greek crises have forced investors to pay attention to something long ignored – rising sovereign risk. According to this week’s reports, Dubai is trying to settle debts for 60 cents on the dollar. Meanwhile, there has been no real progress in the unfolding Greek debt crisis.

Given the scale of fiscal deterioration in much of the developed world, the trouble is unlikely to end with Greece. For now, however, this looks like a mainly EU-specific problem.

Germany is, for the moment, unwilling to talk about bailouts, and demands austerity measures from the Greek government. EU finance ministers stated Athens must comply with austerity demands within 30 days or risk losing control over its own tax and spend policies. But the truth is, the EU has no real enforcement mechanism, and Greece knows it.

The Greek government promised to reduce its fiscal deficit to 2.8% of GDP by 2012, and to under 9% by the end of this year. However, the EU authorities are fooling themselves into believing this to be possible – current Greek deficit is 12.7% (and that is only the official figure; Greece has forged data before). Due to both political and economic reasons chances of Greece meeting such targets are near zero. The Greek population is largely against austerity (and keen to express it via crippling strikes and riots), making it highly unlikely that the socialist Papandreou government will be able to enforce any meaningful measures.

Some 95% of Greek debt is held by a number of large European banks, so a Greek default would most likely spark a massive bank crisis in Europe. The contagion would inevitably spread to Portugal, Spain, Italy, Ireland and possibly other countries. But even if Greece is bailed out, it will unlikely meet the conditions that will come attached to a bailout, hence just kicking the problem down the road for another while.

And of course the problem is much larger than just Greece. Fundamentals are very poor across much of the eurozone, meaning that a number of countries could easily follow Greece down.

The root of the problem is the one-size-fits-all monetary policy of the euro. The monetary policy set for the centre (Germany, France) was always going to be inappropriate for the economies of the periphery. Instead of adopting stricter fiscal discipline (since monetary and exchange rate policy was no longer in their control), Greece, Spain, Portugal etc used the extremely low interest rates and high credit rating they gained access to thanks to the EMU to go on a long, wild spending spree. The cheap credit fueled housing bubbles as well as ever growing public sectors and generous welfare systems. It was inevitable that the day of reckoning would come.

Southern Europe’s competitiveness has also declined sharply as these countries joined the eurozone with an exchange rate that overvalued their currencies, raising the cost of labour.

The fiscally precarious states benefited from low rates because, in the eyes of investors, their bonds enjoyed an implicit guarantee of the stronger eurozone members. Once investors finally started paying attention to their fiscal situation, and to the risk of Greece being let to fail, the spreads between German Bunds and Greek bonds have widened considerably, increasing the country’s debt servicing costs.

In a staggering display of self-delusion the Greek prime minister said yesterday that Greece wants to be able to borrow on the same terms as other eurozone countries. I suppose we shouldn’t be surprised at such misguided sense of entitlement; entitlement, after all, is the theme of our times. Papandreou also stated “it is a fallacy to say the Greeks are reckless”. Yes, Greeks indeed are the model of prudence and their current fiscal mess and the fact they have been in default for 105 years out of the last 200 should just be ignored by the markets (or ‘socially useless’ speculators in modern day political speech).

Although distrusting Greece’s willingness and ability to reduce deficit, the markets, for the moment, continue to believe in an eventual bailout. Should it start looking like there will be no such thing after all, the spreads on Greek debt would dramatically expand and most likely push Greece into default.

Yet the fiscally responsible Germans have little appetite for bailing out Greece. A bailout, in their view, would destroy EU’s monetary (and any remaining fiscal) discipline and undermine the credibility of the euro. Not to mention that it would not solve the structural problems facing the eurozone. Since German taxpayers are hardly going to be willing to open their wallets to the profligate states every time there is a crisis, a bailout of Greece may only bring closer an eventual break-up of the EMU.

Having said that, German banks have massive exposure to Spanish, Irish, Italian and, to a lesser extent, Greek and Portuguese debt – to the tune of some 523 billion euros. Germany will undoubtedly take that into consideration when deciding on bailing Greece out or letting it fail.

So what are the options for Greece? The traditional remedy would be currency devaluation, but eurozone members don’t have such luxury. Control over their monetary policy is in the hands of the European Central Bank (ECB).

The most prudent thing for Greece would be to undertake the severe budget cuts necessary to get its fiscal deficit down to 3% of GDP over the next few years. Such extraordinary fiscal tightening would result in a few years of declining GDP and high unemployment. There is not much indication that Greek voters are even remotely considering taking a few years of pain (austerity & recession) for a future gain.

Another option is default, which would reduce the debt burden but also result in a severe and long recession/depression. Government spending would be cut drastically and immediately since Greece wouldn’t be able to borrow for quite some time. Finally, Greece could also decide to leave the eurozone, go back to drachma and, in effect, devalue its debt. It would make the country more competitive. Of course their borrowing costs would also soar. However, this appears to be the least likely path for Greece to take.

Essentially, Greece and the Greek voters should be given two choices: take the pain and make the necessary cuts or leave the EU. This would leave the decision in the hands of the Greek people, avoiding further cries of them being stripped of their sovereignty, and it would ultimately be better for EU’s monetary and fiscal discipline than a bailout and the moral hazards that come with it.

After all, Greece is not eurozone’s only problem. Budget deficits have reached unprecedented proportions in many EU countries. Concerns about the weak fundamentals and the state of public finances in Portugal, Spain, Italy, Ireland, the UK are evident in the financial markets, with rising sovereign bond yields and sliding euro.

Portugal’s and Spain’s external debt position is worse than that of Greece; their household debt is also considerably higher. Spain, apart from a nearly 10% deficit, has unemployment close to 20% and a banking system weighted down by a massive amount of overvalued real estate. Oh, and the socialist Zapatero government is not any more likely to be able and willing to cut spending than the Greeks. Italy’s and Ireland’s external debt obligations as well as GDP and unemployment rates are also worse than those of Greece. So while the markets’ focus is primarily on Greece, contagion is a very real threat. And not even Germany has the finances to bail out the likes of Spain. Given its size, a full blown fiscal crisis (or default) in Spain would most likely be the death of the euro.

The eurozone governments have to borrow approx 2.2 trillion euros from the capital markets this year to finance their budget deficits (Greece needs some 60 billion just to make it through the year); it won’t be an easy task. A wider fiscal crisis in Europe appears increasingly likely.

Yet ballooning national debts, out of control deficits and rising sovereign risks are not just a European issue. Most advanced economies have huge fiscal problems. The IMF projects the G20 government debt/GDP ratio to reach 118% by 2014. This will severely constrain economic growth.

A recent study by Carmen Reinhart and Kenneth Rogoff (‘Growth in a Time of Debt’) found that “the relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more.”

The following chart shows the public debt to GDP ratios across the world.

(And let’s not forget the true public debt/GDP levels are several times higher then the explicit figures that exclude massive unfunded liabilities for public pensions, healthcare, social security.)

Consider also the high government spending as a percentage of GDP in many advanced economies today, which causes a further drag on growth, and you get a future of slow economic growth and high unemployment. (In Greece, as well as the US, UK and other countries government spending now makes for approx 50% of GDP.)

The fiscal deterioration will become worse still due to the massive demographic challenges in the developed world. The IMF estimates that increased health spending and other costs related to aging population will drive debt to GDP levels of advanced economies up by a further 50% over the next 20 years.

We will therefore see a significantly higher economic growth in low debt, and most likely sluggish growth in high debt economies such as the UK, US, much of the eurozone and Japan. (A strong rise in government bond yields of much of the developed world is also inevitable.)

But it’s not just government debt. There’s too much debt everywhere, including in the private sector (although the private sector has started deleveraging, while the public sector increased leverage). Total debt is highest in Japan at 459% of GDP and the UK at 469% of GDP (or 380% if adjusted to reflect UK’s position as a financial hub). Spain follows in the third place at 342% (in Greece total private-public debt stands at around 225% of GDP).  

Over the next decade sovereign debt crises and defaults seem inevitable. Those countries that can resort to the printing presses will take the path of a massive monetization of debt, hence reducing their debts through severe inflation. That is the most likely outcome in the US and UK. (Clearly, paying our debts back in devalued currency is simply default by another name.)

Of course the most desirable way to address the budget problems would be by radical spending cuts. The scale of fiscal tightening necessary to return to healthier debt levels would cause a medium-term drag on growth. But not reducing debt will ultimately have much greater consequences.

However, chances we will witness drastic spending cuts in the UK, US and across the eurozone in the next few years are rather slim. The culture of entitlement has made it near impossible to talk about the hard facts. Our political elites will continue to ignore the fact that the bloated welfare states have become unsustainable and we can no longer afford them. The reason is simple – it’s not what the voters want to hear. Instead of acknowledging painful reality and the need to make sacrifices, we prefer to keep kicking the problems into the future. Until the inevitable day of reckoning comes.

Indeed the developments in the US and UK are not at all encouraging.

The Obama administration is determined not to waste a good crisis and continues to focus on a massive expansion of government. Instead of letting the free markets work and acknowledging that it’s the private sector that creates wealth and will be the engine of growth, the political leaders on both sides of the Atlantic show an enormous zeal to meddle in the free markets and reinvent and fix what wasn’t broken.

Redistribution of wealth via tax hikes (as well as introduction of entirely new taxes), a ruinous healthcare reform, expensive energy and climate change legislation, pro-union policies, excessive and ill thought-out regulation… Obama has shown a deep lack of understanding (and indeed contempt) of private business and a determination to socialize the US economy.

And while the productive part of the economy is being hammered, the public sector has been enjoying an unprecedented boom. In 1902 total US government spending was approx 7% of GDP. In 1928 it came to just over 10%; two thirds of that was state and local and just 3% was federal spending (about the same as 150 years earlier, excluding increases during war periods). Government spending has since exploded, making for more than 40% of GDP – two thirds of that being federal expenditure. Public spending increases in 2009 alone came to well over $1 trillion, a rise of more than 20% from 2008.

The UK has fared even worse, with government spending increasing from about 36% of GDP to almost 55%, putting increasing pressure on the dwindling productive segment of the economy.

The following chart from the Wall Street Journal shows the shocking and unsustainable spending explosion. US government spending has grown seven times as much in real terms as median household income over the last 40 years!

And, just as in the UK, employment and compensation in the public sector have continued to increase while the private sector has taken the pain. (Public workers not only enjoy far higher wages than their private sector counterparts but also benefit from extremely generous pensions. These largely unfunded public sector pension liabilities will naturally just serve as further drag on economic growth for many decades to come.)

As the following chart from the Business Insider shows, the US has gone from producing jobs in wealth creating private industries to jobs in the wealth destroying government sector. By the end of 2007 the total number of government jobs exceeded the total number of goods producing jobs.

Indeed, whether we look at the public sector gorging itself at the expense of the private sector, or the widespread culture of entitlement and welfare state (at the expense of the dwindling numbers of hard working taxpayers), this is what has come to characterize our time: enabling the unproductive and lazy to steal from the productive and enterprising. Otherwise called socialism.

So what is being done? Do we see any plans for serious fiscal tightening and debt reduction? Quite the opposite, our leaders seem to be enjoying a rather long vacation from reality.

Obama (and Gordon Brown) have apparently not been listening to Reinhart and Rogoff, or they wouldn’t be attempting to solve our problems by issuing yet more debt.

Perhaps we shouldn’t be too surprised that debt reduction doesn’t seem to be our policy makers’ priority. Indeed, one might think our extreme indebtedness is nothing more than a minor nuisance. Neither our political elites nor the central bankers and leading economists appear to grasp the obvious: that years of cheap, excessive credit and high debt were precisely what got us into trouble. And yet we’re still happily continuing on the same path.

In only three years the Obama administration will have increased the national debt by some $4.35 trillion. (And that excludes the huge deficits of off-budget programs like Medicare, Medicaid, social security.) The budget freeze proposed by the administration for 2011 is projected to save some $15 billion (or about 0.4% of the total budget, a drop in the ocean). Note that it’s merely a budget freeze, not a cut in nominal terms. Worse still, the the vast majority of federal programs (incl. Medicare, Medicaid, social security, military, homeland security etc) are to be exempt from the freeze.

It should be obvious that the US won’t get its debt under control unless it sharply reduces government spending, including on health and pensions that have simply become unaffordable. The US is not much behind Britain and the eurozone when it comes to the horrific shape of public finances. The only advantage, for now, is the dollar’s status as the world’s reserve currency (and of course the country’s control over its own monetary policy).

But that doesn’t change the basic fact – you cannot spend your way out of a fiscal crisis. The current path is unsustainable. The Obama prescription of more debt, more spending and more taxes is a triple ticket to ruin, plain and simple.

But, it would be unfair to focus solely on the US, for here in Britain we are in an even greater mess.

The UK has not only the world’s highest total debt/GDP (along with Japan) but also one of the worst budget deficits at 12.6% of GDP. (According to OECD, only Iceland and Greece have higher deficits, at 15.7% and 12.7%, respectively. The UK is expected to post a 12.8-13% deficit this year, overtaking Greece.)

The speed of the debt run-up has been nothing short of alarming. Unsurprisingly, Britain is already paying higher interest rates to borrow than Spain or Italy. While the yields on gilts have recently risen significantly, they are heading far higher – as soon as the markets start taking a look at other basket-case economies aside of Greece. The pound has fallen by some 25% vs the dollar, and has much further to go unless the markets start seeing some credible solutions from Britain.

Yet there is no political will to face the excessive debt, no meaningful plans for deficit reduction. Gordon Brown’s government has rejected any idea of implementing spending cuts in 2010/2011. And the opposition? David Cameron said spending cuts during the early part of a Conservative government wouldn’t be ‘particularly extensive’.

Government spending has exploded over the 13 years of Labour governments and is now completely out of control. But one would look in vain for austerity measures and severe fiscal tightening, not just from Labour, but also from the (so-called) Conservatives.

The micro-cuts that both the government and the Tories are proposing will not even make a dent in the monstrous amount of public spending. The pledges to ring-fence all main areas of spending, including the wasteful, bureaucratic and inefficient NHS, instantly expose any deficit reduction plans as lacking of credibility.

What remains are tax raises. As if Gordon Brown’s hike of higher earner income tax from 40% to 50% (or 62% once national insurance contributions are added on) wasn’t bad enough, further tax increases are likely on the way. All that (along with the insanity of the additional 50% bonus tax) will only achieve one thing – further damage to the dwindling private sector already suffocated by a gargantuan web of high taxes, red tape, hostile regulation and uncertain political environment.

From Labour’s point of view, there is no harm in further undermining the only economically productive part of the economy. Expansion of government and redistribution of wealth are the objectives. What Brown and Obama have in common is their disdain for and antagonism toward anyone earning (or striving to earn) a decent income, and the desire to redistribute from the hard working and productive to the idle and unproductive.

It matters little which party wins the upcoming general elections; all three of the country’s main political parties have fully embraced ‘progressive’ (read socialist) ideas. A Tory victory may be slightly less disastrous than another Labour term, but nothing that the party is offering will set Britain onto the right path.

And the people have only themselves to blame. Thanks to the vast expansion of government too many millions are now enjoying an idle life of welfare-dependency. Add the millions more in public sector jobs with their high wages and appallingly generous pensions, and it is little wonder that politicians are unwilling to do anything that would anger the majority of the voters.

We have become a society with an overwhelming sense of entitlement – at the expense of those who still believe in self-reliance and hard work, only to see their wealth stolen by the parasites. This unsustainable situation will inevitably blow up, and deservedly so. Only then will a new cycle be able to start. And perhaps, just perhaps, we will even witness a return to common sense one day – as in smaller government, less interference in the free markets and the productive sector, less dependency and more self-reliance.

But in the meantime, as public debt is becoming a crushing burden on most developed economies, the only thing that appears certain is a widespread sovereign debt crisis (and defaults) a few years from now.

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