One of our great friends and colleagues Frank Salinger, is an attorney and government affairs consultant in Washington D.C.. He, like us, works a good deal on financial services issues, in DC and in states across the country. Our collaboration, which is frequent, is an unalloyed joy to me, and his wisdom and insights valuable both to us and to our clients. Frank writes an occasional newsletter which he circulates by email, and he has given us permission to reproduce it here for our clients and friends. Follow Frank on Twitter @annapolislawyer

AUGUST 2011
THOUGHTS ON BUSINESS & GOVERNMENT
The Debt Ceiling

Mr. Toad’s Wild Ride

“Now, people when I say that look at me and say, ‘What are you talking about, Joe? You’re telling me we have to go spend money to keep from going bankrupt?’. The answer is yes, that’s what I’m telling you.”

—Vice President Joe Biden

Watching the political class respond to the S & P downgrade—followed by the market swoon and end of week recovery—has, I’m sure, frustrated business leaders.

First, the downgrade was the least surprising news since the death of Amy Winehouse. For weeks, S & P’s sovereign debt unit telegraphed that a $4 trillion target long-term deficit reduction plan would be necessary to retain the now lost AAA rating. In fact, they made it clear they viewed a $4 trillion cut as a mere down payment for future cuts.

On notice that $4 trillion was necessary, Congress enacted a plan that reduces spending by $2.5 trillion over ten years. This is supposed to occur in a two-step dance. First, discretionary spending caps spread over ten years are supposed to generate $1 trillion in savings reduction from both defense and non defense spending.

Next, an uber-partisan “Super Committee” is expected to agree to the remaining $1.5 trillion more in cuts or tax increases with a process guaranteeing a vote by December. If Congress can’t agree, automatic cuts begin in 2013 split equally between domestic and defense spending. These cuts exempt big ticket entitlements such as Social Security and Medicare.

OK, let’s get real. First, any Congress cannot bind a future Congress. In other words, future Congresses can simply reverse this plan and enact something else.

We’ve seen this movie before. If you are old enough, do you remember the Gramm-Rudman-Hollings Act of 1985? Dan Rostenkowski’s Budget and Emergency Deficit Control Reaffirmation Act of 1987? The Budget Enforcement Act of 1990? All were well-intentioned schemes to cut deficits.

In fact, the 1985 law provided for automatic spending cuts (the oddly named “sequesters”) if the deficit exceeded a set of fixed deficit targets. Obviously, none of these laws worked.

So how much are the actual cuts in fiscal year 2012? According to the Congressional Budget Office, the cut will be $21 billion, or less than 1% of a nearly $3.7-trillion federal budget. Let’s put that in perspective: The super carrier USS Gerald Ford, still under construction, costs more than $9 billion (and that’s without her complement of aircraft). The US Postal Service deficit alone s $8 billion. In sum, not much.

It’s hard to take budget cutting seriously. Earlier this year, the House refused to cut the $50 million sponsorship of NASCAR and NHRA auto racing teams by the military. While I confess that I’m an auto racing fan, it’s hard to imagine this expenditure is really the tip of the spear for our national defense. Do taxpayers really need to spend $20 million to sponsor Dale Earnhardt Jr.?

As to the downgrade, I’m no economist—although it’s hard not to be cynical about the rating agencies which seemed to think Fannie and Freddie were just dandy almost until the moment they sank. I do like controversial Wall Street guru Martin Armstrong’s take: “The S&P Downgrade was about as stupid as if it were carried out by a trained chimp. I believe the S&P Downgrade was a market manipulation no different than when they rated mortgages AAA. They only saw the immediate profit from quick trade. I believe they were too stupid once again to realize they were pulling another foundation stone out of the pyramid we call the Global Financial System.”

Official Washington’s reaction to the downgrade was almost amusing. Some feigned shock and surprise (I guess they missed all the warnings).

Others, like Super Committee member John Kerry blamed the Tea Party. According to him, the downgrade because our debt is too high was the fault of the people who wanted to reduce the debt. Huh? To be fair, it wasn’t his fault. Politicians from both sides simply read from prepared talking points. Clearly the “Tea Party downgrade” trope didn’t test well because it disappeared within a day or so.

What does all this mean for business leaders? My advice, hold on to your wallet. Regardless of the outcome of the 2012 election, business will pay more. On the federal level, it won’t be from tax increases. It’ll be from “revenue raisers” (the tax that dare not speak its name) or “loophole closers” (someone else’s tax break).

On the state level, 42 states face revenue shortfalls in 2012—totaling a staggering $110 billion Worse, federal discretionary spending cuts are likely to impact federal support for services provided by state and local governments. These will worsen state budget problems and lead to increased state taxes and fees.

Look for renewed efforts to impose sales taxes on internet sales—although federal law precludes taxing pure internet transactions. California’s new law requires large, out-of-state retailers to collect sales taxes on Internet purchases by California customers. This “Amazon tax” has online retailers cutting ties with local affiliates.

Illinois and Tennessee are considering levying taxes on internet transactions if the vendor has a distribution center in state. States are also tinkering with their abandoned property “escheat laws” (the equivalent of rifling through the sofa cushions for loose change).

All this argues for additional monitoring and lobbying on the federal and state levels. Unlike the political class which was (or feigned being) stunned by the downgrade, involvement in the legislative and regality process means business will not be a surprised when government comes looking for money.

The prevailing wisdom is that Congress (and some states) are ungovernable due to the partisan divide. This is nonsense. There has always been a partisan divide (the nonpartisan “Era of Good Feeling” ended after President Monroe retired). I began my time in Washington as a law school intern for a member of the House Judiciary Committee during the Nixon impeachment. In 1974, the GOP lost 49 House seats giving the Democrats a majority above the two-thirds mark.

The class of 1974 was united, liberal and eager to take Nixon to task and remake America. Yet life—and government—moved on. Today is no different.

Let’s get started.

Frank Salinger