The Magnitude of the Mess We’re In

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In an opinion piece last fall in the Wall Street Journal, George Schultz, and several colleagues from Stanford University’s Hoover Institution, very cogently describe the horrendous economic and fiscal mess in which the United States is now embedded.  Trillion dollar deficits for four years in a row, now going on five, a persistently weak recovery from the great recession of 2008, several rounds of quantitative easing by the Federal Reserve now totaling over three trillion dollars, and worst of all, a complete lack of consensus by political leaders on how to respond to this dangerous situation.

The President and the Democratic majority in the Senate, flush with victory after the November 2012 elections, believe that they have a mandate to continue their present expansionist policies.  The Republican majority in the House of Representatives, only slightly diminished by the 2012 elections, feels equally strongly that it has a mandate to continue applying the brakes.  As a fiscal conservative I agree with the Republicans that we must return to the sound fiscal and monetary policies advocated so eloquently in the above WSJ article.

What strategy can the House Republican’s follow to move federal policy in this direction?  House Speaker John Boehner has suggested that any increase in the debt limit be matched dollar for dollar by cuts in federal spending over a ten year period.  For example, the “Boehner Rule” would require that an increase in the debt limit of $1 trillion, enough to last about one year, would be offset by spending cuts of $100 billion a year for 10 years.  If such a regimen were then repeated a year from now, another $100 billion in spending cuts per year would be needed as well, and so on.

Taking into account the baseline budgeting process in Congress, whereby budgets are automatically increased from one year to the next by the anticipated rate of inflation, and also the occasional need for emergency appropriations to cover natural disasters and other dire events, the Boehner Rule would have the likely effect of holding spending approximately constant from one year to the next in absolute terms.  While this is not the same as what most people would understand by actual spending cuts, nevertheless it does represent significant restraint in federal spending, compared to recent patterns.

As the economy continues on its current growth trajectory of about 2% per year, this would mean that new tax revenues would eventually catch up with relatively flat spending levels and eventually lead to a balanced budget.

It sounds good but does he mean it?

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In today’s Omaha World Herald, Representative Lee Terry explains why he voted against the fiscal cliff deal just approved by Congress a few days ago.  It is because “raising taxes with little to no spending cuts does not make for a balanced agreement.”

Of course he is entirely correct in this assessment.  But will he stand firm in the next two months as a new deal is negotiated to either implement or replace sequestration which makes across the board spending cuts?  Will he stand firm when conservatives complain about cutting defense and liberals complain about cutting social programs?  Will be stand firm when the AARP complains about cutting entitlements?  We need to do all of these things and more!

House Speaker John Boehner has said that Republicans will be “singularly focused on the deficit and the debt” in the next two months.  But the President has said that he will not “play games” with raising our nation’s debt limit.  Will Mr. Boehner, Mr. Terry and the Republican majority in the House be prepared to withstand withering criticism from the mainstream press if the default deadline grows close without agreement for significant spending cuts?

We are rapidly approaching the moment of truth.  The future of our country depends on the fiscal responsibility of our national leaders.  Let’s hope that enough of them are made of the right stuff!

One Cheer for Lee Terry

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Congress has averted the immediate Fiscal Cliff but no significant action was taken to address our long term fiscal problems.  According to the Wall Street Journal, the deficit will shrink slightly below $1 trillion for a few years and then continue its inexorable rise. The can was kicked down the road for two months by delaying sequestration until March 1.  In other words this was a bad deal and Republicans in the House of Representatives should have voted it down and held out for a much better deal.

At least, Nebraska’s 2nd District Congressman, Lee Terry, voted against it.  Speaker John Boehner declared that the new 113th Congress would make the federal debt and deficit its singular focus.  Let’s hope that Mr. Boehner means what he says and that Mr. Terry supports him when the chips are down.

One year ago Mr. Terry voted to extend the payroll tax holiday for two months (annual cost $110 billion) and then voted against a full year extension two months later, after the die was cast.  Shenanigan’s like this are unacceptable and should be interpreted as complacency and deviousness about addressing serious problems.

House Republicans are in an incredibly difficult position.  We’ve just re-elected a President whose basic economic policy is more artificial stimulus (government spending), which just makes the deficit and debt that much worse.  The Republican House is now the sole bastion of common sense economic and fiscal policy.  We have to hold their feet to the fire.  Our survival as a strong nation depends on it.

Is Growth Over?

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                                             Is Growth Over?

In a recent New York Times op-ed column, Is Growth Over?, the Keynesian economist Paul Krugman argues that our current information technology revolution may not be potent enough to increase our economic growth rate beyond the American historical average of about 2%.

As much as we hope for a faster rate of growth, let’s assume that he is correct.  In fact our average rate of growth for 2010 – 2012 (since the recession ended in June 2009) is 2.1%.  What are the economic implications of 2% growth indefinitely into the future?  They are slower job growth, higher unemployment and therefore lower tax revenue.

High unemployment is bad enough for the millions of unemployed and underemployed.  But the fiscal implications are much worse because they affect the entire country.  We’ve already had four years in a row of trillion dollar deficits and the 2013 budget projections don’t look any better.  So continuing our present course presents a grim outlook, to say the least.

What are the alternatives?  We have two choices.  One is to boost the private sector with measures like pro-growth tax reform, relaxing onerous regulations, boosting domestic energy production and promoting international trade.  If such pro-growth policies are not politically doable, then the alternative is massive tax increases and spending cuts.

Our first priority must be to rapidly shrink the federal deficit down to zero.  Otherwise we are inviting fiscal calamity which can hit at any time without warning.  Fiscal conservatives should always remain focused on this #1 problem.  If no agreement can be reached for a rational plan to significantly reduce the deficit, then get the job done anyway that is possible.

We have got to wake up the American people to our urgent fiscal condition.  If going over the cliff is what it takes, then so be it!

No Deal is better than a Bad Deal

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It is beginning to look like President Obama and House Speaker Boehner may not be able to negotiate an acceptable deal by December 31st to avoid going over the Fiscal Cliff.  The President wants tax rates to rise for incomes above $400,000.  The Speaker has offered to raise tax rates for incomes over $1,000,000 but it is not clear if House Republicans will go along with this, even if accepted by the President.

What is the effect of such increases in tax rates?  According to the Wall Street Journal, raising taxes for incomes over $500,000 would affect 750,000 small business owners, while an income cutoff of $1,000,000 would affect 311,000 small business owners.

What will be the economic impact of restoring Clinton era tax rates on small business owners?  A recent study by Ernst & Young predicts that employment would fall by 710,000 jobs and that economic output (GDP) would decrease by 1.3% on an annual basis.

Conclusion:  although more tax revenue is needed, as well as significant spending cuts, to get our fiscal house in order, it matters where this new revenue comes from.  What we really need is pro-growth tax reform.  This means lowering marginal tax rates and curtailing deductions and loopholes.

Yes, it is preferable to avoid going over the fiscal cliff.  But a deal needs to be structured which puts us on a sound fiscal and economic track for the long term.  Principle matters.  No deal is better than a bad deal.

Avoiding the cliff and restoring confidence

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New York Mayor Michael Bloomberg has proposed a sensible way forward with an Op Ed column, “Avoid the ‘Cliff,’ Restore the Confidence” in the December 12, 2012 edition of the Washington Post . His thesis is that businesses took on too much risk in the run up to the 2008 crash but now they are sitting on hordes of cash because they lack confidence that our political leaders can come up with a serious, credible plan to reduce the deficit and put our country on a sustainable path to economic growth and fiscal health.

His proposal for accomplishing this task is remarkably similar to that outlined by David Walker and discussed in my previous post on December 10, 2012.  That is, we should adopt the Simpson-Bowles framework, including tax increases and spending cuts.  At least a significant down payment on this plan should be agreed to before the end of the year.  The agreement would include a commitment to enact broader-based tax reform and entitlement reforms in 2013.

With trillion dollar deficits for four years in a row, now going on five, we definitely need more tax revenue as well as large spending cuts.  The biggest challenge in implementing this general framework is to figure out how to raise tax revenue in the least damaging way to the economy.

The tradeoff here is between raising tax rates versus eliminating tax deductions and loopholes.  Democrats (apparently) prefer raising tax rates rather than eliminating deductions.  This is unfortunate since it is well established in economic theory, as well as plain common sense, that the lowest possible marginal tax rates will provide the greatest stimulus to private risk taking and investment. This is the only sound way to create more jobs.

Democrats may have the strongest political position in the current negotiations but the Republicans have the soundest basic economic principles.  If the Republicans are able to keep the focus on the fundamentals, we will succeed in finding the way out of our current predicament.

What do we need to do to avoid the fiscal cliff?

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Although Republicans need to be prepared to jump off the cliff, at the same time they also need to make every reasonable effort to avoid taking this drastic action.  Mr. David Walker, the CEO of Comeback America and former Comptroller General of the United States, has described very clearly, on the Politico website, what kind of deal the Republican House of Representatives should be looking for.

In return for raising taxes on the wealthy, the House should insist on two concessions from the President and the Senate.  First of all, there must be an immediate and significant down payment on the spending cuts required by the sequester.  Comprehensive tax and social insurance reforms, a so-called Grand Bargain, would be deferred until a set date in 2013, to give the new Congress time for careful deliberation.  The debt ceiling limit would be raised just enough to get by until the new deadline next year.   A fail-safe hammer would be put in place to kick in if the deadline is not met.

Mr. Walker suggests that the long term goal, say by 2024, should be to reduce debt to 60% of the economy.  This will require an approximately $4 trillion combination of revenue increases and spending cuts over the next ten years.  There would be appropriate interim milestones set up to be met along the way.  My personal preference is to hold out for a balanced budget by a date certain but the main thing is to negotiate an ironclad agreement to put our fiscal policy on a sustainable path.  Anything less will lead to a dangerous fiscal crisis in the very near future, far worse than the present danger of going off the cliff.

Jumping off the cliff with Barack

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Washington Post columnist Charles Krauthammer urges the House Republicans to make it clear that they are willing to go over the fiscal cliff if it proves to be impossible to get a budget deal which includes significant spending cuts as well as tax revenue increases.  His most recent column, which appeared in the December 2, 2012 Omaha World Herald, points out that the Republicans have plenty of leverage if they are only willing to use it.

Many economists claim that restoring the Clinton tax rates for everyone, as well as the $110 billion automatic spending cut sequester,  which would be the consequences of going off the cliff, would cause a new double-dip recession with a big increase in unemployment.  No one really wants to take the chance of finding out if this scenario would actually play out, neither Democrats nor Republicans.

With an exploding national debt, caused by trillion dollar deficits for the last four years in a row, with no end in sight in the near future if present policy continues, the Republicans will generate huge public support for substantial, but sensible, cuts in both discretionary and entitlement programs.  Nothing should be off the table, neither further defense cuts nor reforms to all of the big three entitlement programs: Social Security, Medicare and Medicaid.  Republicans will be viewed most favorably by the general public if they do not try to protect any sacred cows in this process.

The biggest cudgel held by the Republicans, is the looming need, in the next few months, to raise the national debt limit.  Republicans should wield this cudgel in an especially visible fashion, and will be supported by the American people for doing so.  This, after all, is the bottom line.  Somebody has to say no to runaway deficit spending, and the Republicans need to make very clear that they are highly committed to accomplishing this urgent task.

A Minimum Tax for the Wealthy?

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Warren Buffett has proposed a minimum tax for the wealthy in the November 26, 2012 edition of the New York Times. It is reprinted in the Omaha World Herald on November 28, 2012. The proposal is for a minimum tax of at least 30% on all income over $1 million.

Mr. Buffett’s proposal is amazingly similar to Mitt Romney’s tax proposal during the campaign. Mr Romney’s plan is cut everyone’s tax by 20% starting from the Bush tax rates which top out at 35%. This means that Romney’s top rate would be 28% and he would limit deductions to an absolute dollar maximum of $25,000 or so. A very high income person would pay 30% according to Buffett and very close to 28% according to Romney. The difference between 30% and 28% is minor! Shall we compromise at 29%?

Mr. Buffett’s purpose is to make the tax code more equitable and Mr. Romney’s purpose is to stimulate the economy with lower rates. It sounds like we may be able to accomplish both goals at the same time! Growing the economy, and thereby increasing tax revenue, is essential to drastically shrink deficit spending in order to stabilize the national debt. Growing the economy is also the best way, the quickest way, to create more jobs and lower the unemployment rate.

With the Buffett and Romney tax proposals so similar, perhaps Congress and the President can agree on a plan for pro-growth tax reform. This will be a big step in the right direction. In fact it is half the battle to solving our economic and fiscal problems. The other half, of course, is to make spending cuts. Progress in this area will be far more difficult and contentious but just as important, if not more important, than tax reform. The (Republican) House of Representatives will have to show a lot of leadership to make progress in this direction.

One way to cut spending

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The fiscal cliff is looming, the national debt is exploding and the economy is stagnant.  So what can and should Congress do to prove that it is serious about our urgent economic and fiscal problems?  Simply extending all of the Bush tax cuts and repealing sequestration amounts to kicking the can further down the road and is not a serious option.  Of course we need pro-growth tax reform, i.e. a major overhaul of our tax code to both simultaneously lower tax rates and curtail tax deductions.  But this is a big project and will take some time to be sorted out by Congress.

What can Congress do quickly, in a matter of weeks rather than months, to get the ball rolling?  The organization, Taxpayers for Common Sense, has recently provided a useful answer.  The report, Sliding Past Sequestration, proposes a plan to cut $2 trillion from the federal budget over the next ten years, or roughly $200 billion per year.  This is an example of a serious budget reform program of the sort Congress should initiate to begin to whittle down deficit spending of over $1 trillion per year.  In this proposal cuts are made in many different federal departments, including Agriculture, Energy, Interior, National Security, Transportation, and also Tax Expenditures.

Check out these possible budget cuts.  More than likely you will approve of some of them and find others to be less appealing.  Note that entitlement cuts such as for Medicare, Medicaid and Social Security are not included in this report.  Nor are cuts in education programs or social programs for low income people such as food stamps and housing assistance, for example.  Of course, adjustments in entitlement programs and social programs will also have to be made sooner rather than later.

For Congress to take the initiative to begin making big cuts in the federal budget will have a very positive impact on its public image.  There will be vociferous complaints from those affected by the spending cuts.  But this will demonstrate that the cuts are serious and will help Congress recover the credibility which is now so severely lacking.