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.
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!
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.
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.
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.
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.
What should we do about the “fiscal cliff”? First of all, we have to recognize that it has been caused by a combination of reckless federal spending and an unwillingness to implement policies which stimulate private sector economic growth such as broad based tax reform, relaxation of onerous regulations and vigorous promotion of free trade. This means that short term measures which merely drive up the deficit will accomplish nothing more than kicking the can down the road and are therefore not helpful. We need a long term solution!
The most valuable single thing we should do right now is to start reforming the tax code along the lines of the Simpson-Bowles Plan. Cut individual tax rates and offset revenue losses by limiting tax deductions. Also cut corporate tax rates, offset again by limiting deductions. I would also say to increase the tax rate on capital gains and dividend income from 15% to 20% (reversing one particular Bush tax cut!) which will still be a much lower rate than for ordinary income and therefore will not discourage risk taking by investors.
Growing the economy faster will shrink the deficit but we also need substantial spending cuts to make a bigger impact on trillion dollar deficits. Of course, cutting $100 billion across the board from discretionary spending as the “sequester” does, is not the most sensible way to cut spending but we’ve got to get the job done! So let the sequester stand unless Congress can agree on a more rational plan of the same magnitude.
Basically what I am saying is that our economic problem of slow growth and our fiscal problem of huge deficits are closely interrelated and that we are much better off to address both of these problems simultaneously. For Congress to take the easy way out by 1) just extending all of the Bush tax cuts, 2) failing to make significant spending cuts and 3) raising the debt limit without substantial reform on taxes and spending, for Congress to proceed on this basis is to shirk its duty in a time of crisis!
Let’s hope that Congress can rise to this critical occasion and do what is sorely needed!