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Who’s Afraid Of The Fiscal Cliff?

Don't worry about that fiscal cliff. It hardly matters, because we are already in such a deep hole.

A lot of people, including Federal Reserve Chairman Ben Bernanke, are worried that we are nearing the edge of a fiscal cliff. I’m more concerned with the hole we are already in.

The “fiscal cliff” refers to the scheduled expiration of a slew of tax laws – most notably the “Bush-era” tax cuts, which have already been extended well into the Obama era, and the “one-year” reduction in employee FICA taxes, which is now in its second year. Combined with the automatic spending reductions also set to take effect January 1, the changes would drain up to $700 billion from the economy. In testimony before Congress, Bernanke warned that, if all the changes go into effect, the economy will respond with shock, contraction and possibly a new recession.

Adding to the concern, the Treasury is also now approaching the debt ceiling that Congress authorized last summer, in the compromise that also created the automatic spending scheduled to take effect at the end of 2012. We are likely to bump up against the new ceiling right around the same time that the end-of-the-year changes come into effect.

I am not particularly worried about the fiscal cliff, however, because we are unlikely to tumble over the edge.

We have been down this road before. The Bush-era tax cuts were originally due to expire at the end of 2010. President Obama wanted to let the cuts lapse for high earners. Republicans refused. At that time, Democrats controlled not only the White House, but both houses of Congress as well. They could not get exactly what they wanted, because Senate Republicans had enough votes to block a partial extension of the tax cuts; Democrats could only extend the tax cuts for everybody or for nobody. We ended up with a two-year extension for everybody.

With Republicans in control of the House of Representatives this year, the choice is exactly the same, and I fully expect to see the same result.

If Obama is re-elected, he will not be in any better bargaining position next year than he is now. Republicans are still almost certain to control the House, and they will be near parity with Democrats in the Senate. Obama has shown that he will continue the status quo rather than allow taxes to rise for everyone in those circumstances. So we’ll be back to where we were in late 2010.

If Mitt Romney wins in November, a lame-duck Obama might refuse to extend the tax cuts for high-income Americans this fall. Republicans will, in that case, just wait him out. Romney will be sworn into office on January 20, and Congress will pass a quick and retroactive extension of the tax cuts. There are enough Senate Democrats siding with Republicans on this issue to ensure this result. At least seven Democratic senators have already said they are willing to consider a temporary extension.

The automatic spending cuts are a new variable; we were not in this position in 2010. But they won’t happen either, at least in their current form, because neither party wants them. Republican fiscal conservatives will still demand big cuts in return for another debt ceiling extension, but the cuts will probably be somewhat smaller, and differently arrayed, than the ones scheduled to take effect automatically. The parameters will likely be decided as part of the next battle over the debt ceiling.

So we are not going to tumble over the fiscal cliff. That certainly does not mean we have a smooth fiscal path in front of us. We are in a deep national financial hole, and it gets deeper the longer we ignore the fundamental fact that our short- and long-term spending plans are unsupportable at any tax load that the U.S. private sector is able to sustain. We cannot borrow and spend our way to durable prosperity. We’ve been trying for at least four years now – arguably a lot longer – and we have succeeded only in digging a larger pit.

From here, it’s possible to see the bottom and get a pretty good idea of what it will look like. Other countries, notably China, will inevitably start to doubt our capacity to return their money. First they will raise our interest rates. If we have not made serious changes to our fiscal policy at that point, the higher interest rates will simply add to our budget deficits, forcing us to borrow more and more money, paying ever higher prices to get it. If we reach the very bottom of the hole, investors will stop lending to the U.S. Treasury altogether.

The way out of this hole isn’t easy. At this point, a merely balanced budget will not be enough; we need a surplus in order to begin to pay down our debt before rising interest rates make it unsustainable. We need to get serious about increasing revenues and reducing spending. The issue goes far beyond whether or not to maintain the Bush-era tax cuts on high earners.

As I have written before, it is not feasible in the long run for the majority of Americans to be net recipients of tax dollars. The top 1 percent of earners is now responsible for about 40 percent of the country’s tax load, while nearly half of Americans pay no federal income taxes at all. Converting more citizens into taxpayers would help fix the problem, not merely by raising more money, but also by making more of the electorate – and this should be everyone who is not truly poor – weigh the costs of government services and benefits against the burdens imposed on the private sector that must bear those costs.

The good news is that we are not about to go over the fiscal cliff. The bad news is that this is because it’s hard to fall off a cliff when you are already in a hole.

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William Nuesslein June 28, 2012 at 12:37 PM
Tax policy is very interesting. Taxes have three functions. Taxes modulate the economic cycle. Income, including payroll taxes decline and unemployment expenditures rise in bad times and work in the opposite way in a boom. They provide income transfers that are required for fuller use of labor resources. A low income person can provide for himself and his family with the help of low tax rates and income credits. They provide the funding for projects considered socially desirable. Low income housing can be built by governments directly or indirectly through section 8 tax expenditures. Right now we have hording of cash by high income folks and corporations, and we have idle resources especially with the 8+% unemployment rate. It makes sense to tax the high income folks and corporations a little more to provide much needed infrastructure investment. Can taxes be too progressive? Probably yes, but the Clinton years showed that his rates made a lot of sense. High marginal rates with deductions leads to having Nelson Rockefeller choose art for museums instead of a political group. Although I greatly dislike Bill Gates, his foundation is working on the eradication of Polio from the Earth. The low income tax breaks should continue, but continuing the high income tax breaks makes no sense to me.
Miguel Hernandez June 28, 2012 at 01:04 PM
As it is the major corporations pay legally pay little or no federal income taxes because they pay huge fees to lobbyists and tax lawyers including millions to the political parties to keep to keep it that way. They even find creative ways for their highly paid executives to avoid paying taxes on their salaries and other compensation benefits. Yet they constantly complain that taxes are too high and thus they are prevented from "creating jobs." the public record clearly show that official tax rates for the corporations have been steadly lowered over the years from 70% to 35% but not one of them pays anywhere near the the lowest level. The corporations and their political allies in Congress also make a lot of nois about "free markets" but they are constantly working at getting Congress to pass laws that are favorable to them at the expense of consumers. In effect we have corporations that actually regulate the supply and demand requiremente of the supposed free market system by in effect, bribing the Congress. To add to the groos unfairness the US Supreme Court has ruled that corporations are people. OK but I am a person as well. So how is it that thatcorporate entities can donate unregulated amounts of money to the political parties but I can't ?

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