Let’s Fall Off The Cliff

We all have been following the dance in Washington about the budget problem that makes headlines every day about how Congress and the Obama Administration are heading for a fiscal cliff. Savvy political observers say that Obama has the upper hand in this fight to lay more taxes upon the rich. The more frantic say that if we fall off of that cliff we’ll be in a new recession. Blah, blah, blah.

That is all BS and we all know that. Or we should. I’m at the point where I think the fiscal cliff might be fine. The tax increases really aren’t that big of a hit on the economy. I mean we had rates that high before the Bush tax cuts and we didn’t sink into the sea. I believe that high taxes are generally bad, and I understand all of the economics behind them. Don’t write back saying that the Laffer Curve proves that rising taxes would be disastrous. The Laffer Curve is mostly false science. It all depends, as they say. Economies don’t boom because of low taxes; they boom because we have adequate real savings to fund future growth. Yes, at some point, the more the government sucks out of the economy, the economy will suffer (Rahn Curve). Laffer is a post hoc ergo propter hoc kind of thing (“A happened and then B happened, thus A caused B”). High taxes are bad, lower taxes don’t necessarily lead to growth.

The good thing that would happen is that automatic spending cuts will go into effect. While these cuts are a drop in the bucket, it’s a start. Over a ten year period, the cuts amount to a trillion dollars, or about $100 billion a year. The truth is that government spending will continue to grow, mainly because of entitlements. Cato estimated that the cuts mean that they will spend $44 trillion over ten years rather than $45 trillion.

The real problem is spending. We are spending our way into poverty, Grecian style poverty. I don’t think that real spending cuts and program reforms will happen because we are no different than all the other countries that eventually went bankrupt. There is no political will to change the entitlement status quo. Recall my articles on the tipping point. We will be a difficult country to kill because we have more wealth here than anywhere in the world, but the way we are going it can be done.

I am not being pessimistic here. This is all fact. Politicians are famous for putting off today what they can do tomorrow. Why are we any different than Greece? Compromise for the sake of the country? We’ve compromised all the way up to $16 trillion in debt. Don’t trust them to cut spending.

This article by Cato’s Michael Tanner sums up the problem rather well.

P.S. Today Greece was downgraded by S&P to SD, “Selective Default.”

Misreading the Fiscal Cliff

by Michael D. Tanner

Added to cato.org on November 21, 2012

This article appeared on National Review (Online) on November 21, 2012.

The fiscal cliff is now less than six weeks away. Negotiators are reportedly locked away behind closed doors working on a grand bargain to avoid the tax hikes and spending cuts that will hit on January 1. Most of the debate so far has centered on how best to raise taxes on the wealthy: whether to increase tax rates, as the president demands, or eliminate deductions and loopholes, as some Republicans seem to be open to considering. Unfortunately, these priorities are almost entirely upside down.

Therefore, let me offer some unsolicited advice for the negotiators:

You can’t hike taxes on the rich enough to balance the budget.President Obama has called for $1.6 trillion in tax hikes over the next ten years. While that is large enough to do serious damage to the economy, it would amount to just 16 percent of the combined deficits that we are projected to face over that period. In fact, the president’s proposed tax hike doesn’t even cover the $2.6 trillion in spending increases that he has called for over the next ten years. Obamacare alone will add $2.15 trillion in federal spending by 2022.

Worse, none of this accounts for the rapidly accumulating unfunded liabilities of Social Security and Medicare. Washington tends to focus on our $1.1 trillion budget deficit or our $16.2 trillion national debt, but our real debt, including those unfunded liabilities, is somewhere between $78.5 and $128.2 trillion. As I have pointed out before, you could confiscate — not tax but confiscate — every penny belonging to every millionaire and billionaire in America, and still not have anywhere near enough money to pay for all that we owe.

Of course, even these estimates assume that hiking taxes will actually generate more revenue. It is worth noting, for instance, that Great Britain hiked its top tax rate from 40 to 50 percent in 2010 as part of a deficit-reduction package. The tax hike was supposed to raise an additional £2.4 billion in 2010–11, but actually brought in £5 billion less than was expected without the rate rise (Britain cut tax rates again in the 2012 budget). This should be no surprise. Not all tax cuts pay for themselves (as some Republicans mistakenly believe), but there is a limit to how much taxes can be raised before they begin to create disincentives for work, saving, and investment that prove counterproductive. For example, Veronique de Rugy, a senior research fellow at the Mercatus Center and an NRO contributor, has pointed out that revenue as a percentage of GDP has held relatively constant over the past 80 years regardless of the top marginal tax rate.

Arguing about what taxes should be raised is a distraction from the real issues.

That’s because we have a spending problem. As my colleague Dan Mitchell points out, all that is necessary to balance the federal government’s budget is for government spending to grow more slowly than the economy as a whole. In fact, the Congressional Budget Office predicts that even without any tax hikes, government revenue will reach 21.4 percent of GDP by 2022, significantly higher than its postwar average. Why, then, will we still have a deficit? Because spending that year is expected to exceed 22 percent of GDP, compared with a post-war average of 19.8 percent, and just 18.3 percent as recently as Bill Clinton’s presidency.

According to the CBO, even if we never add another government program, federal spending will reach 46 percent of GDP by mid-century. True, some of that spending is interest on an ever-rising debt, but even if one assumes that the government had no interest expenses beyond those on the $16.2 trillion it currently owes, federal-government spending would still approach 30 percent of GDP by 2050. There is no possible way to raise taxes enough to pay for that amount of spending without wrecking the economy.

President Obama claims that his plan includes spending cuts — in fact, $3 in spending cuts for every $1 in tax hikes. But he hasn’t actually offered any details beyond smoke and mirrors. The president’s plan, for example, includes $1 trillion in spending cuts that were already agreed to as part of the 2011 debt-ceiling deal, a neat exercise in double-counting. He also includes savings from not fighting a war in Iraq or Afghanistan after 2014, money that was never going to be spent in the first place. And, finally, he includes $634 billion in savings from not having to pay interest on the phantom spending he’s cut. More realistic estimates suggest that the president is actually proposing almost $3 in tax hikes for every $1 in spending cuts.

Even those spending cuts are not real cuts, in the sense of less money being spent, but simply reductions in the baseline rate of increase. And while the president’s proposed tax hikes would go into effect immediately, the spending cuts are pushed off into the dim and distant future. In fact, according to recent reports, the president actually wants new stimulus spending in the short term, to be followed by spending cuts once the economy has bounced back.

We’ve been down this road before. Fans of Charles Schulz’s Peanuts know that every fall Lucy promises Charlie Brown that this time she really means it when she says that she will hold that football for him to kick. Yet, somehow, every time she finds a reason to pull that football away and Charlie Brown ends up flat on his back.

In 1982, Ronald Reagan agreed to raise taxes as part of a deal that promised $3 in spending cuts for every $1 in tax hikes. By the time Reagan left office, tax receipts had indeed risen by $290 billion. But not only had spending not been cut, it had actually risen by $318 billion, an increase in spending of $1.10 for every $1 in new taxes. The result was an even bigger budget deficit than the country had before the deal passed. Writing in his memoirs, Reagan called the tax-and-spending agreement one of the biggest domestic mistakes of his presidency, noting that “later the Democrats reneged on their pledge and we never got those cuts.”

In 1990, President George H. W. Bush approached the football, famously breaking his “read my lips, no new taxes” pledge, and agreed to a deal that promised $2 in spending cuts for every $1 in taxes. As with Reagan, the tax hikes proved all too real, an almost $60 billion increase by 1992. But once again, not only did the spending cuts fail to materialize, spending actually increased by $128 billion, a $2.10 increase for every $1 in tax hikes. The deficit, of course, increased as well.

If that seems like distant history, the 2011 deal to increase the debt limit promised $1 trillion in spending cuts, even before the upcoming sequester. Instead, spending since then has increased by $132 billion. And both Republicans and Democrats are currently scrambling to avoid the sequester’s cuts as well.

The real issue is the size of government. As Milton Friedman used to point out, the real cost of government is what it spends, not whether that spending is paid for by debt or taxes. Spending more than we take in is demonstrably a bad thing. But raising taxes sufficiently to support an ever-growing government is not appreciably better. Consider this: Would we be better off with an unbalanced $1 trillion federal budget or a balanced $3.7 trillion one?

As noted above, federal spending is set to rise to 46 percent of GDP by 2050. When you add in state and local spending, government at all levels will be consuming more than 60 percent of everything produced in this country. We cannot long remain economically productive or personally free with a government of that size.

Any grand bargain, therefore, must include significant reductions in government spending. These cuts must be real, actual cuts, not just reductions in the rate of growth, and must occur now, not in the “out years.” They should include structural reforms to deal with the insolvency of Social Security and Medicare.

If we accept anything less, we may soon find ourselves longing for the days of the fiscal cliff.

Michael Tanner is a senior fellow at the Cato Institute and author of Leviathan on the Right: How Big-Government Conservatism Brought Down the Republican Revolution.


5 comments to Let’s Fall Off The Cliff

  • John

    Stop calling it the fiscal cliff. Instead, call it the “responsible austerity”. The best part about it is that there are some large spending cuts that will be automatically instituted. This is the only way spending cuts will ever get passed by the Republicrats.

  • Hans

    The fiscal cliff, coined by Bank Bernank..John, we should also stop calling anything “austerity” as only the generation from the 30′s know the meaning..

    Even with B/S there will no [cuts] because of base line budgeting…

    Smoke and mirrors by the Demcos and the First Cry Baby Speaker…

  • dd

    Jeff, you are so right. the lead-in was written perfectly. you are no being pessimistic, you are just telling the truth.

  • Bertrand Kolecza

    I’m not in economics science. But as far as I understand news here in Brazil, all levels of government already take from us around 60% of GDP (although some say it is around 39%). Well, we are not productive, neither personally free. And will not be for a long time to come. Our political parties are all leftsided (from the center to the extreme) and their recipe is always the same: to spend more (actually four times) than they sequester from us. It is a hell of a country.