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Fiscal Cliff Russian Roulette: Is It The Right Way Forward ?



by Paul Ballard
November 1, 2011Fiscal Cliff Russian Roulette: Is It The Right Way Forward ?

After Thanksgiving turkey, I watched my nephews play a video game on TV. It required nerve and skill, or else one side, or the world, collapses. And they did several times! As I watched, I saw parallels to the Fiscal Cliff game now played by our political leaders in Washington D.C.
In Fiscal Cliff, Pres. Obama and Republican leaders in Congress must agree revenue increases and spending cuts to reduce the U.S. deficit, before the national debt ceiling can be raised for borrowing on existing obligations. If not, massive across-the-board spending cuts totaling $1.2 trillion will automatically apply to all Federal programs, and the 2001 Bush tax cuts will expire raising income, payroll and capital gains taxes for all Americans. The USA will be seen to default on its financial obligations, sending shock waves through U.S. and global markets, triggering a downgrade of US credit rating.
Fiscal Cliff is, in essence, a dangerous, high-stakes Russian roulette game played with the American economy. Any miscalculation by our political leaders and the U.S. economy – poised for increased growth and employment, could instead fall into recession in 2013. Production losses, more unemployment, and increased national debt would result!
Markets and the U.S. economy are already reacting to the uncertainty. Many U.S. corporations are cutting investment and hiring. Others, including investors, are accelerating dividend payouts to beat a potential tax hike. Uncertainty is heightened because negotiations are taking place behind closed doors between Pres. Obama and Speaker Boehner, with little public input or transparency.
For the U.S. Congress, this is an artificial economic crisis they created, where budget sequestrations are concerned. During 1981-2010, the Federal debt ceiling was raised forty-two times – twenty-one times for Pres. Reagan, five times for Pres. Clinton, and ten times for Pres. G.W. Bush – with limited debate and no budget measures attached. It was a routine procedure to enable continued drawdowns on existing obligations.
Republicans and Democrats agree reforms of the U.S. tax code and Federal spending are needed. But they disagree on the key components. Such reforms are clearly needed long-term (next twenty years). But, in a still recovering economy, faster economic growth must be a still higher priority in 2013-14. This is especially so because other major economies are losing steam, notably China, India, Japan, and the Eurozone, which is poised to fall into recession in 2013.
For me, key questions on Fiscal Cliff are : How will short-term actions now keep our economy growing? How can these avoid preempting and complicating vitally needed long-term reforms in taxation and spending ? Long-term, what mixes of tax revenues and spending, and of spending programs, will yield sustainable and vigorous U.S. economic growth? What process and sequence of policy actions will achieve this?
Republicans and Democrats agree some combination of revenue increases and spending reductions are needed in 2013. But Republicans put emphasis on spending reductions – especially in entitlement programs and in non-defense “discretionary” spending. They would make all the Bush tax cuts permanent, and would end the payroll tax holiday. They propose raising revenues by cutting “tax expenditures” – deductions currently allowed from Federal income tax – but without specifying which ones.
Pres. Obama and Democrats would keep the 2001 Bush tax cuts for all but the wealthiest Americans, earning over $250,000 a year by raising top nominal income tax rates back to 37-39%. They also would protect entitlements, finding spending cuts elsewhere, including defense, and would probably preserve for now the payroll tax holiday.
For now, the outcome of Fiscal Cliff is unclear. Negotiations are underway. But somewhere between the two positions there clearly is the makings of a deal. However, as I see it, there are key points now and for the long-term:
On revenues: Federal tax receipts are now at a thirty-year low at only 15% of the total economy (GDP) in 2011. This compares with 21% in 2001. Achieving deficit-reducing, debt-lowering, faster economic growth, without significantly raising revenues is virtually impossible. Scaling back tax deductions will be nowhere near enough to restore revenues to 2001 levels, when there was a budget surplus.
Ad hoc changes now in “tax expenditures” – such as the mortgage interest deduction – could depress the housing market as it is bouncing back, and complicate long-term tax reform. Moreover, such tax deductions likely affect middle class Americans more than the wealthiest. For some senior Republican lawmakers, raising top nominal income tax rates now may be more effective to achieve short-term agreement without prejudicing the long-term.
With increased uncertainties of late in economic output and hiring, it would seem better to keep the payroll tax holiday for a year or two, until sustained growth is assured.
On spending: Republicans want to initiate now a plan for long-term entitlement reform – particularly in Medicaid and Medicare, but also in Social Security, through some combination of eligibility age increases, slowing inflation adjustments, and means-testing benefits. Looking out at future budget projections long-term, the entitlement programs will grow rapidly and, to be sustainable, their costs will need reducing significantly over time – especially in healthcare areas.
But can such actions be taken now without preempting and making long-term reform more difficult? Also, shouldn’t changes to Medicare and Medicaid be part of broader cost-reducing healthcare market reform – introducing competition, consumer choice, removal of oligopolies etc.? Otherwise, with medical inflation unabated, funding cuts could cause many Americans, especially the most vulnerable, to suffer considerable hardship in future.
So, in my view, we really need to prepare a bipartisan long-term entitlement reform plan, using the full range of policy tools to reduce their fiscal impact over time.
Now that funding two costly wars in Iraq and Afghanistan is ending fully in 2014, defense spending – still one quarter of total Federal outlays – could be substantially reduced. Quicker drawdown in forces in Afghanistan could help increase budget savings.
Pres. Obama and Democrats propose spending cuts of $4 trillion in a ten-year deficit reduction plan, based upon Simpson-Bowles’ commission recommendations. But details have not been fleshed out. In Fiscal Cliff, they propose fresh economic stimulus through $50 billion in infrastructure investments (mass transit, high-speed rail, roads).
Long-term the USA clearly needs to invest much more on infrastructure, as well as in education and skills training and retraining to boost its global competitiveness. But infrastructure is by nature a longer term investment not always suited to short-term economic stimulus. And more could be done through private investment in build-own-transfer (BOT) and similar schemes, with the right incentives. On the other hand, 2011 Jobs Bill measures proposed to strengthen education (by avoiding teacher layoffs) and job training would be very timely and useful to address still high US unemployment and underemployment.
Long-Term Strategy: Short-term actions under Fiscal Cliff would, I feel, be best as part of a long-term strategy to grow the U.S. economy at a sustained faster rate – 4-5% annually as in the 1980s and 1990s.
This has three implications :
First, top priority must be given to ensuring faster economic growth in 2013-14. Our political leaders can be flexible in the dollar amounts of deficit reduction now, provided a credible plan is put forward.
Second, since 1981, the USA has tried two contrasting approaches to sustaining high economic growth. In 1981-88, and in 2001-08, Pres. Reagan and Pres. G.W. Bush pursued a deficit-financed expansion strategy that achieved economic growth at the cost of unsustainable increases in the national debt. By contrast, in 1993-2001, Pres. Clinton in agreement with Congressional Republicans followed a high-growth path (averaging 5% a year) based upon a balanced budget approach, by raising revenues, cutting spending, and eventually reducing the national debt. The success of this latter strategy shows that raising revenues need not inhibit but can enable sustained growth and job creation. This approach deserves to be followed in the future to help address the high-debt legacy from 2001-08 and the Great Recession.
Third, Fiscal Cliff Russian roulette is an ineffective and dangerous way to grapple with the U.S. economy’s long-term challenges. It would be better to revert to established appropriations processes for deliberating and agreeing revenue and spending plans. This has the great advantage of transparency – allowing all of us as U.S. citizens to participate and view the process unfold. Our lawmakers should agree now to return to routine approval of future debt ceiling increases – based on the “no disapproval” procedure proposed by Sen. McConnell in 2011.
This would be the finest Christmas gift Pres. Obama and the Republican Congressional leadership could give the American people this year. Unlike other exciting video games, Fiscal Cliff is one we would do better never to play again!
Happy Christmas and a Joyous New Year!




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