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Realism about the fiscal cliff

28 December 2012

Summary:  The fiscal cliff dominates the news.  What will happen if we fall off it. How we can avoid it, preferably by easy painless solutions.  Here we peel back the consensus wisdom to see what lies beneath. We’ll look at the cliff from different perspectives.

We dream of easy solutions!

We dream of easy solutions!

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Contents

  1. It’s not important
  2. It’s important
  3. About the GOP in-fighting
  4. Economists look at the cliff
  5. For More Information

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(1)  It’s not important

For three decades the results of changes in tax policy have been described in apocalyptic terms. Reagan’s tax cuts were to stimulate a fantastic economic boom; it didn’t happen.  Clinton’s tax increases were to devastate the economy and produce little or no added revenue.  Instead the budget was balanced and growth accelerated. Bush Jr’s tax cuts were to boost the economy; slow growth was followed by a crash.

Now we face another round of the game. The fiscal cliff involves spending cuts and tax increases, so that falling off the cliff will devastate the economy.  Perhaps so.  Perhaps these fears are exaggerated.  Especially fears about the effect of the “cliff’s” tax increases.

Here are two of the many studies showing the minimal effect of tinkering with the tax code.  No surprise considering the small size of these in terms of GDP.  These are by the Congressional Research Service:

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(2)  It’s important

Sensible people often describe wars as senseless. Fighting about imaginary lines on the land, fighting for possession of a field or farm.  While that’s true in a sense, in a sense it’s very false.  Peoples often have different values or incompatible goals, so that a clash becomes inevitable. Only the time and place remains uncertain — and in a sense irrelevant.

So it has become inevitable for the Republicans and Democrats. They have different visions of domestic policy (although they largely agree about foreign policy).  The American people remain almost equally divided, preventing a resolution to decades of divided government.  Both sides seek the traditional western solution, a decisive battle.  The fiscal cliff might provide them an opportunity.

We’ll see if both sides take advantage of this opportunity.

Meanwhile the American people demand the sensible solution: a balanced budget, spending cuts that affect other people (preferably foreigners), and no tax increases (or only on other people).

We believe! Yea, we believe in fairies!

We believe! Yea, we believe in fairies!

Only a trial of partisan strength can resolve this political conundrum.

(3)  About the GOP in-fighting

Many see the Republican Party as torn by in-fighting between moderates and Tea Party Extremists.  While true, there is another equally valid perspective.

Consider this statement of the consensus view: “Orcs v. Goblins: Crazed Republicans Turn on Each Other in Ugly Fiscal Cliff Battle“, Lynn Stuart Parramore, AlterNet, 23 December 2012 — “The little people look on as evil threatens the land.”

On the other hand, the two wings of the GOP might be playing good cop – bad cop.  Or good cop – mad cop.  This improves the GOP’s negotiating strength — as the “moderates” beg for unwarranted concessions necessary to gain the support of their Right-wing extremists.    The Tea Party act as shock troops, their extreme views pushing the Overton Window to the Right.

Even the partisan polarization between Obama and the GOP seems exaggerated, as many are warning:

(4) Economists look at the cliff

  • Falling Off the Fiscal Cliff“, Jason Saving (Senior Research Economist), Dallas Fed’s Economic Letter, December 2012
  • Over the Cliff We Go“, Brad DeLong (Prof Economics, Berkeley), Project Syndicate, 27 December 2012 — “Spending cuts and tax increases that in the long run restore fiscal sanity and balance are good. Having them all hit a weak, still-depressed economy simultaneously is not good.”

(5)  For More Information

About the fake polarization of American politics:

  1. Polarization and hot rhetoric conceal two similar political parties. Will we ever notice?, 29 October 2010
  2. In America, both Left and Right love the long war, 30 March 2011
  3. The good news: America’s politics are neither polarized nor dysfunctional. That’s also the bad news., 16 November 2011
  4. Conservatives, celebrate the historic victory you won today!, 7 November 2012
  5. The votes were counted and one wing of our one ruling party won. Rejoice!, 8 November 2012
  6. How Obama AND conservatives both won on Tuesday, 8 November 2012
  7. What will Obama do in term II? He’ll finish the great work of term I!, 10 November 2012

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18 Comments leave one →
  1. 28 December 2012 4:16 am

    Michael Lighty from the National Nurses United — the best Union in the USA! — updates PDA members in Oakland on what on the Robin Hood Tax could do for the world economy, 20 December 2012:

    “The Robin Hood Tax can raise up to $350 billion a year – answering the question of how we can pay for turning our country’s economy around. Take some time and watch NNU’s Michael Lighty explain the importance of a Robin Hood Tax and why the nurses are supporting HR6411, The Inclusive Prosperity Act.”

    .

    Like

  2. 28 December 2012 6:26 am

    Joe Firestone wrote two of the best paragraphs I’ve read about the “fiscal cliff” (emphasis added):

    Of course, too much deficit spending can cause demand-pull inflation. But the proper remedy for that is to raise specific taxes and lower specific spending in such a way that price stability and full employment, as well as other good outcome result from fiscal policy. The size of the deficit or surplus is not a proxy for such real outcomes, and responsible fiscal policy should not be attempting to maximize, minimize or optimize either deficits or surpluses, rather than the real outcomes of government fiscal policy. In other words, run fiscal policy in accordance with expected real outcomes, and forget about deficits and surpluses per se. They should be treated as insignificant side effects, not as as centerpieces for fiscal responsibility, as they were under the gold standard.
    [...]
    Please, no more foolish legislation that tries to constrain the freedom of action of future Congresses! The context of fiscal policy is always changing, and the Government must be adaptive to changing conditions. Future governments have to take into account things that have gone or are likely to go wrong. We should not, and really cannot bind them to “triggers” that can’t take into account the future conditions that may present themselves.

    How we can avoid it, preferably by easy painless solutions?

    The ironic thing is, the “easy, painless” solution is the appropriate one, and we can’t bring ourselves to implement it: forget about the deficit and do what needs to be done now, now.

    Whatever the future effects of an increased deficit, it will be easier for future generations to deal with those than with the consequences of failing to maintain and modernize our infrastructure, to educate our citizens and to invest in future technologies while allowing poverty and long-term unemployment to undermine the strength of our families and our work force. Add ecological carelessness, the diversion of too many of our best and brightest into an overgrown, counterproductive FIRE economy, and our devolution into the world’s greatest banana republic… and we are leaving future generations one hell of a burden, alright, but it has nothing to do with the debt.

    Like

    • 28 December 2012 6:46 am

      Closes,

      I totally reject the “leave the spending status quo for another day.” This is the pressure that properly directed can drive reforms.

      Tax increases on the upper class now, on a incremental schedule of annual steps up, should be done now (as the CRS says, this will reduce inequality, also).

      Equalize the treatment of earned and capital gains. Reduce dedications, and radically simplify the tax code.

      Stop burning money. Reallocate spending from corporate subsidies and war to rebuilding our infrastructure, stat. Reform health care along the lines of one of the successful mixed systems used in Europe.

      Recreate the well-funded open access college system enjoyed by the boomers, which paid such ample dividends to America.

      Reform and refund the primary and secondary education institutions.

      There are popular and obviously beneficial measures that could be done now, if we cast off the shackles of the mind that prevent action.

      Like

    • Todd Guthrie permalink
      28 December 2012 6:58 pm

      I think that Coises summary of Firestone’s comment is a very good point – one that most economists seem to forget these days when they look only at macro numbers.
      As a nation and a people, I think we need to look at the real things that our government does and can do to help real people in real ways, rather than look at how an abstract net residual may help abstract net people according to certain abstract economic theories.

      Mr Maximus gives the two great examples of real things that help in real ways – infrastructure and education.

      A few years back someone gave me an analysis of why the political debate has more or less stagnated for the last two decades. It has stuck with me since. He said that the debate about how much government we should have was something that the last generation concerned themselves with as they placed themselves somewhere along a spectrum between capitalist and socialist.
      But that debate doesn’t really help us today. People today can be happy very limited government, as in Singapore, or they can also be happy with very expansive government, as in Sweden. The question that will plague the next generation is not how much government is the right amount, but how effective is the government we have at meeting the needs of its people.

      Like

    • 28 December 2012 7:47 pm

      Todd implicitly raises a vital point, worth remembering as we starts new year: economics is powerful tool for understanding our world. But it looks only at material wealth and income, whereas life encompasses so many more things.

      To paraphrase Mr Spock, economics is only the beginning of wisdom.

      Like

  3. 28 December 2012 8:44 am

    It looks like the ‘fiscal cliff’ might be the American version of the 1997 VAT increase in Japan. Around 1996 Japan had begun to crawl out of the recession, though the deficit was still high. It’s 1997 that they raised the VAT in order to try to reduce the deficit. What happened that instead of the deficit getting smaller, the deficit got even larger. This triggered a double-dip recession and prolonged the economic pain for many extra years.

    I think American exceptional-ism just makes everyone blind to any parallels in other countries. We’re different so we think what happened doesn’t apply, and then the USA goes on to make exactly the same stupid mistake. The USA duplicated the same policies of propping up the big banks, in the end, we went “more Japan than Sweden” with the financial crisis and the banks. Now we’re heading for exactly the same tax increase during a recession. I think it’s going to be ‘epic fail.’

    Like

  4. OldSkeptic permalink
    28 December 2012 10:03 am

    Meaningless nonsense. So the US Treasury issues bonds and the Federal Reserve buys them. The US Govt owes money to itself? These are accounting items that could be deleted at the stroke of a pen.

    Compared to the private (mortgage, corporate, etc) debt (roughly 150% of GDP). The derivative speculation (at least $600 trillion .. the US GDP is only 14 trillion) and the rest, this is chump change.

    What is the real reason why some people are going on about it? Looting basically. And a political rational to loot more from ordinary people.

    Look FM you are are military site. Gutting vet pensions and health (etc) payments means what? More money for ‘hardware’, which means more profits and hence more bonuses for their CEOs.

    Like

    • 28 December 2012 2:26 pm

      OldSkeptic,

      There are people who rely on experts, such as scientists, for answers in technical fields. That’s one of the principal functions of the FM website. We take an issue, like climate science or debt deflation, and show what top experts say about it — usually with direct quotes.

      So, for example, in economics we have dozens of posts showing how Keynes’ words can help us understand today’s problems.

      Then there are people like you, who dismiss the work of scientists. Casually. Arrogantly. With no visible basis for your opinion. As you do here for economists. As you have done so often with climate scientists.

      I used to feel sorry for such people. Then I realized that although well-meaning, it’s possible they do almost as much damage to the world as the small number of actually evil people. So I no longer feel sorry for you. And feel no need to respond to your rants about things you don’t understand.

      BTW — the FM website has posts making quite a few accurate economic forecasts, often in direct opposition to consensus opinion. I doubt you can say as much. For example, during the Spring 2008 inflation scare I wrote that the danger was deflation (“Rising sector prices plus tight money can create deflation”). And so it was, as we entered a debt-deflation spiral three months later. A simple application of basic economic theory.

      Like

    • 28 December 2012 2:38 pm

      “Meaningless nonsense. So the US Treasury issues bonds and the Federal Reserve buys them. The US Govt owes money to itself? These are accounting items that could be deleted at the stroke of a pen.”

      If you would like an explanation, read any Economics 101 textbook.

      Or read Inflation: Causes and Consequences by Milton Friedman (1963). “Inflation is always and everywhere a monetary phenomenon.” It’s one of the contributions to economics for which he was awarded the Nobel Prize. Economists have learned much since then, but it’s often worthwhile to read the foundational works.

      Like

  5. 28 December 2012 3:52 pm

    Falling Off the Fiscal Cliff“, Jason Saving (Senior Research Economist), Dallas Fed’s Economic Letter, December 2012 — Opening:

    Rarely has a Federal Reserve chairman spoken of an event in more ominous terms. Falling off the “fiscal cliff,” a phrase coined by Ben Bernanke to describe a massive and abrupt shift in federal taxes and spending, may accompany the last words of “Auld Lang Syne” to begin 2013.

    Commentators spanning the ideological spectrum have pronounced an economic apocalypse of varying proportions. Some have forecast that the country will slide into recession for at least two quarters and possibly all of 2013, that consumers will become even more reluctant to spend and that the international economy will suffer. The Group of 20—a collection of industrialized nations whose members (including Japan and much of Europe) face their own economic challenges—pegged the cliff as the single most significant threat to global economic growth in 2013.

    These are serious claims, with wide-ranging implications not only on Capitol Hill but also for monetary policymakers. As such, it’s important to better understand the fiscal cliff and its overall economic implications, examining key components, their size and how they interact.

    Like

  6. Thomas More permalink
    28 December 2012 11:11 pm

    FM remarks: “Stop burning money. Reallocate spending from corporate subsidies and war to rebuilding our infrastructure, stat. Reform health care along the lines of one of the successful mixed systems used in Europe.”

    These are the huge ones. Estimated national security spending per annum today runs in excess of 1.2 trillion, most of it wasted on piffle like the TSA, titanium teeth and $21,500 canine tactical suits for anti-terrorism dogs, drone strikes that mostly kill innocent women and children, etc. Estimated spending for American health care per annum runs in excess of 2.2 trillion. U.S medical costs are probably around 40% higher than comparable medical services in the rest of the developed world, and perhaps 70% to 80% of current military expenditures are pure waste, nothing but meaningless counterproductive “security theater,” as Bruce Schneier puts it.

    Stripping out 70% of current national security spending and 40% of current wasted American medical spending (the problem with U.S. medical care is not so much unnecessary care but simply overpriced procedures – U.S. doctors, for example, make about 200% of what doctors in Europe or Japan make per year) would free up somewhere in the ballpark of 1.6 trillion to 1.8 trillion dollars per year. That’s real money. In two years we could completely modernize America’s road and bridge and rail infrastructure with that kind of money. In three years we could fully upgrade America’s information infrastructure to 1 Gbit fiberoptic for every home and business. Then we could start paying down the national debt, freeing up (eventually) a further 500 billion per annum in interest payments, which would create a virtuous cycle in which the more surplus we have, the more we can invest in America’s future, and the more we invest in our future, the faster our economy grows so the more surplus we have.

    Of course this is not likely to happen. Strong entrenched special interests demand poor American infrastructure. For example, the 4 giant media monopolies that currently rule American books/movies/CDs/DVDs/newspapers are horrified by the prospect of fast broadband throughout the United States because this would make it easy for consumers to download all the movies and mp3s and ebooks they could ever want. So the U.S. government has a strong vested interest in keeping American broadband speeds as slow as possible.

    Likewise, military durable goods shipments remain one of the few bright spots in American manufacturing. Consumer electronics and textiles and refrigerators and washers and dryers are now all manufactured in places like China and Mexico, but M1A1 Abrams tanks and M16s are always going to be built domestically, so once again the U.S. government has a strong vested interest in keeping the manufacture of U.S. military durable goods going. The American medical-industrial complex remains the single strongest job creator in our current weak economy, so once again there’s a big vested interest in continuing America’s current wasteful bloated medical spending.

    Like

    • Breton permalink
      29 December 2012 5:58 am

      I was going to comment that FM’s List above reads so sane, mature and terribly reasonable. And yet, they seem so unattainable even in the margins. Why…..cui bono?! And then along comes More with his reasons.

      Pitifully accurate in some regards.

      I bet my neighbors were entertained this PM by the daily TV fare; if I interrupted them during a commercial with an entreaty to explore the Fiscal Cliff, I suspect I would be offered some Holiday cookies and a glass of wine to dissuade my train of thought.
      If you live with an Optimism Bias and it is not your Cliff…….

      Breton

      Like

  7. Breton permalink
    29 December 2012 12:14 pm

    Here’s a good one for the FIscal Cliff Notes: “Business As Usual Inside Obama’s Pentagon“, Chuck Spinney, TIME, 6 December 2012.

    Straight from FM’s reading list, too! (Wish the cute little Fairie pictured above had delivered it but I found it on my own, alas.)

    Breton

    Like

  8. 29 December 2012 6:52 pm

    Paul Krugman just wrote about this in On the Economics and Politics of Deficits:

    The point is that the whole focus of budget discussion is based on a combination of bad economics and bad (and fundamentally dishonest) politics. We’re looking not so much at a Grand Bargain as at a Great Scam.

    This point cannot be repeated enough. Nothing can be resolved to our benefit while we allow our so-called leaders to feed us bullshit and lap it up as if it were wisdom.

    Like

  9. tiradefaction permalink
    4 January 2013 12:53 am

    “So it has become inevitable for the Republicans and Democrats. They have different visions of domestic policy ”

    Is that really so? I think as you’ve pointed out numerous times in the past, they don’t actually differ on most domestic policies, such as economics, and civil liberties. Or am I misinterpreting what you mean by “domestic”?

    Like

    • 4 January 2013 5:39 am

      tiradefaction,

      Sloppy writing on my part! The two parties represent different factions of our ruling elites, and they have different views. They differ somewhat on social policy (although not as much as they pretend to differ), such as regulation of who gets to screw whom — and how the results are handled. They differ on aspects of government regulation, taxes, and spending. The cliff brings these views to a clash.

      These views concern how the government is used for the benefit of our elites. This accounts for the difficult of naive people attempting to relate what our leaders say (what they’ll do for us) and what they do (which seldom benefits us).

      Like

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