Down The Fiscal Rabbit Hole
A few quick things on the current hyperventilation regarding the so-called ‘fiscal cliff’.
It isn’t a cliff.
Not at all. It is a roll out of a series of things that have cumulative effect, but which can be undone over a sensible timeframe. There is no sudden drop-dead moment when the lights go out. Yes, the Bush tax increases come into effect. And note my language: this is a tax increase imposed on us by the Republicans under George Bush. It is the offset to his disastrous tax cut. So it is an increase. Moving on: that increase hits everyone on January 1st. But since its impact will be on the amount deducted from incomes, its full impact will accumulate through the year. Households will react to the loss of purchasing power at different times throughout 2013, so there is no single moment when the impact smashes into GDP. There is no cliff, but there is a steady slide.
All that cash withdrawn from paychecks will suck demand from the economy. That means that sometime in 2013 we will most likely head into recession. This is what vexes business and is why it now has found its anti-austeirty voice. I find this amusing for the simple reason that by getting into a tizzy over the loss of demand big business has declared its allegiance to Keynes. Anyone who worries about the impact of a rise in taxes on GDP, and concludes that such an impact will be the loss of demand and hence will lead to contraction, is a Keynesian. Pure and simple. Notice also that this position implies that big business is not concerned that the deficit is too high. Postponing tax increases means the deficit will go up, not down. Since that’s what big business is now calling for, they are actually arguing that the deficit might be too small, not too large. Nice huh?
No it isn’t possible to raise revenues and lower tax rates at the same time. At least not if narrowing the deficit is your goal. Tax rates are already too low. Especially on high income earners. Rates need to go up. We have defunded government, we have not expanded it. We can afford what we spend once we get rid of that defunding effort. Our social programs have not suddenly become too much of a burden, we have deliberately stopped paying for them.
This was, of course, a long term strategy driven by the right and not opposed by a compliant left. Both parties sat at the table when the game was played. One wanted to eliminate entitlements by defunding them and then crying about our inability to pay for them; the other was too timid to fight back. Indeed, under Clinton, the so-called left actually added to the defunding momentum.
Oh and all this talk about raising revenues through closing loopholes is daft. Each loophole is well defended by an army of lobbyists – usually the people who bought Congress to put the loophole there in the first place – so it isn’t credible to imagine we will close many, if any. Besides the biggest loopholes are those that fund the middle class: the antiquated subsidy of home owners via the tax credit in mortgage interest, and the deduction they get for state, local, and property taxes. These aren’t listed as outlays in the budget because no one wants to embarrass the middle class by showing how much welfare gets pumped into it each year. So they are buried in the budget reports and called ‘tax expenditures’. Any drive to raise revenues without raising rates will have to do away with such things. Thus middle class taxes will go up significantly. The ruse of keeping tax rates down is simply so that the Republicans can save face with their rabid base. Taxes are going up one way or another.
One last thing: the fear mongering talk about ‘cliffs’ is designed to make it difficult to defend entitlements. It also means that debate will be truncated. In that fervid atmosphere mistakes will be made, which is why we all ought to slow things down and avoid hyperbole. In the midst of such an artificial crisis things like Social Security become sitting ducks. Already we are hearing talk about raising the retirement age again. This is because life expectancy has risen way beyond what it was when the program was introduced. Alan Simpson of Simpson-Bowles notoriety is a major advocate of such a move. He has been an outspoken opponent of entitlement programs since his election it Utah. Of course he doesn’t have to worry. His twenty years in Congress earned him lifetime health benefits and a full pension. He just thinks other sought to work longer and harder to get what he has. Sounds fair, right?
Let’s think twice though. This is because much of the increase in life expectancy is an illusion.
Yes we live longer on average. But much of the increase in overall life expectancy comes as a result of better care for infants, making life expectancy at birth much higher than it used to be. But it is that portion of life beyond retirement that we ought focus on, and which represents the actuarial problem, so gains made for infants are irrelevant. When we focus this way, we find that the gain is much less, indeed for low wage earners the gain is minimal. So the increase in retirement age from 65 to 67 has already solved a considerable part of the problem – such as it is – and little more is needed. The actuaries calculating the retirement age saw this coming as far back as 1946. And in the revamp of 1985 they nailed it. What they missed, though, is the inflation of incomes. The payroll tax funding the program has a cap of around $110,000. Incomes above that level are free of payroll tax. Adjusting for the underestimate of the impact of inflation on incomes by removing that upper cap or raising it significantly is all that is needed to solve the program’s minor difficulties.
Medicare is a whole different issue. There the problem is the lack of cost control and low productivity in the health care industry. Bending the trajectory of future cost increases is the primary goal, and, parenthetically, the last year or two have seen major strides in that direction – health care cost have risen more slowly, so we need not panic.
And this ought be our theme throughout: no panic. There is no cliff. The world will not end if we don’t hammer out an urgent bargain. We can afford to be sensible on this one. So don’t listen to the hyperventilating pundits. They’re the ones who called the election close. They were wrong then. They’re wrong now.
Stay calm.
