Republican Tax Increase, and The National Debt

Yes that’s what we’re all discussing.

The current political furor over whether to maintain the Bush tax cuts, and for whom, is entirely missing the point. The original law written way back in more pleasant days, included a “sunset” provision. That is to say those who voted for the decrease back then were simultaneously voting for an exactly equivalent increase now.

That makes the discussion somewhat different.

The law should be interpreted as a temporary tax decrease only. It was designed to go away ten years after enactment.

Why?

Because back then a permanent tax decrease would have had to be matched by an equivalent spending cut to keep the budget in the same balance. That was the rule in 2001. But, because there was no political will to slash the budget by $1.3 billion, the Republicans, who were in charge of Congress at the time, came up with the ruse of a ten year sunset clause. That made the tax cut temporary, and thus there was no need to slash spending.

Voters, being the inattentive bunch they are, missed this trickery, leaving those of who noticed apoplectic and impotent.

The thought amongst right wingers was that they would be able to dump the need to match tax cuts with spending reductions, and then they would make the cuts permanent. The hubris in this was that they imagined they would control Congress for the foreseeable future. Remember these were the days of Karl Rove’s everlasting GOP majority.

Whoops.

Then reality hit in the shape of the enormous crash at the end of the Bush administration, and the revival of the Democratic party.

So today’s debate is about how to undo the cynicism of the Republicans with the least damage, whilst recognizing that any tax increase at the moment represents a significant threat to our recovery.

This all makes the Republican party’s posturing quite sickening. They didn’t have the fortitude to follow the rule in 2001 and slash spending to balance the budget. Such was the size and imbalance of the tax cut that to meet the balancing requirement would have meant draconian, and immensely unpopular cuts. That was an electoral non-starter. So the GOP fudged. Not only did they create and tolerate huge fiscal deficits, they did so because they couldn’t muster the courage to follow through on their oft stated desire to cut government spending.

That’s cynicism writ large.

Now we have to listen to the exact same folks lecture us all on the dire consequences of fiscal deficits as if they never had anything to do with their creation.

So let me get this straight: ever since Reagan the Republicans have presented themselves as the “small” government party. At the same time Reagan and Bush [the younger] are the only two peacetime presidents, ever, to preside over an intentional – i.e. non-cris driven – run up in national debt. Why did that debt run up? Because the electoral calculus prevented the GOP from actually following through on its rhetoric. Knowing the popularity of the programs that would have to be cut, not to mention that the hallowed offense budget would also have to go down, the Republicans ran away from actually making government smaller. They cut taxes and then allowed deficits to balloon. It is not possible to write a more irresponsible, and frankly immature, script.

The GOP morphed into a party driven by fiscal recklessness. For political gain.

And here we are again going through the same game.

The sensible economic strategy currently is to allow the high end tax cuts to expire on schedule and then to legislate to keep the low end cuts in force for a while longer. That helps reduce the budget deficit somewhat, and yet does the least damage to the recovery. Please notice that language: we have to pass a new law in order to prevent a tax increase.

If we do nothing, then the 2001 law is clear: we get that huge tax increase. The original law was passed and signed by Republicans. That makes the imminent tax increase a Republican tax increase.

Could we all be honest about that – just for once?

Meanwhile for those of you wondering why the increase is OK for the high end taxpayers, let me point you to basic economics.

The questions are these: why is it OK to increase taxes on high income earners? and, Is that not counter to the need for stimulus?

The answer is to do with the way in which high income earners spend or save. Very high income people meet their consumption needs on the early part of their income. They tend to save and invest the rest. So reducing that part of their income that they would otherwise save by taxing it, has a lesser impact on consumption than the exact same tax would on people who earn much less.

Yes, savings go down, and in theory that means less investment available in the economy. But we live a a time of abundant cash. We don’t need the savings. We do need to get the growth of the deficit under control. So raising taxes on higher level incomes has minimal impact on consumption and allows us to start towards fiscal responsibility.

Before any of you call me out as an incipient fiscal hawk allow me to explain my position on the debt.

I am not someone who advocates no debt. My position is simple: growth in debt is fine as long as its growth rate is less than the growth rate of the economy as a whole. Government debt is useful. It can be a permanent feature of a healthy economy. It may even be a necessary component of a healthy economy. In particular, government debt in times of private contraction is important to prevent an implosion. Now is such a time. As the private sector gets rid of debt, the implied contraction of the economy should be offset by an inflow of sufficient government debt to ensure that the transition is as uneventful as possible. Without that transitionary cushion, any private contraction, such as that now going on, inevitably produces depression and deflation.

But I am not one to advocate debt that is uncontrolled. The point of borrowing is to sustain growth. So the result of debt should be manifest in a faster rate of growth than otherwise. So to me at least, rising debt is just fine, as long as GDP rises faster.

Of course that is all relative. Right now GDP is in the tank and so debt is rising much more quickly than the economy at large. By implication, and by applying my approach, there will come a time when the debt is controlled and thus forced to grow much less quickly than GDP. The notion being that the balance cannot be slavishly enforced in times of crisis, but should be enforced through longer time periods.

Hence.

The need for tightening budgets at some point in the future. But, we are nowhere near that point. We are not even close.

Lastly for those of you who imagine that the US is on the road to fiscal ruin:

1] where we you in 2001 when the tax cuts plunged us into unprecedented deficits?

2] the US is not Greece: it borrows in its own currency and can thus print money sufficient to pay its debts; moreover it controls its won budgets, so it can enforce fiscal control when it wants or needs to.

3] US debt is high, but nowhere near impossibly so. It has been worse.

4] as I mentioned above: we need government debt to offset the current decline in private debt. Else the economy will implode again.

I hope all that is clear.