Economics

America Is Still Hurtling Towards the Fiscal Cliff

It's time to bring meaningful reforms to America's unaffordable and outdated entitlement programs.

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It is telling that, according to a recent survey by Macro Risk Advisors, the biggest threat facing U.S. investors isn't a meltdown in the eurozone, or a crash in China, or even a misstep by the Federal Reserve. In fact, their biggest fear is the uncertainty engendered by election season, and the "fiscal cliff" over which the United States is set to hurtle come January 2, 2013.

The cliff in question is a $607 billion combination of tax increases and spending cuts, and is the result of failure by Congress in 2011 to reach agreement on how to reduce the federal deficit. Without political intervention, it will come into force just as our New Year's Eve hangovers start to wear off. But how bad could it be?

According to the Tax Policy Center, taxes would rise by more than $500 billion in 2013, as almost every tax cut enacted since 2001 would expire. Average marginal tax rates would rise by 5 percent on labor income, by 7 percent on capital gains, and by more than 20 percent on dividends.

Almost every American will be hit. Most will feel the impact of a rise in payroll taxes and higher income tax rates, with middle-income Americans facing an average tax increase of almost $2,000. Those on low incomes will suffer the withdrawal of tax credits, while high earners will face punitive taxes on high-end health care plans and a squeeze on their investments.

You don't have to agree with President Obama's former advisor Christina Romer—who estimates that increasing taxes by 1 percent of GDP leads to a 3 percent reduction in GDP overall—to see that tax rises of this magnitude are likely to be very damaging, especially in the context of an anaemic and largely jobless economic recovery.

But even avoiding these tax rises wouldn't leave the U.S. with a rational, pro-growth tax system. Policy makers desperately need to comprehensively reform the code, eliminating a maze of exemptions, deductions, and special favors, while cutting rates across the board. Unfortunately, that's not how Washington works.

When it comes to the spending cuts, the story is rather different. Here, at least, the threat to U.S. economic health is vastly overstated. The lion's share of the scheduled cuts come courtesy of the Budget Control Act of 2011, which mandates automatic cuts of around $109 billion a year, starting on January 2 and continuing until 2021.

That sounds drastic, but should be put in context. The federal government has run a trillion-dollar deficit four years in row, and currently borrows 30 cents of every dollar it spends. It barely raises enough revenue to cover "non-discretionary spending" on things like pensions, debt interest payments, and health care for the poor and elderly—let alone to fund national defense (where America spends five times as much as its nearest competitor, China) and other government programs. Such profligacy may be manageable now, with treasury yields at record lows, but bond markets can be capricious. The U.S. is storing up enormous trouble for its future, even before you consider the impact of inexorably rising health care costs and an aging population.

Moreover, these automatic cuts are calculated against a baseline of projected spending increases. As Mercatus Center economist Veronique de Rugy has pointed out, "After the initial cuts, spending will grow by $1.65 trillion, as opposed to $1.8 trillion, between 2012 and 2021." Defense spending—the target of half the automatic cuts—will initially fall to 2007 levels (in inflation-adjusted terms) and then return to 2012 levels by 2018. So while these cuts will undoubtedly pose an administrative challenge, they are hardly the public sector apocalypse—or the open door to America's enemies—that their critics would have you believe.

Indeed, the problem with the fiscal cliff spending cuts is not that they go too far, but that they don't go nearly far enough. They entail no meaningful reforms to unaffordable and outdated entitlement programs at home, and they impose no serious restraint on America's trigger-happy interventionism overseas. They're a start, but that's all. In the long run, the U.S. needs to do the same thing as every other Western state: Radically re-think government from the ground-up and question absolutely everything.

Fiscal cliff or no fiscal cliff, the 112th Congress has shown itself spectacularly ill-suited to that task. One can only hope its successor will do better.

A version of this article originally appeared in City AM, a London-based business newspaper.

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  1. Somehow the news reporters always neglect to mention that the “fiscal cliff” would actually be an improvement — automatic spending cuts would be triggered, thereby reducing the rate that the national debt will increase.

    Here’s to the fiscal cliff!

    1. Except for the tax increase, of course….

      1. Let’s not forget inflation and more quantitative “easing”.

        It might be the only way to fix our problems but it’s going to feel like having a burst appendix removed with a pen knife in the back of an old farm truck racing down a dirt road.

  2. ENSLAVE ALL DOCTORS! ENSLAVE ALL UNDER 45! BABY BOOMERS MUST LIVE IN COMFORT FOREVER!

    1. As the entitlement state begins to show its true tyranny, I’d not be surprised to see acts of terrorism committed against cruise ships.

      The eskimos sent their old off on icebergs to die. We send our old off on 35 day vacations to the south pacific and caribbean to suckle at the teat of their children in bondage.

      1. Mmmm teats in bondage?.

  3. Significant and meaningful reform to the entitlement state is my single biggest issue. I would be willing to hold my nose and vote for a candidate who I otherwise had serious misgivings about if I felt he was serious about entitlement reform. In that vein, I would have voted for Paul Ryan at the top of the ticket, but I won’t as a Veep. I fully recognize that the reforms he’s proposed are woefully inadequate, but they are nonetheless a first step towards hopefully greater reforms (as an aside, Biden’s pleas to the old people at the VP debate made me cringe and rage).

    The biggest failing of the libertarian party is that they have not been out front on this issue specifically. The LP will not get the votes of many elderly who have been programmed into the binary thinking that ruins this republic. But the young seek a shift, and while there are certainly dupes in my generation, there are also a good number who regardless of their other positions, fully recognize that the entitlement state will be the chains around their necks. Sadly, among the various and sundry libertarians on the national scene, from Ron and Rand Paul to Gary Johnson, they have failed to make this one of their primary causes. And it is to my great dismay that I feel that they have failed me in providing that voice.

    1. I quite agree with your point of view.

  4. Indeed, the problem with the fiscal cliff spending cuts is not that they go too far, but that they don’t go nearly far enough.

    In other words, the spending “cuts” only offer a meager return for the highly burdensome tax increases.

    The economics ignoramus will, of course, wail and pull their hair at the prospect of losing the “aggregate demand” that the spending represents, as if spending for its own sake was the goal of economic activity, rather than a means to an end. But the real effect of the fiscal cliff will come from the tax increases, as they totally change the opportunity cost schedules of each individual, imposing a series of choices they would probably not consider if they kept more of their production.

    1. It really doesn’t matter.

    2. Actually the danger of the tax increases is likely just as badly overstated because it is highly unlikely that those “tax increases” will raise anywhere near $500 billion and frankly I’d be shocked if they went up by even $200 billion.

      The problem is that $500 billion number is based on a static analysis that assumes no changes in taxpayer behavior as a result of the tax increases.

      It is true that the total number of dollars removed from the economy would be somewhere between that $200 Billion and $500 Billion as some economic activity would be foregone or altered to cut the tax burdens but on the flip side having a deficit that is at least 25% smaller than it is today means that many fewer government bonds being sold and those investors looking for other investments to make money with.

      1. Re: Rasilio,

        Actually the danger of the tax increases is likely just as badly overstated[…]

        Possibly, but tax increases still are able to gum up the works, as tax producers scramble to hire the people that can help them hide their money from the grabby hands of government rather than use their money on investments, savings or goods/services. A tax hike is still destructive in that way even if people still pay the same nominal rate as ever.

        1. tax producers scramble to hire the people that can help them hide their money

          So, its a tax hike AND a jobs program?

  5. “Toward”…

  6. It absolutely doesn’t amount.

  7. I picture a Thelma and Louise seen with Obama and Reid in the front seats racing towards the cliff as the prez slams the pedal to the metal.

    Hopefully their volt runs out of charge before they get there?

  8. I just see Jason Hu has single-handedly pushed the coffin lid, heart shocked that http://www.cheapfootballcleatsmall.com/ comes from a fear of the unknown. The coffin lid open, drove my curiosity I looked at them on the coffins. On this one, so my curiosity pressure over fear. Of course, I am no longer the main reason for the fear is very good save with a fox’s body, looks like a very thin sleeping fox general.

  9. But what about all of those horrible sequestration cuts that threaten to cut increases in spending by almost 120 billion per year!

    Wait, that doesn’t sound too bad?
    On second thought how can we get more sequestration?

  10. Reforms?! Ha! We’re going back into a recession in 2013, because no one is going to solve the Obamacare tax increases. Europe is going to continue to implode and probably Israel goes to war with Iran. Oh yeah, and the US Recovery was a fed-induced load of horse-shit. So, let’s go back into a recession with the candy-man Prez – there’s only 50% of the bond market left to buy-out! What will be next?? MBS? AND AND? MBS is way riskier…sovereign debt crisis before this Prez’s term is up, guaranteed.

  11. Greek unemployment is 25.4%, just like American 18-29 unemployment. Next time you see an obama prositi-ot, slap the shit out of him/her.

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