On the Edge

The election is over and the fiscal cliff is looming. It is time to get back to Washington, roll up the sleeves, find some common ground, and fix the problem. Senator Kay Bailey Hutchison (R-TX, retiring) has assured us that both Democrats and Republicans are intent on confronting the situation, so we can all relax, right?

Unfortunately, Senator Hutchison is wrong. There is not one, but several fiscal cliffs, and depending on your party or your philosophy, these cliffs are different, mostly contradictory, and demand completely opposite solutions. Compromise can only be reached on common ground, but the only common ground is that there is a problem, and something needs to be done, soon. It is extremely important that the right thing be done, because should the wrong thing be done, not only will the problem persist, but it will be made worse.

So what are these cliffs? If you are a Democrat, the first cliff is the debt ceiling. Should Congress fail to authorize the borrowing of more money, the Federal government will be unable to pay about 43% of its bills, necessitating drastic and immediate spending cuts. The lack of government spending will plunge the economy into a second recession. The second cliff is the end of the Bush tax cuts. The increase in taxes on the poor and middle class will take money out of their pockets, and so being unable to spend it, the economy will fall into a second recession due to lack of consumption. The prescribed Democratic solution is to immediately borrow a lot more money, raise taxes on the wealthy, cut taxes on everyone else, grow the economy (through government spending), and spend like mad.

If you are a Republican, the first cliff is the end of the Bush tax cuts. The increased taxes on high earners and on dividends (for everyone) will remove money that might have been used for reinvestment in companies or to create jobs. Rather than creating jobs, companies will lay off workers to buffer their margins against the increased taxes, and the economy will continue to fester or even end up in a deeper recession. The second cliff is the debt ceiling and annual deficit. Should Congress approve additional borrowing without a plan to pay it back, potential lenders will lose faith in the U.S. dollar, making it increasingly difficult for the government to borrow money. Unable to borrow the money, the government will need to turn to the printing press, the end result of which is runaway inflation, and poor and middle class people will become destitute. The prescribed Republican solution is to borrow a little more money, keep taxes low for everyone (or even cut them more), grow the economy, cut spending a lot, and aim to start paying down the debt within a decade.

The cliffs really are quite different, and there are only three points of agreement: borrowing more, growing the economy, and cutting taxes on the poor and middle class; except, for Republicans, while borrowing more is part of the solution, it is also part of the problem, and so must be done as part of a larger plan to stop borrowing. If we cut spending, we go over the Democrats' cliff. If we keep spending, we go over the Republicans' cliff. If taxes go up on the high earners, we go over the Republicans' cliff; but if taxes go down, we go over the Democrats' cliff. Going over any cliff will harm the economy and make the problem worse. We need to know which cliffs are real, but even more important; the proposed solutions might not be enough to stop us from going over any cliff.

Consider an economy with 100% taxation on net business income. Within 10 to 20 years, such an economy will disappear. No one will start or grow a business because there is no way to recoup the initial investment. Businesses established before the 100% tax rate will slowly disappear, until there are no businesses left.

High taxes kill an economy, while low taxes neither hurt nor help. The effective rate on business is the total tax paid divided by the net income of the business. History shows that the harmless effective rate, the rate below which total taxes no longer hurt an economy, is around 10%. The fester effective rate, the rate at which an economy neither grows nor shrinks, changes with population growth and money supply, but for the current United States, it seems to be right around or slightly below the Bush tax rates. In other words, if the Bush taxes are extended again or made permanent, our economy will simply fester, perhaps even slowly shrink. If taxes are cut yet again, our economy will grow.

Personal tax rates are a little bit different, but follow the same basic rule. People need extra money in their pockets, businesses need the extra money in peoples' pockets, but excessive taxes take away that extra money. The Federal taxes on personal income are already harmless for the vast majority of Americans. It is the state and local taxes that are killing the personal part of our economy, and there is nothing the Feds can do about those, except to cut or not raise the Federal personal rates.

With multiple historical examples and solid math, it is the Republicans who are correct as to the tax cliff. For the borrowing cliff, the Republicans are again supported by math and historical examples of runaway inflation, while the Democrats are actually contradicted by history and math. The solution needs to be small tax cuts (from the Bush rates) and significantly less borrowing, which means significantly less spending.

What is the working proposal, and what will it do? Republicans are still pushing for moderate spending cuts, while President Obama has advocated for a "balanced" approach. By "balanced", Obama means that spending cuts should be matched dollar-to-dollar with revenue increases through additional taxation, and it is unlikely that Obama has changed his interpretation of the term. Assuming a static economy, as Obama does, his new taxes will bring an additional $50 billion per year. Where will $50 billion in new taxes and $50 billion in spending cuts get us? From borrowing $1,640 billion per year (43% of the Federal budget, 11% of GDP) to borrowing only $1,540 billion per year (41% Fed, 10% GDP). Meanwhile, our economy will continue to fester, and then get worse, as inflation hits due to the massive borrowing. Obama's plan is a non-starter. The Republican plan of mild spending cuts is close to a non-starter.

We need a different approach. Government in 2001 was doing all right (balanced budget and all), so let us cut back programs and spending to 2001 levels, adjusted for inflation, while maintaining the Bush taxes. This constitutes a $1,000 billion spending cut, dropping our borrowing to a more manageable $640 billion per year (22.8% Fed, 4.6% GDP). Add on Obama's tax for high income earners, and we borrow only $590 billion per year (21.1% Fed, 4.2% GDP). This is a 20:1 ratio of cuts to revenues; still marginally insufficient, but nowhere near what is on the table.

What about a dynamic economy? If Obama's tax harms the GDP by 3%, which already seems to be happening, then Federal revenues may drop $65 billion, while Obama's tax only brings in $50 billion, for a dynamic loss of $15 billion, and Federal borrowing goes up to $655 billion (23.4% Fed, 4.8% GDP). If we include the increase in social services that a festering economy demands, the borrowing gets even worse. On the other hand, if that one Obama tax is lowered instead, and the GDP grows 3%, the Feds get an extra $65 billion, meaning we borrow $575 billion (20.5% Fed, 4.0% GDP).

The solution is clear; we need to cut spending a lot, to Clinton-Gingrich levels, and cut taxes a little, from Bush levels. The spending cuts will necessitate a decrease in government size and interference with our economy, which will help the GDP increase even faster. If local and state governments chip in to reduce government and taxes, we could be seeing a booming economy and budget surpluses in 4 or 5 years. There is plenty of room to cut government, even from 2001 levels.

Unfortunately, the path forward means a change in Democrats from political animals to reasonable beings. Many Democrats can potentially make this change, but President Obama is a strong and stubborn believer in big government. When big government failed in the 1980's, Obama had a "crisis of faith". Rather than use the opportunity to educate himself, Obama concluded that the Soviets just did something wrong, and he could do it right; "we are the ones we have been waiting for." But the mistake the Soviets made was big government, and it is the same mistake that Obama has been making. President Obama has promised to veto any bill that does not contain tax increases, and has balked at even moderate spending cuts, so what is he likely to do at the suggestion of small tax cuts and massive spending cuts?

There is only one path forward: Democrats must go against Obama to override his veto. All of the policies demanded in this article have been supported by Democrats before, in the 1980's and again in the 1990's, and 2000's, so Democrats can support them yet again. The problem lies the political cost of going against Obama. President Obama has been re-elected for his final term, by basically a 50/50 split, pushed over the top by "low information" voters (a la Derrick Smith, Jesse Jackson Jr., legalized pot). Consider which image will be worse; a marginalized radical in the White House, or a double-dip recession (or possibly even a collapsing nation)? You could even impeach the marginalized radical for his multiple scandals, install President Biden, blame the failures of the past four years on the radical and his corruption, fix the problems, and take credit, and save face. Maybe even install Mitt Romney as the new VP, a symbol that the country is healed. Obama becomes a bad memory, Joe Biden and Harry Reid become heroes (as disgusting as that sounds), and then comes President Hillary Clinton (which used to sound disgusting, but sounds a lot better than President Obama).

Democrats, do not fall for your own propaganda. Do not fall for Obama's propaganda. Do not misinterpret an election determined by "low information" voters (as most elections are, unfortunately). The nation cannot afford it, and neither can you, personally, or as a party.

The election is over and the fiscal cliff is looming. It is time to get back to Washington, roll up the sleeves, find some common ground, and fix the problem. Senator Kay Bailey Hutchison (R-TX, retiring) has assured us that both Democrats and Republicans are intent on confronting the situation, so we can all relax, right?

Unfortunately, Senator Hutchison is wrong. There is not one, but several fiscal cliffs, and depending on your party or your philosophy, these cliffs are different, mostly contradictory, and demand completely opposite solutions. Compromise can only be reached on common ground, but the only common ground is that there is a problem, and something needs to be done, soon. It is extremely important that the right thing be done, because should the wrong thing be done, not only will the problem persist, but it will be made worse.

So what are these cliffs? If you are a Democrat, the first cliff is the debt ceiling. Should Congress fail to authorize the borrowing of more money, the Federal government will be unable to pay about 43% of its bills, necessitating drastic and immediate spending cuts. The lack of government spending will plunge the economy into a second recession. The second cliff is the end of the Bush tax cuts. The increase in taxes on the poor and middle class will take money out of their pockets, and so being unable to spend it, the economy will fall into a second recession due to lack of consumption. The prescribed Democratic solution is to immediately borrow a lot more money, raise taxes on the wealthy, cut taxes on everyone else, grow the economy (through government spending), and spend like mad.

If you are a Republican, the first cliff is the end of the Bush tax cuts. The increased taxes on high earners and on dividends (for everyone) will remove money that might have been used for reinvestment in companies or to create jobs. Rather than creating jobs, companies will lay off workers to buffer their margins against the increased taxes, and the economy will continue to fester or even end up in a deeper recession. The second cliff is the debt ceiling and annual deficit. Should Congress approve additional borrowing without a plan to pay it back, potential lenders will lose faith in the U.S. dollar, making it increasingly difficult for the government to borrow money. Unable to borrow the money, the government will need to turn to the printing press, the end result of which is runaway inflation, and poor and middle class people will become destitute. The prescribed Republican solution is to borrow a little more money, keep taxes low for everyone (or even cut them more), grow the economy, cut spending a lot, and aim to start paying down the debt within a decade.

The cliffs really are quite different, and there are only three points of agreement: borrowing more, growing the economy, and cutting taxes on the poor and middle class; except, for Republicans, while borrowing more is part of the solution, it is also part of the problem, and so must be done as part of a larger plan to stop borrowing. If we cut spending, we go over the Democrats' cliff. If we keep spending, we go over the Republicans' cliff. If taxes go up on the high earners, we go over the Republicans' cliff; but if taxes go down, we go over the Democrats' cliff. Going over any cliff will harm the economy and make the problem worse. We need to know which cliffs are real, but even more important; the proposed solutions might not be enough to stop us from going over any cliff.

Consider an economy with 100% taxation on net business income. Within 10 to 20 years, such an economy will disappear. No one will start or grow a business because there is no way to recoup the initial investment. Businesses established before the 100% tax rate will slowly disappear, until there are no businesses left.

High taxes kill an economy, while low taxes neither hurt nor help. The effective rate on business is the total tax paid divided by the net income of the business. History shows that the harmless effective rate, the rate below which total taxes no longer hurt an economy, is around 10%. The fester effective rate, the rate at which an economy neither grows nor shrinks, changes with population growth and money supply, but for the current United States, it seems to be right around or slightly below the Bush tax rates. In other words, if the Bush taxes are extended again or made permanent, our economy will simply fester, perhaps even slowly shrink. If taxes are cut yet again, our economy will grow.

Personal tax rates are a little bit different, but follow the same basic rule. People need extra money in their pockets, businesses need the extra money in peoples' pockets, but excessive taxes take away that extra money. The Federal taxes on personal income are already harmless for the vast majority of Americans. It is the state and local taxes that are killing the personal part of our economy, and there is nothing the Feds can do about those, except to cut or not raise the Federal personal rates.

With multiple historical examples and solid math, it is the Republicans who are correct as to the tax cliff. For the borrowing cliff, the Republicans are again supported by math and historical examples of runaway inflation, while the Democrats are actually contradicted by history and math. The solution needs to be small tax cuts (from the Bush rates) and significantly less borrowing, which means significantly less spending.

What is the working proposal, and what will it do? Republicans are still pushing for moderate spending cuts, while President Obama has advocated for a "balanced" approach. By "balanced", Obama means that spending cuts should be matched dollar-to-dollar with revenue increases through additional taxation, and it is unlikely that Obama has changed his interpretation of the term. Assuming a static economy, as Obama does, his new taxes will bring an additional $50 billion per year. Where will $50 billion in new taxes and $50 billion in spending cuts get us? From borrowing $1,640 billion per year (43% of the Federal budget, 11% of GDP) to borrowing only $1,540 billion per year (41% Fed, 10% GDP). Meanwhile, our economy will continue to fester, and then get worse, as inflation hits due to the massive borrowing. Obama's plan is a non-starter. The Republican plan of mild spending cuts is close to a non-starter.

We need a different approach. Government in 2001 was doing all right (balanced budget and all), so let us cut back programs and spending to 2001 levels, adjusted for inflation, while maintaining the Bush taxes. This constitutes a $1,000 billion spending cut, dropping our borrowing to a more manageable $640 billion per year (22.8% Fed, 4.6% GDP). Add on Obama's tax for high income earners, and we borrow only $590 billion per year (21.1% Fed, 4.2% GDP). This is a 20:1 ratio of cuts to revenues; still marginally insufficient, but nowhere near what is on the table.

What about a dynamic economy? If Obama's tax harms the GDP by 3%, which already seems to be happening, then Federal revenues may drop $65 billion, while Obama's tax only brings in $50 billion, for a dynamic loss of $15 billion, and Federal borrowing goes up to $655 billion (23.4% Fed, 4.8% GDP). If we include the increase in social services that a festering economy demands, the borrowing gets even worse. On the other hand, if that one Obama tax is lowered instead, and the GDP grows 3%, the Feds get an extra $65 billion, meaning we borrow $575 billion (20.5% Fed, 4.0% GDP).

The solution is clear; we need to cut spending a lot, to Clinton-Gingrich levels, and cut taxes a little, from Bush levels. The spending cuts will necessitate a decrease in government size and interference with our economy, which will help the GDP increase even faster. If local and state governments chip in to reduce government and taxes, we could be seeing a booming economy and budget surpluses in 4 or 5 years. There is plenty of room to cut government, even from 2001 levels.

Unfortunately, the path forward means a change in Democrats from political animals to reasonable beings. Many Democrats can potentially make this change, but President Obama is a strong and stubborn believer in big government. When big government failed in the 1980's, Obama had a "crisis of faith". Rather than use the opportunity to educate himself, Obama concluded that the Soviets just did something wrong, and he could do it right; "we are the ones we have been waiting for." But the mistake the Soviets made was big government, and it is the same mistake that Obama has been making. President Obama has promised to veto any bill that does not contain tax increases, and has balked at even moderate spending cuts, so what is he likely to do at the suggestion of small tax cuts and massive spending cuts?

There is only one path forward: Democrats must go against Obama to override his veto. All of the policies demanded in this article have been supported by Democrats before, in the 1980's and again in the 1990's, and 2000's, so Democrats can support them yet again. The problem lies the political cost of going against Obama. President Obama has been re-elected for his final term, by basically a 50/50 split, pushed over the top by "low information" voters (a la Derrick Smith, Jesse Jackson Jr., legalized pot). Consider which image will be worse; a marginalized radical in the White House, or a double-dip recession (or possibly even a collapsing nation)? You could even impeach the marginalized radical for his multiple scandals, install President Biden, blame the failures of the past four years on the radical and his corruption, fix the problems, and take credit, and save face. Maybe even install Mitt Romney as the new VP, a symbol that the country is healed. Obama becomes a bad memory, Joe Biden and Harry Reid become heroes (as disgusting as that sounds), and then comes President Hillary Clinton (which used to sound disgusting, but sounds a lot better than President Obama).

Democrats, do not fall for your own propaganda. Do not fall for Obama's propaganda. Do not misinterpret an election determined by "low information" voters (as most elections are, unfortunately). The nation cannot afford it, and neither can you, personally, or as a party.