Fiscal Cliff: Negotiation Failure could be the Best Option
It should come as no surprise that the "fiscal cliff" negotiations are taking place under utterly bogus premises. Instead of significantly cutting $502 billion from the $1,327 billion per year 2012 budget deficit as would take place automatically if the negotiations fail, both parties in the fiscal cliff negotiations are planning to keep the budget deficits at well over $1 trillion per year. The U.S. debt-to-GDP ratio would continue to explode.
According to the Washington Post, the Republican proposal made on December 3 would only seek $220 billion per year in deficit reduction ($2.2 trillion over 10 years):
• $80 billion revenue through tax reform achieved by closing loopholes and capping deductions.
• $60 billion in health spending cuts.
• $30 billion in other mandatory spending cuts.
• $20 billion gained by changing the way the government calculates cost-of-living adjustments for entitlements.
• $30 billion in further discretionary spending cuts.
According to Politico's November 29 prediction of the eventual compromise, the deal will only produce $260 billion in deficit cuts (2.6 trillion over 10 years):
• $120 billion from tax increases.
• $120 billion from discretionary spending cuts.
• $40 billion from entitlement cuts.
Neither party is willing to risk naming programs that should be defunded. They fear offending one interest group or another. That leaves the automatic across-the-board cuts of the Budget Control Act of 2011, which would take place if the negotiations fail, as about the only way to cut spending. These would cut government expenditures to the same level as four years ago. This is the least we should do.
President Obama has sold his voters on the idea that he can raise enough money to pay for the government's expanding health care, social security, food stamp, and other spending programs simply by taxing the rich. But there has never been enough money available from that source. The most equitable solution would be to restore income and payroll taxes to their level of ten years ago as would automatically take place if the negotiations fail. Then almost all voters would learn the costs, first hand, of increased government spending.
President Obama wants to keep the budget deficits high because he takes the Keynesian view that increased budget deficits stimulate the economy. But this view has been proven erroneous by the Roosevelt depression of 1933 to 1939, by the Japanese depression of the 1990s, and by the failures of the Bush stimulus plan of February 2008 and the Obama Recovery Act of February 2009.
Dr. Valerie Ramey, Professor of Economics at the University of California San Diego, recently calculated the amount of economic stimulus that results from increased government spending. Instead of the multiples of government spending predicted by Keynesians, she found that deficit spending only increases GDP by about one-half of the increase in spending. The late Prof. Milton Friedman, relying on his permanent income hypothesis, came to the same conclusion that increased government spending would have little or no stimulus effect upon private spending.
A study by Gabriel Calzada Alvarez and his colleagues at Madrid's King Juan Carlos University calculated that Spain lost 2.2 jobs in other industries for every government-subsidized green job that was created. The problem is that renewable energy, being more expensive, wastes government resources while raising the cost of energy to domestic households and businesses, including manufacturers.
And as we have pointed out, budget deficits don't reduce unemployment in countries experiencing large trade deficits. That's because the stimulus leaks out as a higher trade deficit. Similarly, fiscal austerity doesn't cause much unemployment because its effects are softened by an increase in exports and a reduction in imports.
Moreover, moving U.S. budgets toward balance might actually reduce unemployment because doing so would restore investor confidence that the U.S. government will gain control over its wildly out-of-control budget. All that is needed for low unemployment and stable economic growth are reasonably balanced budgets, stable monetary growth, and balanced trade or a trade surplus.
The burden of the debt as a percentage of GDP at mid-year 2012 was already 100 percent. It amounted to about $50,000 per American citizen, or nearly $200,000 for a family of four. At today's low interest rates, the expense of servicing the debt is already great. If interest rates rise, as seems inevitable, the burden would become insupportable.
Moreover, increasing the debt is not only unsustainable, but it invites hyperinflation and economic collapse. Everyone still alive 10 years from now will feel the pain. When the crisis occurs there will be a huge hit on people who are on government programs. Baby boomers will see their fixed-income retirement plans lose their buying power.
Our huge budget deficits cannot be solved by wishing them away. If we can't bring them down to a sustainable level now, when the next elections are 2 years away, it will never happen.
If the negotiators cannot do any better than a measly $220 billion in deficit reduction, then the best option for the country would be the $502 billion in deficit reduction that would take place automatically if negotiations fail.
The authors maintain a blog at www.idealtaxes.com and co-authored the 2008 book, Trading Away Our Future. Dr. Howard Richman teaches economics online. Dr. Jesse Richman is Associate Professor of Political Science at Old Dominion University. Dr. Raymond Richman received his economics doctorate from the U. of Chicago