by Benjamin Studebaker
Remember a few days ago when we were discussing a possible fiscal cliff deal that Obama might or might not go for? Well, Speaker of the House John Boehner discovered that his republicans would not support the tax increases on the those earning more than $400,000, the increase in capital gains and dividends taxes, and the cap on deductions at 28% of income. So Boehner abandoned that arrangement–it’s dead. Instead, Boehner proposed something called “Plan B”. (British readers are familiar with a different Plan B that proposes a stimulus alternative to their coalition government’s austerity policy; this is not that.) Plan B was substantially more favourable to the republican position, but nonetheless, the republicans in the house refused to support it, and now it is dead too. So where does this leave us in our struggle to avoid the fiscal cliff, the combination of large spending cuts and tax increases that kick in on January 1st and which the CBO forecasts will lead to a recession in 2013?
First off, we need to get a sense for how Plan B differed from the original deal that was on the table, in terms of what resolution it offered compared with the various other scenarios.
- Bush Tax Cuts Expire for Everyone
- Unemployment Benefit Extension Expires
- Payroll Tax Cut Expires
- Across the Board Spending Cuts (to everything except Entitlements/Federal Employee Pay/Veteran’s Benefits)
- Recession in which the economy likely contracts by 0.5% and unemployment soars to 9.1%.
- Bush Tax Cuts Expire for those earning more than $400,000
- Unemployment Benefits Extended Further
- Payroll Tax Cut Expires
- Social Security Cut
- Infrastructure Spending Increase
- Capital Gains Tax Hike (from 15% to 20%)
- Shareholder dividends taxed as regular income.
- Cap on tax deductions at 28% of income.
- Bush Tax Cuts Expire for those earning more than $1,000,000
- Unemployment Benefits Extension Expires
- Payroll Tax Cut Expires
- Capital Gains Tax Hike (from 15% to 20%, but only on those earning more than $1 million)
- Shareholder dividends taxed as capital gains.
- No deduction cap.
- Extension of Inheritance Tax Cut
Grover Norquist, the lobbyist responsible for the infamous pledge never to raise taxes, gave Plan B his blessing on the grounds that it averted larger tax hikes under the fiscal cliff. Yet, despite this, Boehner’s republicans balked at the hike on those earning more than $1 million.
Now, let’s be clear–even if Boehner had passed Plan B in the house, it would probably fail in the senate, and even if it had survived the senate, the president had vowed to veto it. The importance of Plan B was mostly symbolic–if the house had passed it, the right could claim to have been the only ones who managed to pass anything through either house of congress. This would have given the politically illiterate the sense that the right was more reasonable in the negotiation than the left was. In reality of course, the right was merely attempting to exploit its total control of the house to pass a pet bill that it knows will never become law.
So with all this in mind, Boehner and company were attempting to pass not a serious proposal, but a symbolic one–and they could not do even that. As a result, the message put out is the exact opposite message. The right looks extremely unreasonable, unable even to pass its leadership’s own plan through a house of congress it controls. Boehner looks feckless and unable to successfully lead the party. Of course, the real culprits are the extremists in the house who could not recognise that the thing was never going to become law anyway and pass it for the sake of helping their speaker make his case that their side was the reasonable one with which the public should side. The Tea Party radicals have once again put egg on the face of their party leaders and sabotaged their own party’s political strategy. The real story here is “Tea Party shoots itself in the foot”, but all the same, the perception will be that this exemplifies Boehner’s failure, and that it is a disaster for him personally.
I have some modicum of sympathy for Boehner here. Boehner is being blamed for failing to lead a group of people who acted with complete irrationality and unreasonableness. It is not his fault that many of the members of his party would rather cause themselves and their party immense political damage than pass a pretend bill that never would have become law anyway. Boehner cannot account for that level of self-destructive behaviour. But my sympathy does not matter–the disaster is Boehner’s, whether deservedly or not.
Looking at all this, I’m still shocked and horrified that we’re discussing tax hikes and spending cuts at all at a time when the economy is not operating at potential and 7.9% of people remain unemployed. It does not agree with my Keynesian sensibilities one iota. Were I in a position to determine policy, I would forestall all tax increases and spending cuts, giving both the left and right a portion of what each desires, pass a second round of stimulus, get unemployment below 6.5% and quarterly growth up and over 3%, and then, in 2014, I would look at the budget again to see, with all the new revenue raised by that growth and all the unemployment and poverty spending made redundant by it, what sort of cuts or tax increases might be needed. Such a plan is certainly doable, despite its lack of mainstream support–US borrowing costs remain below 2%, and it is estimated that, with extra spending due to the poor and unemployed made unnecessary and an American economy operating at potential, the deficit would be between $400 and $500 billion without any tax hikes or spending cuts. That’s between $600 and $700 billion lower than it is presently and, coincidentally, that’s about how much of the deficit the fiscal cliff would otherwise remove. A $400 billion deficit, it should be noted, is also easily sustainable, as the economy grows at a fast enough rate at that deficit level to make up the difference in our debt to GDP numbers.
It is an immense cruelty to those adversely effected by the economic crisis that we will instead embark upon a policy of some combination of needless hiking of taxes and slashing of spending. Make no mistake about it–both parties have failed here. Obama, with his obsession over raising taxes, will damage the recovery. The republicans, with their fixation on cutting spending to shrink the state, will do the same. Their compromise, should they yet produce one, will be one in which Obama gets tax hikes, a bad policy, in return for republicans getting spending cuts, a bad policy. Their compromise will provide us not with the best of what each has to offer, but with the worst.
An interesting graph from Krugman showing how the majority of the present deficit comes from economic under-performance:
I really like your writing — I noticed you are applying to graduate school, and I wish you the best. Based on your depth of reasoning and clarity in writing, I am certain a number of top schools will be happy to have you.
I agree that both parties share blame. I was a bit shocked to read that Obama’s reaction to Boehner offering $800bn in additional revenue was “I get that for free”. Even if he does believe that, it serves no value in a negotiation.
In this circumstance, though, I feel some compromise may be for the best. More and more money is going to the most wealthy, and they are the ones being targeted for taxing. I think taxing is fine, provided it can be shown that the gov’t can more effectively distribute that capital. For example, if the Mitt Romney’s of the world tend to take their excess marginal revenue out of the American economy, then it serves no societal value for that revenue to not be taxed additionally. It’s a matter of wealth allocation. The current taxation schemes for things like capital gains seem to lend to the idea that individuals are better at allocating capital, so we won’t “penalize” with taxes. In theory this idea seems to make sense, but I’m not sure in practice it works as well (at least not now).
Also, there is a huge issue with unfunded liabilities, which isn’t front-and-center because it isn’t a line item on the budget (yet). An article written by accountants (granted, from right-leaning organizations, so take it for what it’s worth), points out that the net present value of our unfunded liabilities for just social security and medicare is greater than $60tn:
The make the claim that we need to be taking in an additional $8tn in revenue to keep up with those liabilities.
The issue is growth — inflation or growth is the only way to get over the hill. My concerns with gov’t spending is that it isn’t effectively leading to growth. There are a number of charts showing the declining returns of marginal gov’t debt. I believe in Keynesianism, but I wonder if something else is happening. We keep spending money and are getting lesser and lesser returns. In that light, my feeling is that there is something structural going on that we aren’t addressing.
Interesting thoughts, and thank you for your kind words.
If those big liabilities put the true debt anywhere near 500% of GDP, we would surely be seeing much higher interest rates on US treasuries that we presently are seeing, so my initial response to the WSJ article is one of scepticism, but I’ll have to check it out further. The article speaks of China’s purchasing of treasuries as though it were critical to US solvency, something we know not to be true:
If the article gets this wrong, it is reasonable to suppose that it has gotten other things wrong as well, though one cannot be certain.
My opposition to a tax hike right now stems from the Keynesian principle that money should not be taken out of the economy in times of economic weakness. The government does not need to take in revenue in order to spend additional sums; it can borrow it. Consequently, in a weak economy, it makes sense to tax less and borrow in the interim–so long as one plans to recoup those deficits when the economy recovers via augmented revenue and higher tax rates. That’s why I would hold off on the tax hike until unemployment is lower and growth is improved.
The signature of a structural problem is one or more sectors in the economy with a very different unemployment experience from the wider organism. We would need to see one or two sectors behaving very differently from the rest in order to have evidence that the problem was structural. What I find more likely is that federal spending is being counterbalanced by austerity on the state and local levels. I found significant evidence of that in my investigations into that subject, which I posted here:
[…] house republicans, who, incidentally, also rejected their own speaker’s alternative “Plan B“). It is, actually, remarkably similar to the compromise I […]