The current Congress may or may not address the Fiscal Cliff before 2012 ends. But even if it does, the odds are that any solution it affixes will fail to solve a problem that has been at least 30 years in making. The real Fiscal Cliff, or rather the Fiscal Canyon, is the longer-term disinvestment and neglect this country has made in education, infrastructure, and attending to the structural inequalities in the United States that are driving most of the problems we face in the short and long term.
The Fiscal Cliff is actually a four-fold set of problems that Congress and the president immediately face.
There is first the expiration of the Bush era tax cuts. These were the massive and fiscally imprudent tax cuts President Bush and Congress pushed though in 2001. They occurred at a time when the Clinton presidency and the economic growth of the late 1990s left the country with successive budget surpluses and the belief was that the government had more money than it needed and that the tax cuts would stimulate the economy. The tax cuts included cuts in the top rates on income as well as capital gains. They were sold as cuts to benefit the middle class when in reality the vast majority of the benefit went to the wealthiest who did little to invest them in job and economic growth. The first decade of the twenty-first century witnesses the worst record in job production in decades.
The biggest focus of the this aspect of the Fiscal Cliff is that if nothing is done, a typical middle class family of four would experience a tax increase of $2,200 if the Bush era tax cuts expire.
Second, there is the budget cuts that are due to kick in. These budget cuts are a result of a deal that Congress and the president reached in 2011. They agreed, or better yet, kicked the can down the road, to a budget framework that declared that if they could not agree to a budget agreement to reduce America’s $1 trillion+ annual deficit and begin to pay down the nearly $16 trillion nation debt, certain automatic cuts would take place. Over 1,000 government programs would face significant budget cuts totally in excess of several hundred billions of dollars over the coming decade. These cuts would come in terms of both military and other discretionary spending.
The tax increases and spending cuts are the most immediate problems of the Fiscal Cliff. If no action occurs most economists think that this cliff would throw the economy into a recession. The reason for this is simple Keynesian economics–a rapid decrease in demand as both consumers and the government cut back on purchases and demand, thereby slowing down the economy.
But there are really two other aspects of the Fiscal Cliff that are coming due too.
The first is that the debt limit for the US government also expires around the beginning of the year. If that is not extended the US government runs out of money. That too is a big problem and must be addressed. If we do not extend the debt limit the United States technically defaults on its loans. It also means it runs out of money to finance the government, thereby forcing a shutdown or curtailment of funding for many programs.
Finally, the original economic stimulus program that the Obama administration passed in the beginning of 2009 runs out. Despite all the noise to the contrary, the stimulus did preserve several million jobs according to most credible economists.
Failure to address any of these four prongs of the Fiscal Cliff is enough to damage the US economy, but letting all four go unintended is a major recipe for disaster. So what do we do? Here are the options.
1. Do Nothing. This is the disaster just mentioned. It hurts the US economy both short and long term.
2. Kick the can down the road. Extend the tax cuts for all for another short period of time and delay the spending cuts too. In effect, “kick the can” down the line for another few months so that the next Congress deals with it. Congress already did this once back in 2011 and it possible they do that again. However, this kicking of the can is very temporary and does little to address the short-term jitters in the US economy (companies failing to invest because they want a stable economic picture) or long term to address the broader structural problems in the US economy.
3. Extend Bush Era tax cuts for the middle class. Enact tax cuts for everyone except those with individual incomes over $200,000 of family incomes of $250,000 per year. This solves the tax increase problem but does not deal with the automatic budget cuts. It also fails to deal with the debt limit and an economic stimulus.
Republicans in the new Congress may be able to live with part of this since they would be voting for tax cuts for the middle class and could say they did not vote for tax increases.
4. Enact Simpson-Bowles Commission Recommendations. The Simpson-Bowles Commission offered proposals on how to deal with long-term debt. This proposal includes reforms (cuts) to entitlements such as Social Security and Medicare. It was DOA when its ideas came out but some still this is a framework for addressing problems.
Beyond the fact that politically it is DOA, it does not really solve economic problems in the long term. Raising retirement ages or cutting benefits hurts the poor and the young, and in many ways, for those in blue collar jobs, raising the retirement age discriminates against those who do physical labor and will not last long enough. Moreover, cutting benefits when fewer and fewer people have pensions and serious retirement income options condemns a new generation of people to poverty.
5. None of the above. In reality, none of the ideas above really solve or address the bigger economic problems facing the United States. All at best are band-aids or whitewashing over more fundamental problems facing the economy.
The key to addressing America’s short and long term debt is by revitalizing the US economy. In part the reason for the budget surpluses in the 1990s was a rapidly growing economy (with higher tax rates than today) and increasing worker productivity as a result of taking advantage of the new computer and information technologies. The first priority should be strengthening the economy by increasing employment, productivity, and wages as opposed to worrying about debt reduction.
But there are challenges to do this. The growing gap between the rich and poor and across races has created structural inequalities that compromise mobility and economic productivity. There are performance gaps in education, significant affordability for college, and an overall declining position in the US vis-a-vis the rest of the world when it comes to education and training in general. The country needs to address this issue for long-term growth and sustainability. This is the Fiscal Canyon–the enormous gap between current expenditures and the investments we need to make in America’s future.
There is also an imperative to invest in our aging road and highway infrastructure, with some estimates placing the need at over $2 trillion to make repairs. This does not include investments for the future to modernize telecommunications and energy.
Finally, there is a demographic issue. Our population is aging and we need to figure out not only how to pay for benefits promised, but also how to ensure that there are sufficient workers for the future. In terms of benefits, the US spends 18% of its GDP on health care–by far the most costly in the world–and it does not have universal coverage or the best marks in terms of outcomes. The issue of course is still how to reduce costs but simply cutting spending does not solve anything if people are sick. Conversely, the aging population means fewer younger workers, but those workers need the skills to do the jobs needed over the next 50 years.
Yes, the Fiscal Cliff is a problem, but the Fiscal Canyon, two generations in the making, is the real issue that Congress and the President should address, but will not.