Thursday, November 29, 2012

The Fiscal Cliff Bargain is Peanuts

The internet and print media are full of accounts of an evolving bargain in the fiscal cliff negotiations. The Republicans will accept $1.2 trillion in tax hikes on the “rich,” and the Democrats will accept $400 billion of spending cuts. (Past experience shows the spending cuts never occur other than for defense). These increases and cuts are to be spread over a ten year period. Annualized, taxes are supposed to increase $120 billion ($.12 trillion) per year and spending cuts by $40 billion ($.04 trillion) per year.

Citizens are supposed to be impressed by figures such as $1.2 trillion or $400 billion. News accounts mention the “over ten years” in passing or not at all.

To see how small these figures are, we apply them to 2012 federal spending and revenues. If this agreement had been in place for 2012 (and had gone as planned), federal revenues would have gone up from $2,468 billion to $2,588 billion. Expenditures would have fallen from $3,795 billion to $3,755 billion. The deficit would have decreased from $1,327 billion to $1,167.

In a word, the fiscal cliff deal yields, at best, small, marginal, and even trivial changes.

In reality, the “rich” will alter their behavior, and tax revenues will rise (if at all) by a fraction of the “agreed upon” change. (Remember Congress can only set rates and rules. It cannot dictate what taxpayers actually pay). As Obama Care’s price tag becomes evident, federal expenditures will exceed expectations, and if interest rates rise, soaring interest payments on the federal debt will send Congress back to the drawing boards.

The fiscal cliff negotiations do not touch the looming disaster of almost $100 trillion in unfunded federal government liabilities under its existing entitlement programs. The Obama administration will leave that problem for the next administration to tackle. The next administration must decide whether to cut the welfare state or tax the middle class at European levels, which requires doubling social security taxes, applying the top marginal rates to the upper middle class, a 20 percent national sales tax, and $10 gasoline.

Such draconic measures will likely prove too much for the next administration and it will try to kick the can down the road to the next administration. Greece: We are not that far behind you unless we get a truly transformational President.

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1 comment:

  1. 1) (Expected) Liabilities change with the interest rate on the debt. Higher rates (6, 10%, 20%) are not too far off; looking backward, we see 1980s numbers, which seemed reasonable at the time.

    2) Niall Ferguson estimates our unfunded liabilities equal $238 trillion, which is 1600% of debt claimed by the US Treasury (i.e., $16 trillion).

    3) The unfunded liabilities of state and local governments is around $38 trillion is fairly linked to the items in the federal balance-sheet.