What's the Matter With Cliff?

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There's a very simple explanation

There are two arguments around the upcoming so-called 'Fiscal Cliff' - the unintentionally coincident expiration of the Bush tax cuts and the implementation of the Sequester cuts put in place in the agreement that ended the Debt Ceiling hostage crisis - one around the impacts on economic growth and the other around the deficit.  There is no doubt that, if nothing at all is done, there will be a negative impact on the economy.  The size of that impact is a subject of some debate, but simple common sense suggests that if you increase taxes and reduce spending simultaneously, you'll be taking a certain amount of demand out of the economy, reducing consumer spending and business investment.

The more interesting argument is the one led by the 'deficit hawks' in Congress.  This is another clear demonstration of the fact that there are very few people in American government who actually care about reducing the deficit.  As we've discussed in the past, this is primarily because the American economy represents the safest asset any investor can purchase in the entire world, and because, regardless of the ridiculous rhetoric you so often hear, it is impossible for a nation with it's own currency to 'run out of money'.  The United States Treasury can produce as many dollars as it needs to meet it's needs and obligations, just as it produced the money you have in your pocket right now.

But ask yourself - what position should a real, honest-to-goodness deficit hawk hold when it comes to the fiscal cliff?  Let's see.  The expiration of the tax cuts increases revenues, while the sequestered spending reductions, well, reduce spending.  The deficit plummets in a matter of a few years.  So there should be a robust clamor of voices in Washington, from Tea Party Republicans to fiscally conservative Blue Dog Democrats to pundits like the Wall Street Journal and Washington Post editorial pages demanding that the lame duck congress do...nothing.  Never has serious deficit reduction been so easily accomplished - by simply sitting on their hands, this Congress can do more to balance the budget than any since the Clinton Administration.  And yet, on this topic, we hear...crickets.

Or rather, we hear nothing that would maximize deficit reduction.  Everybody, it seems, has a suggestion on how to prevent the legislation of the fiscal cliff from actually reducing the deficit.  The most important lesson to be learned here is just how hard fiscal discipline is in the kind of representative democracy we have in America.  Whether for reasons of ideology or convenience, Congressmen and women can come out all for a balanced budget, but individually their election strategy is to simultaneously reduce the federal tax burden on their constituents while increasing the amount of government largess showered on the people and businesses they represent.  They like reduced spending in theory, but as soon as you start talking about specific programs to be cut the enthusiasm dissipates rapidly.  At the same time, there is often a willingness in the majority to implement deficit financed tax cuts, which, when coupled with unabated spending inevitably drives up the deficit.

The other problem making true deficit reduction unlikely is the overall composition of federal spending. It has often been said that the US Government is really just an insurance company with an army, and that explains why there is such resistance at the legislative level to make substantial reductions in spending programs.  The great majority of the money appropriated by Congress goes to Social Security, Medicare, Medicaid and defense and security agencies.  These spending programs are widely considered untouchable, despite the many calls for cuts from outside Congress, and what remains of the federal budget isn't enough to eliminate the deficit.

There is, of course, a simple solution to this problem, but it's oddly one you never seem to hear mentioned in policy discussions.  You could simply accept that this is the level of government services the American people have demanded, and just go ahead and fund them all.  Federal revenues of 22-24% of GDP will accomplish that.  You could do it with a carbon tax, a sales tax, a VAT - there are many ways to accomplish the basic goal of providing the people what they demand of their government.  And in two months there will be another path to this simple solution - to do nothing at all.
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