Sunday, December 16, 2012

Fiscal Cliff a Joke and so is the coverage

The "Fiscal Cliff" is an over hyped joke.  It is also bad economic policy.  The "Fiscal Cliffs" real name is the Budget Control Act of 2011.  It was passed by congress and signed into law by the president in August 2011.  We will try to break down the history of the act and then tell why the Fiscal Cliff is baloney.

Back in the summer of 2011, President and the Republicans were arguing over raising the debt ceiling.  The debt ceiling is usually raised automatically without issue.  However, due to the TEA party influence on the Republican party, they were forced to take a harder line than usual during the negotiations   The republicans agreed to raise the debt ceiling in exchange for a bill that would automatically curb the debt based on automatic taxes increases and budget cuts at the end of the year 2012 after the presidential election.  The provision would only come into effect if no other budget deal was worked out.

The Republicans thought Obama might lose the 2012 presidential election. So they gave Obama a bill quite favorable to Democrats.  The BCA ends the Bush tax cuts and cuts military spending by about 10%. It cuts helath care spending by 2% and the non defense spending by 8 %.

The term "Fiscal Cliff" was created by Ben Bernanke, Chairman of the Federal Reserve Board, during testimony to congress in February 2012.  We was referring to the effect that a sudden increase in taxes and cuts in spending might push the economy over the "Cliff" and into recession.  May of the provision come into effect over the year 2013, leaving plenty of time to work out better legislation.

If you want to read more, here is a nice write-up from the Congressional Research Service on the Budget Control Act of 2011.

The reason the fiscal cliff act is bad economics is because it is dampens economic activity too much while the country is recovering from a large recession.  During a recession, you typically want to add to government spending to increase employment and growth. European countries like England and France are suffering because they imposed too harsh an economic  austerity trying to reduce their debts.  They ended up pushing their countries into a longer recession, decreasing economic activity and tax revenues, and increasing the period of austerity.

The Fiscal Cliff is also bad economic policy because there is no short term reason to reduce the debt. Especially not during a period of low inflation, high unemployment and low interest rates. In fact with record low interest rates, the government should be borrowing money to make investments in areas such as infrastructure or education.

Long term, we all agree, for reasons of stability, we need to reduce the debt to a manageable level (say 50-70% of GDP). And most reasonable people agree on how to do that:  slight increase in taxes on the wealthy, slight cuts in government programs and reducing the cost of healthcare.  We may also want to reduce social security and medicare payments to wealth individuals, reduce the size of the military (especially the navy), and reduce subsidies and loopholes in the tax code.  Just about everyone agrees on the above proposals

So how did the debt become an issue right now. We believe the issue comes from the Republicans anti-government beliefs pushed on by the new TEA party.

When discussing the debt, I always here two commonly offered reasons to reduce the debt.  they are "I have to live on a balanced budget and so should the government" or "government debt will crowd out private debt lowering private investment."  Actually most people do not live on a balanced budget.  They frequently borrow against future earnings for current consumption (credit cards, Christmas load) or current investments (college tuition, a car to get to a job).  The government should have the ability to do the same thing.

Second, for the "crowding out issue," no one is quite sure of the relationship between private investment and interest rate levels.  And if it does occur, how much business investment was actually affected (probably very small). Current, top rate businesses can borrow for 10 years at 2.35% interest.   But the possible small benefit of reducing interest rates is not in proportion to the damage that might be done to the economy.

The real reason for reducing the debt is ideological and selfish. The don't believe if the government helping people:  not older people, poor people, sick people or minority people. Plain and simple.  The the Fiscal Cliff negotiation is just another political tug of war.

The coverage is also pretty bad.  They cover it like a sporting event with winners and losers. The are missing a great chance to cover the nuts and bolts of national government fiscal policy.  This is a chance to show the American people where their money goes. Instead of explaining where we spend our money or any context about what we are buying, we are stuck with Boehner's latest proposal or Obama's new statement.

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