Normative Narratives

The Fiscal Cliff Revisited

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With the conflict in the Gaza strip in a fluid state, I have decided to forgo blogging about this issue until more solid decisions are made. Instead I will answer a commenter’s question:

Q:  Lets talk about the fiscal cliff, the wisdom of austerity in america, and the implications to organized labor… GO!

A:            If America “goes over” the fiscal cliff, then automatic spending cuts and tax increases will kick in. This is, for all intents and purposes, the same thing as “austerity”. There is no wisdom in American austerity right now. With the fiscal multiplier > 1, credit markets in a “liquidity crisis” (meaning even at zero % nominal interest rates, private investors still favor investing in federal bonds over private markets), and unemployment still at unacceptably high levels, there should undoubtedly be more government stimulus, not austerity. Being in a liquidity crisis, the “crowding out” effect of stimulus spending is non-existent; government investment doesn’t get in the way of private investment because there is inadequate private investment to begin with. Government stimulus could reduce the unemployment rate by hiring more teachers, undertaking new infrastructure projects, investing more in affordable healthcare, or investing in research and development projects (in renewable energy, for example). All of these measures would not only cut unemployment, but would also increase human capital, ensuring America will continue to grow despite the negative consequences of globalization / job-outsourcing (Globalization is mainly a positive force, but there are some negative issues that have affected the U.S. middle class specifically). There is no wisdom in austerity in America right now as it would cause a double dip recession. With 0% borrowing costs, and flexibly monetary policy (two things the EU does not have which make austerity measures an unfortunate reality there), there is no reason the U.S. should engage in austerity programs.

The issue of reducing the federal deficit is important. The U.S. has needed to overhaul its tax code for a long time, specifically with regards to tax deductions / exemptions. Certain entitlement programs, such as Medicare and Medicaid, need to be re-examined to ensure that they run efficiently and are not wasteful. However, this is true of all government programs; they should all be subject to review to ensure they run efficiently. This is nothing new and is not an indictment of any specific program. Anything that requires a lot of resources should be subject to review, to ensure those resources are being allocated as efficiently as possible. Making sure a program runs efficiently (best use of available resources), is different than austerity (cutting resources).

However, these long term goals (tax code overhaul and fixing entitlement spending), are separate from avoiding the fiscal cliff, which is a short term goal. By refusing to talk about tax rates without addressing entitlement programs / tax exemptions, the G.O.P. is basically holding the U.S. economy hostage, saying if we do not come to an agreement about these complex issues fast, we are willing to send America back into a recession. Overhauling the tax code and fixing entitlement programs is a huge undertaking, one that cannot be completed before the fiscal cliff passes. Adjusting tax rates and avoiding the fiscal cliff is a simpler matter, which has been made into a complex one. Different factions, insisting on addressing peripheral matters instead of working on a deal to avoid the cliff, are playing game theory with the U.S. economy. The most pressing issue for the U.S. is to avoid a fiscal-cliff-recession. U.S. debt is sustainable as long the government can borrow at low rates and print money without the risk of inflation, which it currently can (because of the liquidity crisis, and the fact that the USD is the world’s most important reserve currency). The fiscal cliff must be addressed immediately; tax-code overhaul and entitlement reform should be addressed without the time constraints imposed by the fiscal cliff. Congress should absolutely start talking about these long term objectives (they should’ve been addressed earlier, but congress hasn’t exactly been a model of efficiency in recent years, in fact tax code reform has been on the agenda for decades), but they should not be artificially held to the same time constraints as a fiscal cliff deal.

Some big employers may threaten to cut their work force if they are faced with higher taxes, but this is for the most part an intimidation technique. Businesses make their decisions based on profitability, increased costs from higher taxes can be passed on to the customer, or manifest themselves in lower wages (which, in light of high unemployment, should not be seen as the end of the world by organized labor, at least they would still have jobs albeit at lower wages), without greatly altering a company’s employment structure (I do not think any business would forgo profits just to show its distaste for higher taxes). However, if the a deal is not reached, then there will be government spending cuts, meaning less money for public sector organized labor (such as teachers unions). Also, a recession would put a dent in people’s disposable income, meaning less demand for certain goods, and less need for labor to produce these goods. In order to avoid higher taxes, business leaders may state higher taxes will lead to lay-offs, but in reality a failure to avoid the fiscal cliff would have much more devastating effects on employment and the economy as a whole (or aggregate demand if you want to be technical).
Businesses supply goods (which require labor and capital among other things), in response to consumer demand. If there is another recession, and consumer demand takes a hit, companies will have no choice but to cut employment and supply fewer goods. Higher taxes on the rich should have modest effects on unemployment, while a recession and/or cutting important social programs would have a much larger impact.


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