Normative Narratives

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Transparency Thursday: The “Fiscal Cliff” Explained, and Partisan Politics on the Hot Seat

Good question Dan.

The “fiscal cliff” is a series of automatic tax increases (or an expiration of the Bush-era tax cuts) and spending cuts (across the board: education, healthcare, military, ect.) that are set to kick in early in 2013. With the economy in it’s current state, everyone believes this will cause another recession in the U.S. (and probably make a recovery for the EU much more difficult as well). This option was supposed to be so unpopular that it forced a new budget plan, yet here we are a month before the “cliff” without a resolution–yet.

The “fiscal cliff” was a resolution to the “debt ceiling” debate in the summer of 2011, when the G.O.P. agreed to let U.S. debt to go past a certain point (as opposed to defaulting on our debt) in exchange for an extension of the Bush era tax cuts. Other than the Bush era cuts, another major tax cut that will expire is the payroll tax cut, which will either make hiring employees more expensive, make workers after tax wages go down, or some combination of both.

The issues are as follows: The Democrats (and probably the Republicans) want the Bush era tax cuts to remain in effect for lower-middle class families. Where they differ is what should happen to tax rates of wealthiest Americans. Democrats wish for tops rates to go back to Clinton levels (39.6% top rate) and to raise capital gains taxes (which are disproportionately skewed to high income Americans, from 15%). Republicans, who believe raising taxes on the richest will cause the economy to stall, do not want to raise taxes on the wealthiest, and instead wish to reduce the deficit by closing loopholes / exemptions, broadening the tax base. and overhauling certain social programs (such as Medicare and Medicaid).

There is evidence this will not do enough to close the deficit, such as the fact that any budget plan stating this does not propose any specific cuts (or their effects on economic growth) and rather states that some ambiguous cuts will be made (i.e. Paul Ryan’s whole budget plan). Republican’s continue to oppose raising taxes on the wealthiest, despite evidence that it will not affect overall economic output.

The G.O.P. raises good points. The American tax code and social spending have needed to be overhauled for some time now. The point is, these important long term issues should not be held to the same short term time constraints as the “fiscal cliff”. If a deal is not reached (or they do not decided to “kick the can down the road” by extending all current tax cuts a while longer), all Bush era tax cuts will expire–both on the rich and the not so rich.

This is why I say the G.O.P. is taking the U.S. economy “hostage”, by saying that if they do not get reforms–which have eluded congress for decades–figured out in a month, they are willing to go over the fiscal cliff and make everyone pay. It is important that people realize going over the fiscal cliff is not a failure of President Obama, or any one person, but a failure of partisan politics in general. If the whole country is made to pay for the inability of congress to avoid the fiscal cliff, it would be a completely avoidable crisis coming to pass. Whats more, taxes on the rich would go back up to 39.6% anyways, we would just have a depressed economy on top of it.

Ironically, it is not raising taxes on the rich or debt from social spending which will cause the U.S. economy to stall, it is a failure to ensure spending remains at its current level (or better yet, increases with new stimulus), and raising taxes on low / middle class earners that would ultimately cause a recession. Low / middle class earners naturally spend more of their tax deductions; their marginal propensity to consume is higher, meaning every dollar they get they spend more than a rich person, boosting the economy, and the “Ricardian Equivalence” argument against tax cuts stimulating the economy does not hold for low income beneficiaries as it does for wealthier beneficiaries, because they do not believe these cuts will be offset by higher future taxes. A combination of higher taxes and lower transfers to low and middle income earners would depress the economy much more than raising taxes on the wealthiest. Going over the “fiscal cliff” would actually cause the debt / GDP ratio to go up (debt would go down, but GDP would go down more), despite higher taxes and lower spending. If the country were running a surplus (like under Clinton), going over the fiscal cliff would be strong counter-cyclical economic policy. In the current context, however, it would just punish all American’s.

In this light, some business leaders have campaigned against the fiscal cliff and agreed to pay higher taxes to avoid it. Some G.O.P. congressman have backed off their hard line approach to raising taxes. For the good of America, hopefully a deal is reached. Then we can being the long process of overhauling the tax code and making entitlement spending more efficient.

Furthermore, if the G.O.P. wants any chance of becoming more popular, and having any campaign to run on other than “do nothing and show how the Democrats failed” (which didn’t work so well in the most recent presidential election), it would make sense, both politically and economically, to ensure America does not go over the “fiscal cliff”.