The Fiscal Cliff: A Return To Reason?

In the wake of the election, it’s nice to hear the usual DC suspects singing a tune of unity rather than obstruction. Time will tell if the principals in this stage show–President Obama, Senate Majority Leader Reid and Speaker of the House John Boehner–back up their words with action, but they seem to have received the message from the American people that politically-motivated inaction will not be tolerated as we march toward the so-called “fiscal cliff.”

Nobody expects the parties to come to the table with a final compromise already in hand, but the Republicans’ insistence on framing their opening gambit as a compromise worries me. While Speaker Boehner’s speech today carried a conciliatory tone, he made it clear that Republicans are still stuck on the same supply-side economic theories that have been offered up as justification for tax cuts for the rich. The argument goes that taxpayers in the highest tax brackets operate small businesses, these businesses are the engine for job creation, and lower taxes for these businesses will spur said job creation. Therefore, Republicans argue, if the government must raise revenue (insert huge sigh here), it should be done through “tax reform,” i.e., eliminating loopholes and limiting deductions. This approach, they say, will lead to economic growth, rising personal income for all, and (drumroll) an increase in tax revenues.

This has the political advantage of sounding really, really good. It suffers from the dual flaws of being false and unfair.

Let me be clear, tax cuts for the wealthy will (all other things being equal) lead to an increase in growth. The fallacy here is that tax cuts must be targeted to the wealthy to achieve this growth. The growth will be generated from increased spending on goods and services, whether that spending is by weatlhy, middle class or poor consumers. Think about it. Why would a small business owner hire a new employee just because the owner will get to keep an extra 5% of the business’s net income? The owner is going to keep the profits and spend the cash himself unless he needs the new employee because of increased demand for his business’s goods or services. Increased demand generates jobs; a mere increase in cash available to a business won’t. Look at all the cash sitting on the sidelines in today’s business environment!

What’s even more disingenuous about the Republicans’ broad tax cuts is that they way overshoot the target–only a small percentage of wealthy taxpayers are small business owners. Corporate executives, entertainers, athletes, doctors, lawyers, bankers, and investors fill these brackets and benefit from the lower rates even if they don’t employ a single person. Republicans also favor reduced or zero tax rates on dividends and capital gains, which disproportionately benefit the rich while having little or no targeted impact on job creation.

The bottom line is that tax cuts do spur economic growth but by increasing demand for goods and services by consumers generally; targeting the extra cash towards the wealthy provides no special job creation benefit. In fact, cash reaching the hands of consumers through government spending impacts economic growth in exactly the same way as a tax cut. Framing the debate over the budget deficit as a “spending problem, not a revenue problem” is perhaps the greatest deceit perpetrated by either political party. By definition, a deficit is an excess of expenditures over revenues, and it’s a mathematical truism that spending and revenues effect the deficit equally.

If the nation’s goal is to reduce budget deficits, the balance between raising tax revenue and cutting spending programs is simply a matter of choosing WHO will have less cash to spend at the end of the year. The net effect on economic growth will be roughly the same no matter who bears the pain of the fiscal policy directly, The allocation is purely about fairness and political might.

Note that if deficits are to be reduced, the net effect on economic growth will be negative, not positive. Jobs will be lost, not gained, as a result of the decline in consumption by affected citizens. If we’re deficit cutting, the Republican fixation on job creation is specious, and their attempt to place the entire burden on the poor and the elderly while preserving the unpaid-for tax cuts that created this fiscal mess borders on criminally fraudulent.

Policy-makers need to first determine how much the deficit needs to be cut over what period of time, and then they must decide who’s going to bear the burden. A detailed fiscal plan is beyond the scope of this rant, but the starting place should be the reversal of the Bush tax cuts. An additional ten-year surtax applicable to the highest tax brackets should be considered to pay back the unpaid-for tax cuts they received over the past ten years. That should still leave plenty of deficit reduction to place on the backs of the elderly and the poor–whose income stagnated during the Bush decade–through cuts in entitlement programs. Half the battle is determining the equitable starting place for determining a fair allocation of the tax burden, and I’d go back to the last time the nation was in surplus, before the unfunded Bush tax cuts and wars.

As a closing observation, many economists argue that deficit cutting is exactly what we shouldn’t be doing during a period of slow growth. They would prescribe a delicate balancing act, actually increasing the deficit temporarily with stimulus (whether spending initiatives or tax cuts) while passing legislation that would pare spending and boost taxes in the long run to achieve deficit reduction when the economy is healthier and self-generating more tax revenues. That may be a difficult gambit for the partisans in DC to pull off,  but perhaps a harbinger of things to come if our current leaders fail to reach a reasonable compromise is the arrival of Angus King on the national scene. The newly-elected Independent senator from Maine views himself as a moderate who might bridge the gap between extremists in both major parties. If our representatiives fail to overcome their fiscal divide, perhaps King will serve as a model candidate for a third party movement backed by independent voters and disenchanted moderates affiliated with both parties.