Why Economists Are United in Their Dislike of the Fiscal Cliff Deal

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Andrew Harnik / The Washington Times / Landov

People gather outside the U.S. Capitol in Washington, Jan. 1, 2013.

One of the truths revealed by the debate over the fiscal cliff is that lawmakers in Washington are in bitter disagreement over the cause of and solution to our economic malaise. There is the Keynesian camp, which believes that the economy is being hindered by a general lack of demand, and that the government needs to spend more in order to get the economy going again. Then there is a faction of economists — let’s call them the uncertainty hawks — who believe that businesses and individuals would be more willing to make the investments necessary to spur economic growth if they had a clearer idea of future tax bills and government spending levels. And finally there are the deficit hawks, who believe economic growth is being hampered by large federal deficits and debt, and that the best way to encourage economic growth is to shrink the deficit, mostly through reducing government spending.

With the recent deal over the fiscal cliff, however, a strange thing happened: Despite the fact that many of these camps’ ideas are in direct opposition with one another, the final deal ended up satisfying nobody — causing economists across the ideological spectrum to declare the deal a dud. Here are their respective reasons:

(MOREFour Misconceptions About Taxes and the Deficit)

The Keynesians: Sure, the U.S. government is running budget deficits of more than $1 trillion per year, while the total national debt sits at more than $16 trillion. But for many economists, these numbers aren’t the most pressing problems our economy faces — not by a long shot. For Keynesian economists Dean Baker, Paul Krugman, and Brad DeLong  it’s the unemployment rate, now at 7.7%, that should worry us most.

So it was frustrating for them to see that both Congressional Republicans and President Obama appeared to want to see deficit reduction as part of a broader fiscal cliff deal. We did kinda sorta see – depending on how you look at it – some long-term deficit reduction. According to the non-partisan Committee for a Responsible Budget, the fiscal cliff deal shaves $650 billion from the ten-year deficit when compared to current policy. But, again, Keynesians would like to have seen more government spending, not less. In addition, while the deal did extend unemployment insurance benefits for another year, it failed to extend the payroll tax cuts, which will raise taxes by 2% on the first $110,000 a worker earns. That hits many of the folks most likely to spend their marginal dollars.

The Uncertainty Hawks: Several economists, including the University of Chicago’s Steve Davis, recently devised a method for measuring economic policy uncertainty, which shows that uncertainty regarding tax and spending policy in the U.S. is higher in the past five years than it has been in some time. That same research suggested that this high policy uncertainty is correlated with stock market volatility as well as other indicators of economic stress like yields on some European government debt.

And, alas, those who believe Davis’ contention that much of the blame for the sluggish economy can be placed on temporary and patchwork policy-making from Washington have little to like about the most recent fiscal cliff deal. It’s true that individual income tax rates, the capital gains tax, and the estate tax have all been “permanently” set (or as permanently as an act of Congress can be). But huge issues remain unresolved. Namely, the automatic budget cuts put in place during the 2011, as well as the need to raise the federal debt ceiling, still need to be dealt with in the next two months.

(MORE: Why the Fiscal Cliff Deal Should Have Included Social Security)

The Deficit Hawks: There is a third school of economists who are concerned primarily about the total debt of the federal government hindering current and future economic growth. This faction, which includes Michael Boskin of Stanford, worry about government debt “crowding out” private investment as holdings of U.S. Treasury bonds replace capital in investment portfolios. In addition, they argue, current government borrowing will require taxes in the future to rise, leading businesses and individuals to cut back on their spending to prepare for this eventuality.

Because of the automatic tax increases that were set to go into effect at the beginning of 2013 — and sensing a broad public appetite for belt-tightening — these deficit hawks saw the fiscal cliff negotiations as the perfect opportunity to put a serious dent in the debt. For these folks, however, the deal’s $650 billion in deficit reduction (over ten years), mostly from raising taxes on high-income earners, is a drop in the bucket compared to the $16-plus trillion the federal government owes. And Congress and the President could not agree to any meaningful cuts to Social Security and Medicare, the entitlement programs that are projected to eat up larger and larger shares of the federal budget as the nation ages and healthcare spending continues to rise.

Like any compromise that comes out of Washington, the fiscal cliff deal has left a bad taste in partisans on the left and the right. But at least each side got something it wanted. Hard core progressives want to see the rich pay a larger share of the federal tax burden, and in 2013 they will. Many on the right did not want to see capital gains taxed as ordinary income, and they got what they wanted for all but the wealthiest earners. But economists can’t view bills in such a piecemeal fashion. Compromise on economic policy – like trading extended unemployment benefits for ending the payroll tax cut – isn’t going to satisfy a Keynesian if the net effect is to reduce the federal budget deficit during a recessionary economy.

While Washington may still be able to eek out a compromise on legislation, it’s now clearer than ever that lawmakers are hopelessly divided when it comes to economic world views. The economic policy of the United States government isn’t so much directionless as attempting to go in every direction at once.

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23 comments
esqcaliber
esqcaliber

That wonderful bill our Congress just passed to save the Nation from going over what has been dubbed th "Fiscal Cliff" had the effect of adding $4 Trillion dollars to the national debt.  So what is a "Trillion?"  A Trilion is a million times a million.  Of to look at it another way, a Trillion is a number that is followed by 12 zeros.  Okay, so what does it mean to you, personally, that the deal added $4 Tillion to the National debt?  Well, first let us look at what is meant by "National debt."  National debt refers to the debt that is owned by every man, woman and child in the United States.  Based on the 2010 census (at which time our population was 311,591,917) the estimate of our population on the morning of January 5, 2013 is 315,113,215.  To say it another way, our population is a little over 315 Million.  So what did that $4 Trillion in new debt mean for every man, woman and child in the United States?  It meant that each one of them is now responsible to repay an additional $12,693.85.  It is "additional" because prior to this new "Fiscal Cliff" bill, your Congress and its profligate spending had already made each man, woman and child responsible for repaying $39,919.84.  The new total for which each one is now responsible is $52,613.69.  While you personally may have been careful with the amount of your spending over the holiday, you Uncle Same was wreaking havoc with your economy.  Happy New Year  [Mayble we should start learning how to say "Happy New Year" in Chinese because up until now it is China who has been covering these huge debts which our Congress has been running up.  In Cantonese it is "Sun nien fai."  In Mandarin, say "Xia man you kuai."

esqcaliber
esqcaliber

Newsy97 said the ball is where it should be -- in the Republicans' hands.  I would like to point out that the Republican House sent bills with specifically identified items for deficit and spending reductions.  The Sentate (the same body that has not posted a budget in over 3 years) refused to even put the bills up to a vote.  Yet by executive order, President Obama, on the eve of the fiscal cliff vote, gave them all a raise.  In the world of business, they all would have been fired for incompetence!

aarontant
aarontant

No mention of Milton Friedman whatsoever?  Adam Smith?  Why name 1 brand of theories and then sit on generalizations of nameless camps?

DavidCearley
DavidCearley like.author.displayName 1 Like

We got $75 billion a year in tax increases while we run $100 billion a MONTH in deficit spending. Unless we want a 50% tax rate for everyone, spending must drop substantially.

j45ashton
j45ashton

I'm with SmoothEdward1.  Most likely it will be a slow, steady recovery.  And a gradual lowering of the debt.  And the stock market will respond accordingly.  The only thing that threatens this is the GOP fighting to make the democrats & Obama fail.

superlogi
superlogi

@j45ashton Lowering of the debt?  Not in your lifetime.  How can there be when the spending increases far beyond our ability to cover it with revenues.  Why do you think the FED is buying Treasury Paper at the unprecedented rate of $45 billion a month.  Democrats and Obama are failures.  Period.

DavidCearley
DavidCearley

@j45ashton a slow steady recovery? With 20 million unemployed and tax revenue down more than 20%? Just what we need. Meanwhile obama says immigration reform (more legal workers without jobs), is his number one priority with the economy being number two...

sternci
sternci

"eek out" a compromise?

SmoothEdward1
SmoothEdward1 like.author.displayName like.author.displayName like.author.displayName 3 Like

Such is the nature of compromise: a solution that no one is completely satisfied with the outcome. The important thing is have movement, to demonstrate the parties can get something accomplished, and stability so individuals and businesses can make plans. Half of the problem with a slow economy is psychological.

newsy97
newsy97 like.author.displayName 1 Like

Bear this in mind, the bill was a stopgap measure to avoid the consequences of last years cowardly debt ceiling punt.

Now the ball is where it should be, in the GOP's hands. It is their turn now and they need to specify exactly what these cuts are that they keep alluding to.

Once they lay out their deficit free vision, the country can decide if they are doable or not. 

After that, we can go into hysteria.

DavidCearley
DavidCearley

@newsy97 Obama's spending is the Republican's problem? Yeah right.

newsy97
newsy97

Spin it any way you want, but the stock market likes it. If there ever was a no spin zone, the market averages are IT.

jsnwsch
jsnwsch like.author.displayName 1 Like

@newsy97  Well, at least the 1%'ers on Wall Street are happy.

superlogi
superlogi like.author.displayName like.author.displayName 2 Like

We've compromised ourselves into bankrupting our children, while at the same time promising them that a benevolent big government will take care of them.  But then, they are children.  Unfortunately, there are far too many others who aren't, but still think like children.

JohnDavidDeatherage
JohnDavidDeatherage like.author.displayName like.author.displayName 2 Like

Interest on the National Debt should be of great concern.  With interest rates at or near all time lows, paying the interest on the debt consumes about 10% of the budget.  How do we pay when interest rates return to normal levels (double+)... And interest rates will rise thanks in part to Quantitative Easing(s) 1-4.

Now is the last best chance to avert this very real disaster. 


akpat
akpat like.author.displayName 1 Like

Like most things there is no simple answer. There is plenty of money out there but its not used well.

The government needs to cut wasteful programs that do not contribute well to the economy of the people, that means defense and security which together come close to 1 trillion a year. We could cut this budget by 50% and still out spend the next 10 countries combined. The cuts need to come from contractors who are producing aircraft at 450 million each that dont work. Its time for a massive slim down and put the  oney to better use like border control and security in schools.

One are we should not cut is SS/medicare/cade and welfare as this money goes directly into the US economy helping to keep it going but other 'entitlements' do need to be cut. I see no reason why we borrow money from countries that dont like us to give to other countries that dont like us, and if people want our protection then its time for them to pay us rather than the other way around.


there is a lot that could be straightened out but in the end it requires cuts in the right places and raises in taxes in the right areas to produce a balanced budget.

DavidCearley
DavidCearley

@akpat axpat, unless we change them, those programs will overwhelm the entire budget.

Junk.Mail
Junk.Mail like.author.displayName like.author.displayName 2 Like

@akpat I don't understand your ``don't cut entitlements'' reasoning. I am not a fan of current exorbitant defense levels but I fail to see how those dollars enter the economy less than entitlement dollars.  Indeed entitlements desperately need to be cut, mostly due to our fantastic civilized successes--we just live (and are able to work) far longer than the designers of those programs could have anticipated.  The time has come to gradually (and predictably) increase the public retirement age to 70. Of course, if one wishes to privately finance early retirement, he should feel free to do so, but as a public safety net concept for those beyond their productive years SS/Medicare are miscalibrated to our current societal profile.

tom.litton
tom.litton

@Junk.Mail @akpat The relatively well off are able to live and work longer.  The poor, not so much...

tom.litton
tom.litton

@DavidCearley I don't know of anything that significantly broadened the definition of the poor.  If it's true, can you point me to the link?

I know the recession has broadened the programs aimed at the poor, but that is neither the same thing, nor Obama's fault. 

DavidCearley
DavidCearley

@Junk.Mail @tom.litton @akpat part of the problem is that we have so broadened the definition of the poor and disabled that far too many are receiving aid. Just the third year of unemployment Obama just added eats up half his tax increases.

Junk.Mail
Junk.Mail like.author.displayName 1 Like

@tom.litton @Junk.Mail @akpat  

Life expectancy in 1935 (when SS created) = 61.7; Life expectancy in 2010 = 78.7
Source: http://www.infoplease.com/ipa/A0005148.html

Of course this doesn't tell the whole story because of infant death and many other factors, but it is easy to see how collecting benefits after 65 in 1935 was way cheaper for society than it is now.

Many people cannot work to 65 now; they often collect disability or welfare. If these benefits are not more expensive than SS (and they should not be) then raising the public retirement age confers a clear deficit reduction.