The 2012 presidential election brings a renewed emphasis on US fiscal health and its long-term future.  A candidate asks: “Are you better off?” But I suggest two more important questions:  What fiscal policies will provide you with a better future?  And what role do you want government to play in that future? 

Where to start searching for an objective viewpoint?

The choices are complex and the ideological divide between the two political parties have led to stalemate in Congress-so what’s an ordinary citizen to do?  I suggest seeking objective information that outlines the possible consequences of specific policies.

The Congressional Budget Office is a good place to start.  It is a bipartisan office that keeps track of the current budgetary mandate and calculates 10-year projections of revenues (or taxes) and expenditures.  Recently it published “An update to the budget and economic outlook: fiscal years 2012 to 2022.” [2] It is a seventy five-page document, so allow me to summarize an important point:  legislators (and by extension voters) are rapidly hurtling toward either of two painful scenarios.


Scenario 1 (called the “Baseline scenario under current law” or more generally “fiscal cliff”), analyzes revenues (or taxes) versus spending while assuming that current law is upheld.  What does this mean?

Under current law, the stopgap measures enacted during the recession to aid economic growth are due to expire by the end of the year.  These include:  the Bush tax cuts, Social Security payroll cuts of 2%, and the indexation of the Alternative Minimum Tax [3]. Eliminating these revenue cuts cause good and bad consequences.

  • Good outcomes:  The annual deficit, currently at -7.3%, would shrink to -1% or less by 2016.
  • The debt by 2022 will rise from $11.3 trillion to 14.46 trillion but decline as a percentage of GDP to a manageable 58%.
  • Bad results:  The consequence of raising tax revenues when the economy continues grow below historical trend is likely to increase unemployment (to 9% from today’s 8.1 %.)  Moreover, the CBO projects a recession in 2013 under this scenario.

Scenario 2 – I call this the “Keep on Truckin’” plan[4].  It would extend the Bush Tax Cuts, AMT indexation, Social Security Payroll cuts and other miscellaneous provisions illustrated by the light blue line in the chart.) This tactic would maintain current spending power to consumers who comprise roughly 70% of our GDP.

  • Good outcome:  Economy, as measured by GDP, avoids a recession and gains sufficient momentum to avoid a recession in 2013.
  • Bad result:  Long-term debt rises to 90% of GDP by 2022, a level associated with stagnant growth and a crowding out of private business investment.[5]

Is there a Via Media, or Middle Road?

The data on spending and revenues forecast dire scenarios unless legislators tackle aligning the tax code with the goal of achieving a healthier fiscal trajectory.  In its current state, the US tax code has become needlessly complicated and does not raise enough revenues to pay its bills.  There is a structural deficit of 3-4%.[6]  Historically tax revenues have comprised roughly 18-19% of GDP, whereas government spending has been around 22%.  During the recent period, both receipts fell and expenditures increased thereby widening the gap to roughly 10% at its worst point.

See charts #2 and #3.

Chart #2 shows the structural deficit: In recent years the gap between revenues and
spending have widened even before the recession of 2007.

 

Chart #3 from www.taxfoundation.org :We may feel that we are paying too many taxes, but since 1985,
our burden has decreased. Who pays higher or lower taxes going forward link to the core issues of whether government
should get smaller or larger, if entitlements should increase or decrease as well as seminal ideologies of each party.

This is why the stalemate is a huge problem.  Inaction will not lead to a better future for the country and could in fact make things worse if borrowing costs increase.  Also, economic growth is slow, so legislators cannot assume that debt will shrink in relation to an expanding gdp as a matter of course.  (If the overall economy grew larger at a faster rate, tax revenues would increase and US debt servicing would seem less onerous as a percentage of total spending.)

Takeaway

Both spending and revenue (taxes) policies loom large in the short term as American voters express their vision and values of how the US government will look to future citizens.  It is easy to lose your head, or at least scratch your head, when so many people are arguing from different sides of the issue, supplying their own statistics and ideology.  The aim of The Huffman Broadsheet is to highlight non-partisan information and commentary that allows you to broaden your perspective, understand the issues, and think for yourself.

 


[1] Rudyard Kipling line from “If” poem

[2] Published August 22, 2012.  See www.cbo.gov.

[3] The Alternative Minimum tax, when first enacted in 1969, was not indexed to inflation.  In recent years, Congress has indexed the income levels subject to the AMT so that fewer people are affected.  If this fix is eliminated going forward, it is estimated that 31 million taxpayers, instead of 4 million, will fall under the AMT regime next year.  For more information, see http://blog.helpingadvisors.com/2011/04/26/taxing-times-alternative-minimum-tax/

[4] Author’s nickname for extending short-term policies permanently

[5]See Reinhart and Rogoff, economists article http://www.bloomberg.com/news/2011-07-14/too-much-debt-means-economy-can-t-grow-commentary-by-reinhart-and-rogoff.html

[6] See chart for recent spending and receipt data.

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