Friday, December 7, 2012

Thinking about the Fiscal Cliff

The fiscal cliff is a self-imposed deadline set earlier this year by Congress intended to force them to deal with a soaring deficit, which is a serious economic problem with interest on the debt now one of the major categories of government expense.  Let’s look at two particular issues:  the Payroll Tax extension and the discussion about revenue (raising taxes) vs. spending.

Two years ago the government decreased the individual contribution to Social Security from 6.2 percent to 4.2 percent hoping to stimulate the economy by giving people more money in their paychecks.  It was a temporary measure in 2011 but renewed in 2012.  The argument for extending the tax cut [yet again] is that it helps lower-income workers who live paycheck to paycheck. ‘The difference in the paycheck might be the ability to pay the electric bill for someone or the chance to go to a sit-down restaurant once a month.’”   In other words, for two years citizens haven’t treated this expressly temporary measure as temporary.  Did they see it as a chance to get their financial house in order or as a windfall?  The proponents of an extension seem to believe the latter.  Politicians don’t usually act in a way that encourages critical thinking.  They didn’t emphasize the temporary nature of this change.  Rather, they assume that given a year or two of extra cash, people will just spend it, thereby stimulating the economy, instead of using it as a planning tool to catch up and become less dependent, perhaps even increasing their own savings.  If the politicians are right, it doesn’t speak well for the critical thinking or discipline of Americans.

Concerning the spending vs. taxes debate, I just wanted to share some interesting data for your consideration.  I agree with many economists that a combination of tax increases and spending cuts has become necessary.  How that develops is someone else’s job and my opinion doesn’t matter.  However, I think these graphs, based on data from the St. Louis Federal Reserve, are a good presentation of the situation.

The first shows revenue and spending for the past 65 years.  The early years show little difference due to the size of the scale needed for the more recent years.  

A closer look at 1990 to the present (under two Republican and two Democratic administrations) shows the tax cut in 2001, when taxes were exceeding spending, but at the same time an increase in the rate of spending.  Despite that. taxes nearly closed the gap by 2008, but closing the gap merely eliminates the deficit, without touching the overall debt.

Below is the same close-up graph with trend lines added.  If spending had stayed on the same slope from 1990 to today (dashed red line), the gap would have closed even with tax cuts and the recession.  Instead the entire slope of spending increased dramatically from 2001 and stayed that way (labeled Recent Spending Trend).  Now some politicians resist any reduction to this current rate of spending growth, even though it included spending to support wars and stimulus packages.  They may even describe moving from the current to a lower rate of increase as a cut - critical thinkers know better.  Is that reasonable or responsible behavior by our leaders?  We surely need both additional taxes to catch up combined with some moderation in spending.  How long can this go on before we follow in the footsteps of Greece, Italy, Spain and others with their forced austerity programs and bailouts, and what entity is big enough to bail out the United States?

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