Friday, November 9, 2012

Don't Fear The Cliff

     This is the position in which John Boehner and House Republicans find themselves in the context of the fiscal cliff negotiations. If they cave into the President and Harry Reid and allow the current tax rates on high earners to expire, whatever crumbs they get in return will be blamed for the economy continuing its downward slide. However, if they stand firm on no tax increases for anyone and push for tax and entitlement reforms, and the fiscal cliff occurs as a result of no deal being struck, the economic demise will be blamed on "those obstructionist Republicans." A rock and a hard place would be desirable to the current position in which the House Republicans find themselves. Seemingly, they are damned if they do and damned if they don't.
     My strategy, if I were Speaker of the House, would be to stand firm on tax policy and entitlement reforms, or give the President and Harry Reid everything they want and let them own it. The former would allow the economy to expand and grow, creating more tax revenue, and the latter would cause tax revenue and the economy to decline further, but without Republican fingerprints. In order for option one to work, Speaker Boehner and House Republicans can't fear the coming cliff and being blamed for its economic effect. For option two to work, they can't fear the backlash in their own party. Either option would require a well articulated public campaign.
     The fiscal cliff, for those who aren't aware, comes January 1, 2013 when the Bush era tax rates expire and every ones taxes will rise, including the taxes on capital gains and dividends. Added to this tax increase are the automatic cuts in defense and entitlement spending that were the result of no deal being reached by the super committee that was created by the debt ceiling negotiations in August of 2011. But how bad is the ensuing economic malaise from the fiscal cliff, compared to what is going to happen as a result of the President being successful in his agenda? Every study that has been done on tax reduction shows the biggest economic gains are made from cutting the top marginal tax rates, little benefit occurs from cuts in lower rates. We can extrapolate from the data that the opposite is also true, i.e. when you hold lower tax brackets at a lower rate and allow top marginal rates to increase, you slow economic growth and receive less revenue to the Treasury. As for the automatic cuts in defense and entitlements, the former is something that is going to happen under a second Obama administration anyway and the latter needs to happen, but probably won't in the next four years.
     If the Republicans make any deal that includes an increase in any tax rates, it would be tantamount to kicking the can down the road, thereby stunting any economic recovery. Now is the time for a well-articulated campaign to save the economy through policies that actually have a history of working. One thing is clear, this past Tuesday's election gave a mandate to House Republicans. The House Republicans were returned to power by the voters after having spent the last two years passing budgets, jobs bills and tax and entitlement reform bills. The President spent the entire campaign, not exalting his ideas and accomplishments, but convincing the voters that he wasn't Mitt Romney. The President's mandate, if one exists, is to not be Mitt Romney. It's time for the House Republicans to pick up the mantle of their mandate, future elections be damned. If we don't solve our debt and economic problems now, it will matter little who controls the empty shell of government that remains in the future.

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  1. Would someone who has reasons to support his/her predictions please give us some ammo about what will happen if we go over the cliff? A wheelbarrow full of dollars for a loaf of bread? The dollar worth 10% of its current value? Gas at $10/gallon, or $15? Maybe if some of these stupid dems had some idea what could happen... And for that matter, I would like to hear an educated opinion.

    1. What I have for you is far from an educated opinion, but I do remember learning in history class that the Federal government has used a paper currency in the past, during the Civil War I believe (or at least soon after, forgive my poor memory). And yes, the currency degraded to the point that it took about a wheelbarrow full to buy a loaf of bread, due to excessive printing. This currency was the origin of the term "greenback."
      Apparently the return to paper back currency was justified by the notion that as long as printing was proportional to the increase of goods available on market that the currency would not "hyperinflate." I don't think Bernake believes in this principle, and although things haven't gotten really bad yet, I worry.
      At the end of the day, paper currency leaves the danger of excessive printing becoming a means of making existing unaffordable debt into affordable debt since the debt is always defined in terms of dollar units. Changing the unit decreases the debt. This is what was done intentionally after the Civil War (to my best knowledge) because the debt was in fact unmanageable.
      But we still recovered that one...

    2. The problem with what Bernanke is doing is twofold. First, the Fed is buying 70% of all the government debt in an effort to artificially keep the interest rates down below 2%. Once the market drives those rates back up, no one is going to service our debt. The other thing that is going on is that all the money that the Fed is spreading through Quantitative Easing is going to have to be pulled out of the market which will cause the inflation about which you are worried.