Saturday, December 15, 2012

The Real Fiscal Cliff

Today, the term "fiscal cliff" refers almost exclusively to two things that are scheduled to happen simultaneously at the end of this year.

The first is the expiration of the Bush tax cuts, which were originally scheduled to expire at the end of 2010 but were extended in bipartisan fashion for two more years due to the recession. Currently, Republicans wish to extend all the Bush tax cuts and Democrats, flush from their election victory, want to extend all of them except the cut on high earners, the one-percenters loathed by Occupy Wall Street and their ilk. If nothing is done by the end of the year, all our income tax rates will go up to what they were in the nineties during the Clinton administration. Oh noes!

The second thing scheduled to happen is usually called "sequestration", though I suppose that term will in the future be used to apply to other things, just as the term "fiscal cliff" has changed definition. (In fact, it has been used in the past to refer to other, less public things as well.) Sequestration is somewhat more complicated. In 2011, a law was passed creating a "super committee" of twelve representatives with equal representation by both parties tasked with hashing out a deal to cut U.S. government spending. The rise of the Tea Party had given the Republicans strong gains in the 2010 elections, including taking over the House of Representatives, and so the deal took place against a backdrop of Republican strength. Republicans had been refusing to raise the debt ceiling, basically the congressional limit on how much the U.S. government can borrow, if Democrats did not agree to spending cuts, and so the law stated that if the "super committee" was unable to come to an agreement on so-called spending "cuts" (usually "cuts" means slowing the rate of spending growth, not actual cuts in spending), then there would be automatic spending cuts of $1.2 trillion, half defense spending and half other spending, both spread out over ten years as most spending issues usually are, to balance the $1.2 trillion raise in the debt ceiling. These automatic spending cuts are together called "sequestration".

The sequestration deal was designed to be so severe as to compel the super committee to come to an agreement. However at the time I predicted the super committee would fail to come to an agreement, and was proven correct. Why? Supposedly half of the spending cuts were to affect Republican concerns, i.e. the military, and the other half Democratic concerns, i.e. everything else. But of course, military spending is only twenty percent of the U.S. government's budget, and on top of that, certain spending programs like Social Security are exempt from sequestration anyway. The sequestration was designed to look both severe and fair to both sides, but in fact it was neither.

Spread out over ten years, the sequestration cuts only about $120 billion a year, which has somehow been reduced to $110 billion for 2013, of which $55 billion in cuts goes to military and $55 billion to other non-exempt programs. This amounts to about ten percent of the current federal government budget deficit, meaning it is only ten percent of the amount the government must borrow every year, on top of tax revenue, to keep spending at its current rate.

To put this in perspective, let's say that Alice and Bob are a married couple whose joint income totals $100,000 a year. Let's say that Alice and Bob spend about $135,000 a year and every year must borrow $35,000 just to keep up this level of irresponsibility. Now a serious spending cut would be something more than $35,000 a year because Alice and Bob not only have to stop borrowing, they also have to start paying back what they borrowed. So Alice and Bob decide to cut $3,500 from their yearly spending which, at less than three hundred a month, will prevent them from buying one of the three new cars they purchase every year. Obviously this is not going to solve their problem. They would have to cut ten times as much in order to really start making a dent. $3500 is only about 2.6% of what they are spending every year.

Compared to our real spending problem, the sequestration cuts are nothing. On top of that, the Democrats were easily able to swallow the non-military spending cuts because most of their high priorities are already protected from sequestration, and besides the programs they defend are a much larger portion of the budget. In other words, both sides lose something in the automatic cuts, but the Democrats calculated the Republicans lose more. So the automatic cuts amounted to a win for them. The sequestration designed to force an agreement actually favored the Democrats, and so they had no motive to compromise. This was borne out in the negotiations, during which Democrats sought a better deal for their interests than the automatic cuts, and Republicans wrongly assumed they would be forced to make a deal. Republican leadership is not pushing hard enough, and I am not the only one who thinks so.

So those are the two things everybody nowadays is calling the "fiscal cliff." It's nothing more than a natural consequence of the compromises our government has been making for decades. Republicans get tax cuts and Democrats get spending. The so-called "fiscal cliff" is a reverse of this dynamic: taxes will rise and spending will be cut. And so the politicians conspire to convince us they are paying attention and finally being responsible, but in the mean time they have taken a term which used to mean something far worse and applied it to a minor detail. The end result will be we might go over this so-called "fiscal cliff", not much will happen, and everyone will say, "Hey that wasn't so bad." And one of the few buzzwords in politics today that favor conservatives will be diluted.

When the term "fiscal cliff" started getting thrown around several years ago, it did not refer to the expiration of the Bush tax cuts. When the Bush tax cuts were due to expire at the end of 2010, nobody called that the "fiscal cliff". The sequestration deal didn't even happen until 2011. So what did the term fiscal cliff refer to? In fact, it used to refer to the disparity between projected government liability due to entitlements and projected revenue. The current so-called "fiscal cliff" ignores entitlements almost completely. Here are two articles from 2008 and 2009 referencing the real fiscal cliff as it used to be understood. I had to search NRO because I couldn't make Google do an actual search of older articles. Most every article I could find had old dates associated with them but were actually written within the last couple of years. Here is Paul Ryan discussing the real fiscal cliff, which has nothing to do with what's being thrown around the news cycle today:

"More people are retiring. Baby boomers are retiring. We're going from 40 million retirees to about 77 million retirees. And because all these three programs [Medicaid, Medicare, Social Security] are what we call pay-as-you-go programs, current workers paying current taxes to finance the benefits for current retirees, what that means is, when you have a 100 percent increase in retirees but only a 17 percent increases in workers filing into the system, because birth rates are lower than they were in the baby boom times, you have a huge problem.  Combine that with health inflation. Health inflation meaning the cost increases in Medicare and Medicaid go up about 6 to 7 percent a year. So you combine demographics with health inflation, and these programs grow at a unsustainable levels to, literally, by the time my kids are my age just those three programs, Social Security, Medicaid and Medicare consume all federal revenue."

In other words, when all the journalists and pundits talk about "going over the fiscal cliff" at the end of the year, it is mostly hype. The little problem they are talking about is meaningless next to the trillions of dollars of unfunded liabilities which the government has promised to its citizens in the form of guaranteed benefits. By most calculations, we would need over $100 trillion in cash right now and be able to invest it at six percent interest in order to cover these future liabilities. Obviously that is not going to happen. This is the real fiscal cliff. Don't let anyone tell you otherwise. So what will happen?

Well, either people will stop getting their government paychecks, or worse, the government will continue printing money to cover its liabilities, causing inflation and the loss of value not just of government paychecks but every paycheck. We don't know precisely when it will happen, but there is no question that it will happen within my lifetime (I am thirty) unless we deal with the problem responsibly. There are essentially two options for going forward. We can blindfold ourselves and just let the inevitable happen, or we can deal with reality and try to fix the problem.

The blindfold option is politically popular. Our government is becoming a near complete democracy, and unfortunately nobody wants to reduce their own cash flow for the greater good. Most, including supposed conservatives, are engaged in an extended run on the government bank. Everyone is trying to get as much out of it as possible before the whole thing blows up in our faces. That is, at least, those who see it coming. Most don't. But what's the harm?

Well, what happens when 300 million people suddenly don't get what their government promised them?  What happens when our money becomes worthless? That sort of situation is called "political instability" to put it mildly, not to mention the fact that most other western nations are facing the exact same situation. Historically, this has meant revolution, war and all sorts of unpleasantness far worse than taking a pay cut right now. We like to blame our politicians for this, but how many of us ask our politicians to reduce the money the government is paying us? Clearly, not enough are, and for obvious reasons. Everybody wants theirs, and until we stop and consider the long term the real fiscal cliff is coming, and it will make the fake one look like falling off a StairMaster.

Now that's whack.