Fiscal Cliff Diving And Debt Ceilings, Oh My

Well, the Mayans were wrong about the world ending, Jack Van Impe was wrong again on the rapture, and the fiscal cliff was avoided. Yahoo! But just as Americans never really seemed to understand what the Mayans were saying (it was the calendar ending, not the world), few Americans really grasped what the fiscal cliff meant.

And it isn’t hard to understand why.

The fiscal cliff, like its parent the debt ceiling, is an arbitrary creation; a crisis of convenient contrivance. Both parent and child were born of power politics, with no connection to economic or financial need. The 2011 confrontation over the debt ceiling produced a series of debt reduction spending cuts known as the sequester scheduled to take effect in January of 2013. These cuts were seen as “fiscally responsible,” despite the macroeconomic nonsense of massive spending cuts during a slow recovery. A year later, those that saw the sequester as fiscal responsibility, acknowledged the fiscal irresponsibility of the sequester. The presence of the spending cuts, paired with the expiration of both the Bush and Obama tax cuts, created a precipitous cliff over which our nation might fall.

Washington managed to set aside enough dysfunction to put a two month bandage on the situation; a road was found to take us halfway down the cliff. The deal passed did the following:

  • Made the Bush tax rates permanent for the first $400,000 of all individual income, and the first $450,000 for all income for married couples
  • Made the preferential tax treatment for capital gains and dividends permanent
  • Increased the rate on dividends, capital gains, and the estate tax for earners above the $400,000 individual threshold and the $450,000 married couples threshold
  • Set a threshold for the phaseout of deductions at $250,000 for individuals and $300,000 for married couples
  • Made the patch for the alternative minimum tax permanent, and indexed it to inflation
  • Extended unemployment insurance through 2013
  • Extended various tax credits and deductions focused on working class families
  • Extended various tax credits and deductions focused on energy reform
  • Extended appropriations related to various agricultural programs and crop insurance for disaster relief
  • Extended various Medicare funding provisions related to the Affordable Care Act (ObamaCare)
  • Suspended the spending cuts until March 2013

Was this a good deal for the President? Was this a good deal for House Republicans? Was this a good deal for the country? Politically, the deal was an unmitigated disaster for conservatives, and an under-appreciated success (with a caveat) for President Obama. The country must wait for the true resolution of this artificial crisis to know if it is good or ill. The caveat for the President? Everything hinges on how the parent problem, the debt ceiling, is resolved.

Which is truly a shame.

The debt ceiling is the most arbitrary of pointless political nonsense I can bring to mind. Typically, it is seen as a social good by populists, conservatives, and even liberals who view it as “common sense responsibility.” After all, households and small business just can’t go adding debt willy-nilly, can they?

Maybe not, but responsible households and successful small business routinely carry several times the leverage that the United States currently holds. Our debt to GDP is right around 100%, and our debt service (interest and principal) related to GDP is closer to 3%. If we compare typical tax revenues to debt, the ratio is closer to 600%, and debt service is closer to 10%. Either way, when a bank responsibly evaluates a party seeking a loan, whether individual or business, their capacity (the difference between disposable income and current obligations) is the critical factor. Most responsible homeowners spend around 30% of their gross income on debt service (for the home itself). This is far higher than what we the people are paying now…at this time of alleged irresponsibility.

The debt ceiling has no connection to sound financial management or macroeconomic realities. It is a universally bad idea which has been solely used as political leverage. Conservative economist Glenn Hubbard tried to rescue the validity of the ceiling by pointing out that the increases in it have typically been associated with debt reduction programs, but these debt reduction programs have never reduced the debt. Economic growth is the only proven debt reducer, and growth only comes from spending, whether private or public in nature. In recessions, as in slow growth recoveries, the private sector isn’t spending.

Smart economics tells us to spend our way out of this recession, and pull back when the private sector is ready to run free and clear. Only bad power politics stands between our nation and a completed recovery. Will we go cliff diving again, or will take the smart drive down the road?

Time will tell…

The Rational Middle is happy to be back from a long hiatus, and hopes all had a wonderful holiday season filled with friends and family…and we are listening…