Peter Foster: Off the cliff, into a swamp?
Senate ignored recommendations of bipartisan commission
According to the 38th annual List of Words to be Banished from the Queen’s English for Misuse, Overuse and General Uselessness , the two least favourite phrases are “fiscal cliff” and “kick the can down the road.” Ironic then that the Democrat-controlled U.S. Senate should, in the early morning of Jan. 1, have attempted to kick the fiscal cliff down the road, or at least — via a 157-page bill — to the Republican-dominated House of Representatives. Although Senate Republicans had overwhelmingly voted for the bill, House Republicans didn’t appear to like the New Year’s package one little bit.
The Senate deal was initially portrayed as avoiding a Thelma and Louise-style ending to the manufactured melodrama of the cliff, under which taxes would automatically be raised and government expenditures cut. However, while the Senate bill appeared to offer compromise on President Barack Obama’s major obsession of bashing the rich, it punted when it came to spending cuts, delaying across-the-board reductions under the so-called “sequester” for two months, and saying nothing about — yet another — looming debt ceiling. The Congressional Budget Office projected that the Senate bill would add another US$4-trillion to a national debt of US$16-trillion over the coming decade.
Greg Mankiw, Harvard economist and former advisor to Republican Presidential candidate Mitt Romney, noted that the Senate package entirely ignored the recommendations of the president’s own bipartisan Bowles-Simpson commission. The commission recommended entitlement reform to constrain spending, and a broadening and lowering of tax rates via the elimination of exemptions and loopholes. Instead the Senate deal offered little or no reform and higher marginal taxes for those guilty of creating more than their fair share of national wealth.
This Congress comes to an end on Thursday, so if no agreement is reached, all American taxpayers will get whacked. However, as Republican Representative Darrell Issa of California pointed out, tax relief without spending cuts merely means tax deferral. GOP House leader Eric Cantor too declared his opposition to the Senate bill, which left Republican Speaker of the House John Boehner in a difficult position. Thus, at press time on Tuesday, all was confusion. Would the House send the bill back to the Senate with amendments? Would the stock market fall off a precipice on Wednesday in the absence of deal? Would the House Republicans be willing to wear the unpopularity of comprehensive tax increases?
Some commentators, such as Richard Salsman of InterMarket Forecasting, have suggested that the whole notion of a fiscal cliff — a term created by Fed chairman Ben Bernanke — has led to unnecessary moral panic around an artificial deadline. The package of tax increases and spending cuts that were due to come into effect on New Year’s day have been portrayed as a certain recession-inducer, to be avoided at all costs. However, Mr. Salsman has pointed out, spending cuts are entirely positive, while the impact of tax increases — at least on the rich — may have been overestimated (although tax increases are always bearish).
While there may be compromise in politics, there is none in economics, and the U.S. national debt will be unsustainable when interest rates inevitably start to rise. Meanwhile, increasing taxes on wealth creators (coincidentally the fourth least-favourite phrase in that To Be Banished list) will inevitably be a job destroyer. Under the Senate bill tax rates would increase from 35% to 39.6% for individuals making more than $400,000, and for couples making more than $450,000. Inheritance taxes on estates would rise from 35% to 40%. Meanwhile all taxpayers would be affected by a 2% increase in the payroll tax.
It’s worth remembering that the main reason that the U.S. is not in a fiscal crisis is because its borrowing costs are so low. This is partly a reflection of Mr. Bernanke’s repeated helicopter drops of “quantitative easing,” which involve the Federal Reserve buying up U.S. government debt, and partly because — from a foreign investors’ point of view — other national investment vehicles look worse.
Inevitably, there has been much concern about the potential impact of the cliff on Canada. However, the biggest immediate problem for the Canadian economy from the U.S. comes not from macro fiscal wrangling but from the micro success of the U.S. petroleum industry in reviving domestic production of shale gas and tight oil. This has led to hefty discounts for Canadian oil bottled up in the Midwest, and a sharp decline over the past five years in natural gas export earnings.
In the longer term, however, the willingness and ability of the U.S. administration to deal with spending and debt problems will be crucial. That battle continues, and every Obama “victory” in terms of bashing the wealthy and failing to deal with entitlements and debt represents a potential loss both for the U.S. and global economies.
The president spoke on Monday of “shared sacrifice,” but numerous studies have shown that a “balance” between higher taxes and lower spending just doesn’t work. What works is a preponderance of spending cuts. As of Tuesday evening, the House teetered on the fiscal cliff, but the prospect of a fiscal swamp appeared ever more likely.