Red Zone "Cliff" Politics

Nothing, it seems, is easier to roll than Republicans.

Ronald Reagan agreed in 1982 to increase taxes $1 for every $3 in reduced spending. Taxes went up but spending reductions never happened. In fact spending had increased by the time Reagan left office. His successor Bush 41 violated his famous promise to read his lips because there would be no new taxes. Seduced by Democrat pledges, he bought into a scam to reduce spending by $2 for every $1 tax increase. The taxes were real and the cuts weren’t – which cost him conservative votes for a second term.

The latest log-rolling happened last week when Speaker John Boehner brought a Senate-crafted bill to the floor of the House for a vote. Laughably named The American Tax Payer Relief Act and larded with spending goodies for Obama’s cronies, enough Republicans joined Democrats to pass the measure which reduced spending $1 for every $41 in increased taxes. In the first year the $40 billion in crony pork will consume two-thirds of the additional taxes and it will add $4 trillion in new spending over the next decade. The media-created “fiscal cliff” was averted, therefore, with almost no spending reductions in return for tax increases whose only contribution to solving the nation’s debt crisis is symbolic.

The economic problems that this country faces were caused the same way that the economic problems of Italy, Spain, Greece, and Japan – excessive spending. History has shown that regardless of the US marginal tax rate, tax receipts as a percent of GDP have fluctuated in a narrow range since World War II around 19.5% – a phenomenon named Hauser’s Law. Why? Because people who pay most of the taxes are well enough off that they can minimize or avoid having to pay their bills with taxable ordinary income. Ask Warren Buffett who brags about it.

Given the reality of Hauser’s Law, spending should also equal 19.5% of GDP to avoid deficits that pile up in the form of our national debt. Instead, spending increased during the first Obama administration from 21% to 24% of GDP, adding $5 trillion to the national debt, which now stands at $16.4 trillion. Budget deficits – spending in excess of tax receipts – are projected to increase that figure to over $20 trillion by the end of Obama’s second term unless something is done about spending.

The deal signed last week will transfer more than $600 billion from the private sector to government over the next ten years. Since it didn’t reduce spending, Obama’s lofty goal of reducing the national debt by $4 trillion can’t be achieved. That can got kicked down the road two more months when on March 1 sequestration will cause $110 billion in automatic across-the-board military and domestic spending cuts to happen unless Congress and Obama agree to a more sensible spending solution.

Moreover, on or before March 27 Congress must pass a budget – something the House has done but the Senate has blocked for three years. Without a budget Congress must again perform the continuing resolution kabuki dance, allowing government operations to continue at the level of the last budget that was approved by both chambers.

But before those two events – sometime in late February – the debt ceiling will have to be increased. It remains to be seen if this confrontation will resemble the ancient gladiatorial fights in the Roman coliseum or modern day professional wrestling. That depends on the Republican leaders, who can be rolled faster than a marijuana joint. Technically, however, the government has already exceeded the debt ceiling and between now and then can only legally borrow to replace maturing debt and must defer paying its bills.

The clash of the Titans – or midgets against Megatron, if you esteem you the Republican leadership as I do – was created in August 2011 when those debt ceiling and continuing resolution stare-downs occurred. During the more than 500 days since then, Obama’s ideological intransigence has prevented a resolution of the spending crisis. And during those 500 days over $2 trillion has been added to the national debt at a clip of about $4 billion per day.

With Obama’s reelection and the fact that Democrats gained seats in the Senate and House, Obama believed he got a mandate to raise taxes on the “rich” but not a mandate compelling spending cuts. A Pew poll released Monday showed that four out of five Americans disapproved of the way the Republican leadership handled the cliff crisis – a data point that will likely bear heavily on their willingness to take hostages in the next round of fighting, not to mention shooting them.

Looking back to the Clinton and Bush 43 administrations, the government borrowed an average of 7.5% of what it spent and government spending averaged 19.9% of the GDP. In the four years of the first Obama administration, the government borrowed an average of 37.2% of what it spent and government spending averaged 24.4% of GDP. This year, the Obama spending spree promises to continue an unbroken string of five years’ of trillion deficits. Deficits add to the national debt, which now exceeds the GDP – i.e. the value of all goods and services this country produces. That’s like having a credit card balance that exceeds your income. You’ll never pay it off unless you stop charging.

By increasing taxes on “the rich” Obama has made this situation worse. Like it or not “the rich” are the job creators. They have more discretionary income and spending it creates jobs. The investments they make create jobs. People with money can afford to take risks, which include losing that money, something people who aren’t “rich” can’t do. There are trillions of dollars sitting on the sidelines because of Obama’s anti-business, anti-rich rhetoric that, over the past four years, could have been creating consumer demand which in turn creates jobs.

Over almost any historic period the net new job growth in this country has been due to small business. Obama's claim that 97% of small business owners would be untouched by higher taxes is sheer folly. The 3% who will pay higher taxes on business profits, which are taxed as ordinary income, employ 54% of the total private workforce in the country.

Without net new jobs, a large percentage of our workforce, which grows every year, can’t be employed. The economy stagnates and the debt/GDP percentage grows, causing even slower growth. Obama is stuck on stupid when he talks about returning taxes to Clinton era levels. Under Obama we don’t have a Clinton era economy. We have a Carter era economy. Nobody wins with higher taxes, especially in this economy. Obama has chosen to ignore historic economic behavior – that what is rewarded (lower taxes on incomes and profits) gets produced in larger amounts (jobs and tax receipts.) What is penalized (higher taxes on incomes and profits) will be diminished, delayed, or diverted.

A case in point. Remember the famous luxury tax – one of the taxes that cost Bush 41 a second term? Ah, yes. The geniuses in Washington decided to tax yachts, planes, furs, jewelry – the toys only the rich buy. Think of all the money that would flow into government coffers … and the middle class would be unaffected. Well, the rich are rich, not dumb, and they stopped buying those highly-taxed goods, which not only cost Washington its expected tax windfall, but also cost the jobs of 330 high-end jewelers, 1,470 aircraft builders, and 7,600 boat builders, according to government number-crunchers. The unemployment benefits paid to those who lost jobs cost the government (that’s all of us) over $24 million, not to mention the loss of income taxes that would have been paid if these people hadn’t been thrown out of work by their government.

We can’t tax our way out of a spending problem. Even a 100% tax on the income of millionaires and billionaires is insufficient to cover the budget deficit, not to mention the trick of getting these people to work and hand over their entire income to the government. If the government could seize their entire wealth – all of their savings and investments – that would amount to about $11 trillion. The national debt is over $16 trillion. Democrats have tossed around the idea of nationalizing all private retirement accounts of all Americans and replacing them with a government-run retirement system. Argentina did it. It wrecked their economy. And it would wreck ours too assuming Obama could get around the constitutional problems.

We can’t grow our way out of a spending problem. The two are antithetical. The more money that is diverted out of the private sector and into the public sector, the more sluggish economic and job growth becomes, as Obama has so ably shown in the past four years with his historically high borrowing, historically high spending as a percentage of GDP, and historically high unemployment. Government cannot create jobs. Government cannot allocate capital efficiently. Keynesian economics is a fraud. Government is a drag on private enterprise, although admittedly a necessary evil. The best amount of government is the least amount of government needed to provide public services and national defense.

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The only real alternative to living on a fiscal cliff is to reduce spending. The primary objective in managing spending must be to eliminate the annual deficits as soon as possible thereby avoiding adding to our mounting debt. After eliminating deficits, spending must be further reduced to generate surpluses that can pay down the national debt. Neither of these goals can be achieved through taxation without wrecking the economy, which will make the debt problem worse.

Spending cuts won’t be easy. The present generation of Americans has become addicted to having government goodies that they don’t pay for in current taxes. Instead, they put them on the government credit card (the national debt) and hope the next generation and the unborn (and politically unrepresented) generations can pay for them. Otherwise, it’s not the current generations’ concern.

Politicians, more worried about their jobs than the problems they were elected to solve, will wring their hands and posture for their constituencies, convincing them that cuts deep enough to eliminate deficits and create surpluses are impossible. Well, if cuts can’t be made, get ready for the economy to crash and burn.

Never happen, you say? Well, worry about this as you go to sleep tonight.

The Federal Reserve is keeping interest rates at artificially low rates. Short term interest is almost zero. This keeps interest payments on the national debt low. It also penalizes savers and people who depend on interest for income, some of whom are pushed into welfare assistance. Low interest normally encourages business expansion, which is potentially inflationary, but our slow growth economy and historically high unemployment mitigates inflation risk. The world is an economic mess right now so there isn’t a lot of competition for capital, slowing down capital mobility and further keeping a lid on interest rates. While there are conflicts around the world, none are explosive, so capital markets are relatively stable. Most important, the credit rating agencies have let the US roam on a long leash, although they have been getting nervous watching Obama pile up debt.

The US is very fortunate to have all of these conditions occur concurrently.

With our debt situation in uncharted territory, any of these factors could change literally overnight causing a chain reaction leading to a rush for the doors. While China is the largest foreign buyer of US debt, the biggest owner of debt is the US – about one-third held by the Federal Reserve and the rest held by the public. Anything that would make US debt less attractive would increase the interest rate payable – assuming bonds could be sold at some price. It would also cause debt holders to dump bonds. That and other things that could push up interest rates would increase our deficit astronomically, depending on how high interest rose. Currently, interest payments are about 6% of government spending. Think of the impact of doubling or tripling interest rates.

Standard & Poor’s downgraded US debt in August 2011 when Congress failed to resolve that fiscal crisis. Moody's, another credit rating service, has warned that the January fiscal cliff resolution wasn’t sufficient. If Congress doesn’t get its deficit and debt management going in the right direction in the coming showdowns, it risks a downgrade by Moody’s. This would make US debt securities less attractive. It could also trigger a sell-off panic which would make financing the deficit and redeeming debt maturities very, very difficult. A US debt default could bring down the world economy.

How likely is a US debt dump and a stampede for the exits? The risk is real and every American should be worried about it happening. We’re in the red zone with all the warning lights blinking. But we can reduce that risk by getting spending under control.

I’ll talk about that in next week’s blog.