Common-sense fiscal policy to avoid the fiscal cliff

Dec 10 2012 - 7:07pm

 

 We all have been bombarded by the media on the impending "fiscal cliff," if budget negotiations fail between President Obama and the Republican Party members of the House of Representatives. "Fiscal cliff" refers to the increase in different taxes and spending cuts scheduled to go into effect by the beginning of the New Year. Let me first discuss what is involved in "fiscal cliff."

If no agreement on the budget is reached, according to non-partisan Tax Policy Center (TPC), taxes would rise by more than $500 billion in 2013 with an average tax burden of $3,500 per household. Average federal tax rate, including individual income taxes, payroll taxes, corporate income taxes and estate taxes, will increase 5 percent across all taxpayers in the income distribution. Middle-income households would face an average tax increase of close to $2,000, which is a little less than 4 percent of pretax income. Average tax rates would increase close to 6 percent for those in the top 20 percent of the income distribution and 7.2 percent for those in the top 1 person of the income distribution on cash income.

 

Fiscal cliff would also result in spending cuts required in the Budget Control Act of 2011. Tax increases across all taxpayers and across the board spending cuts would throw the economy in recession. According to Congressional Budget Office, the growth rate in inflation-adjusted GDP would decline to 0.5 percent during the year 2013. Professor Blinder of Princeton University, in his op-ed in the Wall Street Journal, Dec. 5, is of the view that unemployment rate could go up as high as 11 percent. Politicians should pay attention to the recessionary effects of austerity measures in the Euro zone countries.

It is ironic that Republicans are Keynesians on tax policy and conservatives on spending policy in a depressed economy. The economic common sense teaches us that in an economy with high unemployment rate and low economic growth, if the private sector is not spending then the government should spend in job creation programs.

Given the state of the current economy and large budget deficits, an increase in spending must be financed. It requires implementing a tax policy that raises funds and at the same time does not decrease overall consumption spending. It defies logic to argue that spending cuts are beneficial to the economy and tax cuts for 98 percent of the taxpayers are not; tying the reduction in their taxes to tax cuts for the 2 percent at the top of the income distribution is economic malpractice. It is economic nonsense to argue that tax increases for the wealthy will decrease their consumption spending, and increase in spending on job creating programs will hurt the economy.

In addition to the tax cuts to 98 percent of the taxpayers, there are government spending programs that will have quick beneficial effects on the economy. It is well documented that the country's infrastructure is in disrepair and inadequate for the high-tech economy and needs to be repaired and/or expanded. Infrastructure investment is both a good short run policy and long run policy. In the short run it will create jobs, which we badly need, and in the long run it will add to public capital that will increase productivity of the private sector. Another area of investment, which requires close attention, is investment in human capital (education). It will not only provide manpower for the technologically sophisticated economy but would also contribute to increase in productivity. These policy measures would contribute to economic growth, make us competitive in the world market and lower unemployment. It can be done at a very low cost to the economy at this time, when interest rate on government borrowing is so low.

Paul Krugman suggests in his book, "End this Depression Now," that state and local governments would be spending "$300 billion a year more than they actually are," if they hadn't faced severe budget crunch. The federal government could provide this money to create jobs immediately, for example, hiring more teachers, firemen, and adding manpower for other essential services.

These fiscal policy measures could be agreed upon now to avoid the cliff and the discussion to reform entitlements and tax code could take place in 2013 when the threat of recession and high unemployment is off the back of Americans. The obsession with deficit at this time is unwarranted because these fiscal measures will increase economic growth, and the budget deficit as a fraction of GDP may in fact fall. The fear that federal government will not be able to raise money by selling securities is also unwarranted, given the fact that the demand for Treasuries remains strong.

Republicans in the Congress must realize that Americans passed their judgment in the recent election by voting for President Obama and supporting his economic message. They must now heed the message voters have sent and take actions which are good for the country and for themselves if the party is to remain a viable political force in the years to come.

 

  

Mathur is former chair and professor of economics and now professor emeritus, Department of Economics, Cleveland State University, Cleveland, Ohio. He also writes blogs for the Standard-Examiner at http://blogs.standard.net/economics,etc. His articles also appear at vijaymathur.blogpost.com.

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