The global cost of fiscal indecision

By Felix Salmon
December 31, 2012

Happy fiscal cliff day! The fiscal prognosis is, amazingly, probably fuzzier today than it has been in weeks: the only thing that seems certain is that no one has a clue what’s going to happen, especially in the House. But amidst the chaos of the intraday news chase, I think two broader stories have failed to get the attention they deserve.

The first is that we have now officially reached the debt ceiling. Naively, I had assumed that any fiscal-cliff deal would automatically include raising the debt ceiling — after all, after going through the present legislative nightmare, who’s going to have any appetite for another one immediately afterwards? And yet, astonishingly, it seems as though even if the fiscal cliff does manage to get averted, the debt ceiling will remain in place, and raising it will require its own separate legislation.

The second broad narrative is the slow death of the Grand Bargain. If and when we do get some kind of fiscal cliff deal, it will be a patched-together hodgepodge of policies designed with exactly one goal in mind: finding a piece of legislation which is capable of getting, somehow, through Congress. It will not be a shiny new tax code which radically rethinks US fiscal policy to put us on a healthy long-term footing: instead we’ll just get something better than the fiscal-cliff alternative of doing nothing at all.

So if you were hoping that the cliff might finally give us the opportunity for a deep rethink of something like the mortgage-interest tax deduction, or even tax expenditures more generally, think again. And other reforms are similarly not going to happen. For instance, Bob Pozen and Lucas Goodman have a sensible idea: pay for a reduction in the corporate income tax rate by allowing corporations to deduct only 65% of their interest expenses.

It’s fun to look at Pozen’s idea side-by-side with that of Cromwell Coulson: Coulson proposes that we tax dividends at the same rate that we tax income, but that we also allow all dividends to be tax-deductible to corporations.

The point in both cases is that both dividends and interest payments are ways of returning capital to people who funded the company, but debt is more systemically dangerous than equity is. So why structure the tax code to make debt more attractive than equity?

This was exactly the kind of debate that the fiscal cliff was supposed to engender: after many years of a “permanent temporary tax code”, we’d finally be forced to implement the kind of profound fiscal revamp that all politicians agree is needed.

And yet, we have failed. The solution to the fiscal cliff will be just as tenuous and temporary as anything which went before it, and will include nothing radically new. The legislative process in the US makes all fiscal policy extremely path-dependent, and the degree of dysfunction in Congress makes any path at all extremely rocky and tenuous. No matter how attractive the final destination, the further away it is, the more likely it is that you simply can’t get there from here.

The result is complete idiocy like running up against the debt ceiling, or raising taxes on pretty much every income-earning American, despite the fact that nobody wants either thing to happen.

If you look at legislatures around the world over the past five years or so, they have all — consistently — proved either reluctant or incapable of making big fiscal decisions when necessary: this is one reason why central bankers have become so incredibly important to the world economy. I don’t know if this is some kind of bug which is found in mature democracies, but the problem is real, and it’s global. And I suspect that even if it doesn’t cause another recession in the US, it’s ultimately going to shave many trillions of dollars off global GDP in the years to come.

More From Felix Salmon
Post Felix
The Piketty pessimist
The most expensive lottery ticket in the world
The problems of HFT, Joe Stiglitz edition
Private equity math, Nuveen edition
Five explanations for Greece’s bond yield
Comments
7 comments so far

It’s important to realize that legislative deadlock reflects social deadlock. It’s not really about elected representation, it’s about the steady states societies settle to.

The social deadlock arises from at least:

a. Conflicts among various groups in a given society. (Given the size of the US or the size of Europe, such conflicts are almost assured.)

b. Conflicts between wishes and fiscal reality. (Low taxes and high spending are widely loved, too bad it doesn’t actually work.)

c. Conflicts between wishes and theories and human reality. (High spending with all the taxes applied to somebody else also seems popular, but it invariably either fails to make revenue or strangles the goose.)

The first set (a) is bound up in issues of religion, freedom, civilization, ways of live.

The second and third (b and c) are about the limits of government and taxation and redistribution, both near-term hard and longer term equally hard.

Posted by BryanWillman | Report as abusive

Still don’t understand why raising taxes — even a little — is a non-starter. The economy is the best we’ve seen in four years, and there is no indication that we should expect rapid improvement from here. Isn’t it time to start addressing the trillion-dollar deficits?

Posted by TFF | Report as abusive

@TFF – sure – but why not cut spending? When will spending EVER be limited? (That’s the counter to your question.)

The practical answer is that lots of politicians will get “fired” for raising taxes, or cutting spending, relatively few so far have been “fired” for running a deficit.

Posted by BryanWillman | Report as abusive

@Bryan, I would do both.

You cannot realistically raise taxes by enough to close the present budget gap. (Maybe you could, but I don’t think America wants to go that direction. Would be an awful lot like Western Europe.) Nor can you conceivably cut spending by enough to do the job that way.

If I were in charge, I would put a definite plan in place for reducing spending some $300B/year (including cuts to Social Security, limits, copays, and increased means-testing on Medicare, increased pension contributions for government workers and delayed retirement age, as well as reductions in discretionary spending). I would aim to increase taxes by a similar amount, especially on the upper middle class (anybody making $100k+ ought to be able to afford a little more, whether they like it or not). Fewer specialized tax credits.

Or you could just go with Bowles-Simpson. Wasn’t a bad plan.

Modest tax increases, especially on the wealthier segments, should not have a sharp impact on the economy. Spending cuts, and tax increases on the lower-middle-class would be felt more immediately. So phase it in to cushion the impact over a couple years.

And yes, we haven’t fired nearly enough politicians for cutting taxes and increasing spending. We need to do much more of that.

Posted by TFF | Report as abusive

@ TFF “Nor can you conceivably cut spending by enough to do the job that way.”

The Maine Department of Environmental Protection could keep our clean state just as clean without any help from the EPA.

We would continue to be the worlds 1st military power at 1/2 the current spend.

Medicare and Medicaid could be combined to cover every American with smart, compassionate, preventative and palliative care at half the current federal/state health spend. It would dramatically limit access to the health system for the 5% of people who drive 50% of the cost, but radically improve the access to care for the vast majority of working people. Under this system there would be a huge resource shift from care for older Americans towards younger Americans, (the workers and their children.)

My wife and I are blessed with 3 living parents and two living children. Any sane outcome based system would prioritize care (more than our present system currently does) towards citizens who have many more years of productive life ahead of them. I don’t view that as in-compassionate just realistic.

Our budget is 1/3 out of balance, ball park 1,000,000,000,000 annually. The entire “cliff” represents less than 20% of the annual delta. Eventually (by choice or not by choice) we’re going to go over it 5 times. It won’t be fun and the changes will adversely affect nearly all of us. It will be MUCH easier to swallow if we start the process now than if we wait until our currency and yield curve start making choices for us.

Posted by y2kurtus | Report as abusive

@y2kurtus, I thought the “cliff” was closer to $500B a year?

Reform of the health system is essential to fiscal viability, and you have some good ideas there (though I would want to see some support for you 5/50 claim). Is a national choice, I suppose, but I don’t see Americans going that far in spending cuts. Too many treasured benefits.

Posted by TFF | Report as abusive

Nice read, Felix. The game is emotions. The term ‘fiscal cliff’ implies doom. If that does not work we face the dreaded ‘recession’ word. Frightening. Yes, it is a sign of the times. And we are all emotional pansies jerked around by the latest fear we decide to accept.

Posted by moxsee | Report as abusive
Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/