The global cost of fiscal indecision

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.


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