Fiscal cliff deal is depressingly European

January 4, 2013

–Laurence Copeland is a professor of finance at Cardiff University Business School. The opinions expressed are his own.–

The deal to break the deadlock in the US looks awful, far worse than going over the cliff, which I suspect would have been a lot less damaging than is usually assumed.

The 1 January agreement was a compromise over the tax to be levied on high salaries, which is purely a political issue with little bearing on the critical economic issue of how to close the deficit, and otherwise simply takes the line of least resistance, avoiding the tax rise on middle incomes, extending benefits for the long-term unemployed and suspending the immediate cuts in defence spending which would have been enforced automatically in the absence of an agreement. Worst of all, it defers the really tough decisions on spending. In fact, given how easily America’s rich can avoid taxes, it is likely that the tax rise which the President has fought so hard to impose on them will generate nowhere near enough revenue to pay for the increased unemployment benefits agreed at the same time. In other words, far from being a first step towards dealing with America’s deficit, this is a step back which will only make things worse.

To see how little has been resolved by this 11th hour deal, just look at Obama’s New Year taunt: “If Republicans think I will finish the job of deficit reduction through spending cuts alone […] they have got another thing coming”. In other words, the hard bargaining is still to come.

The whole mess is typical of America today, polarised between a Republican Party in which the moderates worried about their country’s fiscal position have been overwhelmed by gay-bashing creationist crackpots, and a Democratic Party determined to turn the clock back to the tax-a-little-and-spend-a-lot policies of Lyndon Johnson circa 1966.

What is actually required for the country’s fiscal stability is a deal to hold out the hope of a long term cut in taxes paid for by new measures to control or at least reduce the growth in the really big-ticket items of Government spending, specifically defence, entitlements, and healthcare. A deal along those lines would certainly have to involve a short term rise in taxes for everyone. But it should hold out the prospect of lower taxes in the immediate future, financed from two sorts of change.

First, America needs wholesale reform of its taxation to eliminate the billions or maybe trillions of dollars lost through tax loopholes, most notably the exemption for loan interest which, by being regressive while at the same time reinforcing the country’s tendency to overconsumption, manages to be damaging both to social justice and the economy at the same time. The long-term goal has to be to arrive at a regime of low taxes imposed on a wide tax base, instead of the present situation which requires ever higher taxes on a narrow (and unfair) tax base.

Secondly, there have to be extensive cuts in the major spending programs. Defence is nearly a quarter of the government spending, so it has to be cut, and welfare costs amount to over 10% (and rising fast), so they too will need to be trimmed. But healthcare is already nearly as large a slice of the government budget as defence, even before the impact of Obamacare, which extends cover to a large swathe of the uninsured population while doing next to nothing to control costs – a catastrophic omission, given that America already spends twice as much as any other country on medical care for no obvious health benefit.

Without urgent action, the US economy will be crippled by the national debt, which is already by some measures far greater than national income, nearly half of it owed to foreigners, mostly to the Chinese Government but also to assorted Asian and Gulf Arab sovereign wealth funds. America’s standard of living is nowadays dependent on the kindness of strangers.

What a contrast with the upbeat mood four years ago, when this President won election with the campaign slogan, “YES, WE CAN!”

‘Can what’, we wondered? Now we know. He meant we can kick the can down the road. How depressingly European!

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