From fiscal cliff to fiscal farce

So after months of argument, threats and dispute, the leaders of the US Congress duly trooped out before the cameras and said they have ‘saved America’s middle class’ from facing a steep fiscal cliff.  In reality, the politicians had turned the fiscal cliff into a fiscal farce.  As American Enterprise Institute scholar Norm Ornstein put it: “This fandango was an immense embarrassment,” calling it “cringeworthy.”  And “the fact that we are going to have another disastrous confrontation over the debt limit in two months, with the radical right wing of the House Republicans determined to send us over the edge if they don’t get their way, is actually frightening.” It was “the worst Congress in our lifetimes.”  Sarah Binder, another ‘expert’ on Congressional politics, described the politicians as “a Congress that can barely get its work done – especially when confronting the most important issues of the day”.

The farce is set to continue as Congress must deal with avoiding the federal ‘debt limit’ being breached by Valentine’s Day and then work out a way to reduce welfare spending for the next generation of Americans in need by March.  All that Congress agreed on the New Year holiday was to extend the tax cuts first introduced by George Bush, except for those taxpayers earning more than $400,000 a year – the infamous 1%.  This saves about $100bn from the budget in 2013.  However, for that small concession to Obama in agreeing to raise the tax burden for the very rich just a little, both the Republicans and Democrats alike were happy to impose  higher social security contributions on every American, or what America’s opinion makers like to call the ‘middle class’.  Apparently in the US, there is no working class.  There is the rich, the middle class and the poor.  But no working class.

The 2% cut in payroll taxes introduced to boost employment just three years ago has been reversed, raising employee contribution rates to 6.2% of gross pay.  This is the biggest hit to average Americans, in order to ‘save’ $126bn, as it reduces middle quintile incomes by roughly $700-1000 a year.  Altogether the fiscal cliff of about $600bn has become a more moderate slope of under $300bn.  But that’s still a sizeable hill of pain for most Americans  and there’s more to come.  So the boast of both Republicans and Democrats in Congress that they have ‘saved the American people’ is so much hogwash.

The deal is really the first signal that in a couple of months time when Congress gets round to deciding how much government spending needs to be cut to reduce the public sector debt burden, that social security costs are going to rise for the average American, there will be more taxes and further cuts in government services.

Nevertheless, Keynesian guru, Paul Krugman, thought it a reasonable deal in the circumstances as there were no serious cuts in social benefits and tax cuts for the middle class were to be continued for the next five years.  But he recognised that Obama has already pushed through an increased medicare age and reduced social benefits in his 2012 budget.  So we can expect more hits to the poor and ‘middle class when the 2013 budget is finally agreed.

That other Keynesian guru, Brad de Long, was less happy as he was worried that the agreement to raise payroll taxes would hit the purchasing power of employees and so weaken the ability of the US economy to recover.  But it’s not the lack of workers’ purchasing power that is the problem.  Indeed, despite real wages falling, consumption as a share of GDP has hardly moved as households run down savings and save less.  It’s investment by the business sector that holds back recovery in a capitalist economy.

That’s why the Congress agreement includes yet more tax relief to the capitalist sector in the form of investment allowances, more special subsidies for various key industries and no closure of any corporate tax loopholes.  Indeed, about $46bn in business tax breaks were included with an extension of research and development tax credits, a provision allowing businesses to write off immediately half the value of new investments and a wide range of other favours for select industries, including tax breaks for railroad track maintenance, restaurant and retail store improvements, auto racetracks, film and television production and rum production in Puerto Rico and the Virgin Islands!

There was no mention of ending key tax breaks for the oil and gas business, or for senior managers of private equity firms and hedge funds.   And the banks also did well.  They retained a key tax break allowing them to defer paying US taxes on certain financial transactions undertaken outside the US.  This offshore tax loophole is worth more than $150bn a year, larger than the money raised by increasing workers’ payroll tax.  The deal is heralded by the worthy Senators and Congress men and women as saving middle America.  In reality, it is saving business from a tax hike.  The US corporate tax burden is now at a post-war low.

Now some more radical Keynesians like those from the Modern Monetary Theory (MMT) group reckon that any cuts in government spending to reduce the $1trn-plus budget deficit are unnecessary. As leading MMT exponent, Randall Wray, put it: “MMT has always argued that a sovereign government that issues its own currency cannot become insolvent.”  So increased government borrowing to cover deficits is not a problem and rising public debt is not an issue because governments can always print money to honour any debt payments.  It is impossible for a government to default (unless it owes money to foreigners).  Leaving aside the issue that about 40% of all US federal debt is owed to foreigners, who will worry if the value of the dollars they own in US treasuries should plummet, can it really be right that government debt can go rising indefinitely without consequences for the capitalist system?

As Wray correctly points out, the ratio of debt to GDP will only rise if the interest cost on that debt rises faster than GDP and governments do not raise enough extra revenue over spending to cover the difference.  But that is exactly what is happening in the US now.  If the level of debt rises, then the cost of servicing that debt (repaying maturing debt plus interest) will rise too and start to eat into spending that could otherwise be used on welfare or government investment in infrastructure or education etc.  Indeed, if the US government debt ratio to GDP is to be stopped from rising, then the current annual primary budget deficit (excluding interest payments) of 5% of GDP, will have to be turned into a surplus.  That would mean a huge rise in taxes or cuts in federal spending, or both.

So one of the reasons that government debt matters to the capitalist economy is that, if it keeps rising, the cost of servicing it will drive up taxes for capitalists or reduce government spending on ‘necessary’ things like defence and homeland security. The capitalist solution then (for both Republicans and Democrats alike) will be to try to get the deficit and debt down by welfare cuts and taxes on the ‘middle class’.  Given that government spending on so-called discretionary items have already been cut to the bone (see graph below), the next cuts will be aimed at so-called entitlement programmes like medicare, medicaid and social security.

 US discretionary budget spending

Remember what Obama said recently:“The truth of the matter is that my policies are so mainstream that if I had set the same policies that I had back in the 1980s, I would be considered a moderate Republican.”  The only difference is that Obama and the Democrats want to make any cuts in welfare slower and more gradual and raise taxes on the better off a bit more.  The Republicans want to cut welfare more quickly and preferably not raise taxes at all.  Jeffery Sachs, newly converted radical from mainstream economics, condemns the Congress agreement because it does not allow the Bush tax cuts to expire!  He wants the fiscal cliff to remain.  Sachs argued that many people will say, “Yes, but why tax the middle class to collect more revenues?”  Sachs answers by saying by that Americans need to be taxed more in order to pay for welfare and education etc. It’s the only way, he says.

So the Keynesian position is to save welfare and government services by more taxation.  It does not enter into their thinking that faster economic growth and employment along with the reversal of payouts and tax exemptions to the rich and the corporate sector could preserve and even improve welfare and government services without raising taxes on the ‘middle class’.   As I said in my previous post, The fiscal cliff, Okun’s law and the Long Depression, neither the Keynesians nor the Austerians offer any policies on how to raise the rate of economic growth on a long term basis. Both accept whatever the capitalist sector can deliver, on the whole.  So they are forced to consider budget reductions either through more taxes or less spending to stop federal debt rising inexorably.

Marx once said in the 18th Brumaire of Louis Bonaparte that history can repeat itself, first as tragedy, then as farce.  But farce can also turn into tragedy.  And over the next two months when Congress imposes a range of cuts in government services and welfare benefits for the foreseeable future, along with more tax increases, this farce may well end up tragically for America’s working class.

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13 Responses to “From fiscal cliff to fiscal farce”

  1. njg Says:

    Thx again Michael for your timely and perceptive post.
    Minor proffing error in first para aside – delete the second “turned” -this is as excellent as ever and incredibly useful for me.

  2. BrianJay Says:

    “It does not enter into their thinking that faster economic growth and employment ….”

    Yes but how to bring about economic growth? Which industries are going to bring that about? Quite simply those that base themselves on two technologies. The first is the huge growth in Fracking of gas and oil deposits which will inevitably make the US a net exporter of fossil fuels. Already new steel plants are being built along with new petrochemical and plastic plants. Siemens and BASF have switched from investment in Germany to the US primarily because of the huge drop in the price of energy, leaving Germany saddled with extreemly high cost windmills and a ban on fracking.

    The second technology that will spur growth is 3D printing. Companies are already cancelling contracts in South East Asia in preference to on shore development. It is projected that 3D prining will be a trillion dollar industry before the end of the decade.

    Thge only problem with this scenario is that it cuts right across the envionmentalist agenda. The bans on pipe lines and refineries instituted in California, which has enormous debts and an unfunded pension obligation, will lead to a rush of companies leaving. In fact the net beneficiaries of these two technologies will be the old red states. And that will lead to very interesting times.

    • paulc Says:

      Saw the rather bemused Jeremy Paxman witnessing some 3-D printing a couple of months back on the tail end of Newsnight.
      I hadn’t envisaged a ‘trillion dollar’ industry emerging out of this technology but if that’s the projection… Regarding fracking and the low costs of domestic energy prices in the US, Dean Baker recently wrote that these gains are mostly temporary since much of the fracking is being shut down due to oversupply at current prices whilst at the same time producers have plans to export natural gas [liquified] and once new facilities [refineries etc] are built, prices will more or less equalise between the US and Europe in much the same way as oil prices in Norway [massive producer and exporter of oil] equalise with Italy [who produce almost no oil and import loads] due to trade.

      • BrianJay Says:

        The interesting aspect here is that US Geological Survey estimate that there are a 100 years supply of Shale Gas and oil in the continental US states. Steven Chu oversaw the drilling investigations conducted to assess the quantity of methane hydrates im the US continental shelf and cut short the programme when Chevron discovered vast quantites – enough the estimate goes for over 1000 years supply

  3. paulc Says:

    “So one of the reasons that government debt matters to the capitalist economy is that, if it keeps rising, the cost of servicing it will drive up taxes for capitalists or reduce government spending on ‘necessary’ things like defence and homeland security.”

    Right now though, the burden of net interest on the debt is near a post-war low. Obviously if debt rises faster than the economy can produce [GDP] then eventually it sucks the life out of the economy but it is not clear why ‘from this standpoint’ borrowing needs to be reduced now in order to protect capitalists from higher taxes. Such borrowing can be made at historically low interest rates that can be largely locked in [long term Treasuries].Though obviously spending more [via borrowing] on increasing the future productive potential of the economy is preferable to borrowing in order to pay for out of work related benefits and/or subsidies for Wall St and oil industry etc.

  4. Warren Ross Says:

    “So the Keynesian position is to save welfare and government services by more taxation.”, says Michael. This is very broad brush usage of Keynsian. I doubt whether this Randall Wray’s position at all.

  5. Daniel de França MTd2 Says:

    Dear Michael,

    I found something rather intriguing

    http://www.shadowstats.com/alternate_data/gross-domestic-product-charts

    What do you think of that? Can I trust this data?

    • paulc Says:

      As I understand it there is good verification for US inflation figures via the Billion Prices Index being compiled at MIT as an academic exercise. At the moment you can see that the US CPI and the BPP index are about as close as they can get and the index has pretty much tracked official inflation numbers for some time. So in short, shadowstats doesn’t seem all that credible.

      http://bpp.mit.edu/usa/

      • Cameron Says:

        Shadowstats uses the Pre-Clinton methodology for determining inflation. What methodology is BPP using? Is it using the hedonics, as in hedonism? Hedonics adjusts the prices of goods for the increased pleasure the consumer derives from them. It appears that it’s using the same as the US CPI.

  6. Don Sutherland Says:

    Reblogged this on Don Sutherland’s Blog and commented:
    This Michael Roberts’ summary and analysis of the fiscal cliff agreement stage 1 agreement reached in the USA on New Years Day. Of interest and importance he highlights not just what is wrong with the Republican Austerian position and, also, the inadequacies of the “neolaboralist” position put forward by Democrats and supported, at least in part, by some progressive economists, eg Paul Krugman.

  7. H. Back™ Says:

    Behold the eternal dilemma application in military security, or social welfare.

  8. Sams Says:

    “It does not enter into their thinking that faster economic growth and employment along with the reversal of payouts and tax exemptions to the rich and the corporate sector could preserve and even improve welfare and government services without raising taxes on the ‘middle class.”

    And yet Obama and the Dems will target tax expenditures – “spending through the tax code” – in the next round of negotiations. And the $600 in revenue from higher tax rates on the rich is certainly welcome.

    Also, Obama is not considering raising the retirement age in Medicare. That’s not going to happen.

    Most importantly, stabilizing the debt in the next decade is critical to preserving the low-income and social insurance programs the US does have. Without stabilizing the debt (in a balanced way that protects low-income folks), these programs will be even more vulnerable to right-wing attacks. So sure, the recent agreement is not anything to celebrate, but the goals for the road ahead are clear.

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