The Three Faces of the Fiscal Cliff

The Fiscal Cliff, we are told, is about the $1.2 trillion reduction in the U.S. deficit scheduled to take effect January 1, 2013, which includes $503 billion in spending cuts and tax hikes in the first year, 2013, and another $682 billion in 2014. Although the matter of what and how much will be reduced on January 1 may be decided in part by the time this article appears in print, the so-called Fiscal Cliff is about more than just deficit reduction, much more.

The roughly $500 billion scheduled to hit the economy in 2013—according to the official line in the press and the Washington political elite—will have a devastating effect on the U.S. economy and tip its already chronically weak and fragile recovery of the past three and a half years immediately over the precipice into recession in the first quarter of 2013. According to the research arm of Congress, the Congressional Budget Office (CBO), in a report released this past November 2012, if the scheduled cuts in spending and tax hikes are allowed to take place, it will reduce U.S. economic output (Gross Domestic Product, GDP) by more than 4 percent in the first quarter, another 2 percent drop in the second quarter, April-June 2013, and drive the unemployment rate above 9 percent again by year end—i.e., an unambiguous double dip recession. Thus, the official line is that if the scheduled tax hikes and spending are allowed to take place, the economy will fall off the cliff into recession once again.

Critics of the Cliff

Some economists have dismissed this claim of approaching economic Armageddon, arguing the Fiscal Cliff is an overblown estimation of a pending economic recession. They note the talk about a cliff represents a convenient manufacturing of a crisis in order to prevent the expiration of the Bush tax cuts of the last decade scheduled for January 1, 2013—tax cuts that have benefited mostly wealthy investors and households and corporations. Moreover, the additional purpose of all the cliff talk is to create a favorable political atmosphere to deal a major blow to Social Security and Medicare. Never waste a crisis has been the call of radical right wing politicians bent on dismantling Social Security and Medicare for years, critics of the Fiscal Cliff point out. And if there isn’t a crisis in fact, create one. And if it can’t be created, at least create the false impression it exists.

What both proponents and critics of Fiscal Cliff alike fail to adequately consider is that even if the entire Fiscal Cliff of $1.2 trillion is averted, the U.S. economy is still headed for a further slowing in 2013 and perhaps a recession whether the Fiscal Cliff is hype or real. Well-respected independent forecasting services like the Economic Cycle Research Institute (ECRI), which has accurately called almost every recession for the past several decades, predicted as recently as November 30, 2012 that the U.S. economy is not only headed for recession, it is already underway according to ECRI’s quantitative index. Even the CBO noted in its November 2012 report “that even if all of the fiscal tightening was eliminated, the economy would remain below its potential and the unemployment rate would remain higher than usual for some time.” Fiscal Cliff or not, the U.S. economy remains fragile and continues to stumble along in a stop-go trajectory.

Dimensions of the Fiscal Cliff’

So what exactly is meant by the Fiscal Cliff? It’s $503 billion that will be taken out of the economy commencing January 1, 2013. Moreover, more than $420 billion of the $503 billion is tax hikes, which represent the Bush tax cuts of the last decade plus the expiration of the payroll tax cuts introduced in 2010 by Obama. The payroll tax is less than a fourth, about $90 billion or so, of the $420 billion total expiring tax cuts. The rest of the $503 billion is spending cuts, mostly unemployment benefits and non-defense spending. Defense spending cuts scheduled to take effect in 2013 amount to only $24 billion, according to the Congressional Budget Office. The $24 billion in 2013 is magnitudes less than the oft-mentioned $500 billion cuts in defense spending reported by the press. That $500 billion represents reductions over a decade to come, and is mostly backloaded to the out years beyond 2013-14. The $500 billion in defense cuts is similar to the roughly equivalent $500 billion or so in non-defense spending over the coming decade. Both were mandated in the Budget Control Act passed in August 2011 as part of the debt ceiling deal between Congressional Republicans in the House and Obama. At that time both agreed to $1 trillion in spending cuts, mostly in education. A further, delayed $1.2 trillion was agreed to in August 2011 to take effect later, this coming January 2013.

The Fiscal Cliff, therefore, includes the $1.2 trillion in spending (defense and non-defense) cuts, a proportion of the $1 trillion in all-spending cuts for 2013 agreed to in August 2011, plus the expiration of the Bush tax cuts, payroll tax cuts, and the Alternative Minimum Tax increase.

But the actual amount that will begin to hit the U.S. economy in early 2013 is the $503 billion, implemented slowly throughout 2013. It’s not $503 billion hitting the economy on January 1, 2013. That’s less than a $80 billion in spending cuts throughout 2013, or barely one-half of one percent of the U.S. annual $16 trillion annual GDP, plus an added $420 billion in expiring Bush and payroll tax cuts. That’s a total fiscal cliff of less than 3 percent of the U.S. (more than) $16 trillion annual Gross Domestic Product estimated for 2013. And it’s even less than 3 percent in terms of its actual impact on the U.S. economy (as explained below).

Fiscal Cliff Is Not About Impending Recession

The Fiscal Cliff debate up to now has assumed that a $1 tax hike is the same as a $1 spending cut in terms of its effect on the general economy. But that’s pure nonsense from an economic point of view. Tax cuts in general, and business tax cuts in particular, do not produce an economic effect equivalent to government spending. That’s true whether one considers fiscal stimulus, i.e., tax cuts or spending increases or whether one is considering fiscal contraction—i.e. tax hikes and spending cuts. And the Fiscal Cliff is a case of the latter contractionary, or negative, impact on the economy.

To explain this point further, let’s look at what has happened to the U.S. economy since 2008 as a consequence of tax cuts and spending increases that were designed to stimulate the economy (fiscal stimulus), and then apply the same logic in reverse with regard to tax hikes and spending cuts—i.e. the $503 billion Fiscal Cliff (fiscal contraction).

First, a dollar of tax cuts does not have the same impact in stimulating the economy as a dollar in increased spending. All things equal, a dollar of government spending boosts the economy more than equivalent tax cutting. And that’s not all. What kind of tax cuts and what kind of spending makes an additional difference. Business tax cuts or consumer tax cuts? Government spending on subsidies or spending directly to create jobs? Furthermore, whether the amount and kind of tax or spending occurs in normal economic periods or in the midst of a major recession, such as recently occurred, also matters. Even the type of recession makes a difference—i.e. whether it was precipitated by a major financial crisis or not.

Unfortunately, politicians—and even mainstream liberal economists—fail to account for these important differences in determining how much of an impact a tax cut or spending increase has on the economy. In economists’ jargon, it’s called the multiplier effect. They assume the multiplier effect is the same at all times, good economic times and in recessions; that it doesn’t matter at what stage of the recession you’re in, how deep it was, how rapidly the economy is declining, or if the recession in question was the result of a financial crash or not.

But even in good economic times, tax cuts have less of an effect on the economy than do spending increases. In not so good times—i.e. the past four years—the multiplier for a tax cut is even less. Since 2008 a dollar in business tax cuts in particular doesn’t even produce a dollar of stimulus. The business tax multiplier is probably around 35 cents. That means for every dollar of tax cuts given to businesses only 35 cents gets invested by business. The rest of the dollar, 65 cents, gets hoarded by business as retained cash, or invested offshore, or in financial derivatives that don’t produce jobs here or is paid out to shareholders in extra dividend payments, in stock buybacks, executive pay bonuses, or is used to pay down business debt. In none of those examples of how the remaining 65 cents is invested or hoarded does it result in investment that creates jobs or in a recovering economy. And that’s what has happened the past four years. Despite trillions of dollars in tax cuts—mostly business and investor tax cuts—most of it was hoarded—and still is. Corporate America, even today, is sitting on a minimum of $2 trillion in cash, and probably much more.

Something similar, though not so dramatic, occurs with regard to government spending stimulus in the worst of times—such as the past four years. In good times a spending dollar creates perhaps another second dollar and a half of spending. But that’s not the case now. At best, maybe a dollar generates $1.2-1.5. So government spending the past four years has not had much total impact on economic recovery either.

The $2 Trillion Failed Fiscal Stimulus 

The common but naïve belief that tax cuts and spending together will produce a significant multiple effect on economic recovery has been refuted by the evidence of the past four years. Mainstream liberal economists argued in early 2009, for example, as Obama’s first economic recovery program was being formulated, that a given amount of tax cuts and a spending increase would result in a multiple effect and a robust, sustained economic recovery within 12-18 months. But that didn’t happen. More than $2 trillion in tax cuts and spending produced the weakest recovery from recession since 1947, historically little in the way of business investment, and even less in job creation. Furthermore, of the jobs that have been created since 2009, 58 percent have been low-paid service, part time and temp jobs while most of the jobs lost were higher paid construction, manufacturing and tech jobs. And two-thirds of that $2-plus trillion was tax cuts. That is, nearly $1.5 trillion in tax cuts—mostly business tax cuts—failed to stimulate the economy.

The record of the past four years confirms that tax cuts in general—and business tax cuts in particular—don’t necessarily create jobs. What it did create was Corporate America’s $2 trillion cash hoard. And that cash hoard is, at year end 2012, being rapidly distributed to investors, shareholders and executives in the form, respectively, of special dividend payouts, stock buybacks, and generous year-end executive bonuses.

The claim that business tax cuts create jobs is one of the great myths sold to the American public during the past half century. Not just under Obama since 2008, but under George W. Bush, Clinton, and starting with Reagan in its original form in the 1980s.

Take the Bush years, 2001-2008. Between 2001-03 Bush pushed through tax cuts for the wealthy and investors totaling more than $2.9 trillion—80 percent of which has been estimated to have benefitted the wealthiest 20 percent households and especially the top 1 percent wealthiest. In addition, hundreds of billions of dollars more in tax cuts, accelerated depreciation write-offs (a de facto business tax cut), and reductions in the foreign profits tax on corporations were also passed in legislative form for corporations in 2004-05. And what was the economic effect? It took 46 months from 2001 just to return to the level of jobs in the economy that existed when Bush entered office in January 2001 and started pushing his tax cuts. Moreover, most of the jobs created after 2004 were in housing construction and finance, two sectors fueled by the speculative boom in subprime mortgages and various financial instruments during those years, which had little if anything to do with Bush’s $2.9 trillion in tax cuts. In other words, the Bush tax cuts didn’t create the jobs promised any more than did Obama’s business tax cuts did after 2009.

It’s a sad fact that after more than $4 trillion in Bush and Obama tax cuts from 2001 to 2012, there are no more jobs in the U.S. economy today than there were 12 years ago—even though the population has risen by more than 20 million.

Tax Cuts to Tax Hikes

What goes around comes around, as they say. That is, if the business-investor tax cuts of the past four years—and under Bush for another eight years—did not produce much in the way of investment, jobs, and economic recovery, then it follows that allowing those same Business-Investor tax cuts to expire come January 1, 2013 won’t have much of a negative impact on the economy in 2013. Put another way, if $4 trillion didn’t create jobs and economic recovery, then certainly withdrawing $400 billion or so starting in 2013 won’t represent a mortal leap from a fiscal cliff. In fact, business investment has been steadily declining over the past year, despite $450 billion in Bush tax cuts having been extended for 2011-12.

A similar parallel point can be made with regard to government spending, though not in the same magnitude. Not all government spending stimulates the economy equally (i.e. not all spending multiplier effects are equal). Like tax cuts, spending effects vary with the type of spending when it occurs in a recession trajectory, and even the type of recession (i.e. financial crash induced or not).

A major problem with Obama’s economic recovery programs since 2009 was not only that it was top heavy with too much business-investor tax cuts that got hoarded; a parallel problem was that the spending part of Obama’s fiscal stimulus was composed mostly of subsidies to the states, defense spending, and long-term infrastructure projects.

The problem with spending subsidies to states is that such spending does not create jobs any more than do business-investor tax cuts, as the record of the past four years also shows. After giving the States $300 billion in 2009, they were supposed to create millions of jobs and help jump-start the recovery. But they didn’t create jobs. The $300 billion to the States only delayed layoffs for 12-18 months. Once the subsidies ran out in 2010, the States began laying off by the tens of thousands every month. State and local government spending cuts since 2010 have been a major drag on the U.S. economic recovery. The Obama administration was forced—in mid-stream 2010—to change its line and argue the $300 billion in subsidies to the States in 2009 at least saved several million jobs and prevented an even worse recession—a hypothetical claim that can be neither proved nor disproved.

Nor did defense spending since 2009 create jobs or lead the economy out of recession. Most defense equipment today is high tech, capital intensive, and has relatively little labor content. Today the cost of building one F-35 fighter jet is about equal to producing nearly 1,000 P-51 fighter aircraft in 1945. Moreover, many of the parts for military equipment today are made overseas by U.S. allies. So defense spending from the Afghanistan troop surge under Obama did little to generate recovery either.

Finally, long-term infrastructure spending by the Obama administration since 2009 has also failed to create jobs or have a significant stimulating effect on the economy in the short term. Of the roughly $100 billion allocated for infrastructure spending in 2009, four years later barely half has been spent.

What it all means is that allowing $400 billion to lapse on January 1, 2013 will have no more negative impact on the U.S. economy in 2013 than the $4 trillion had in preceding years. Nor will the token $24 billion in scheduled defense spending cuts have any discernible effect. The remaining amounts of the $503 billion Fiscal Cliff in 2013—i.e. the $50 billion or so in other non-defense spending and the $90 billion in payroll tax hikes—will have some impact but not all that much in a $16 trillion GDP. The payroll tax cut effect will not be as large as many estimate, in any event.

The payroll tax cut introduced in 2011 was roughly $110 billion. But the net effect was only around $70 billion, since it was introduced simultaneously with the elimination of another worker tax cut called the Make Work Credit which reduced the payroll tax cut effect by at least $40 billion.

So if the Fiscal Cliff is not about impending economic recession, what then is really behind all the hype? That’s where the Three Faces of the Fiscal Cliff come in. The Fiscal Cliff is first and foremost about protecting and expanding the Bush tax cuts for the wealthy and their corporations; only secondly is it about cutting deficits and debt; and thirdly it’s about taking back the accumulated social wage of tens of millions of American workers that is sometimes called entitlements’—i.e. Social Security benefits and Medicare. The third face of Social Security-Medicare is strategic. It enables the wealthy and their corporations to realize both the first and second objectives at the same time, which otherwise would not be possible. Keeping the Bush tax cuts and cutting deficits and debt are both not possible—until the third is added.

Tax Cut First Priority

As noted previously, the Fiscal Cliff is not about an impending double dip recession in 2013. Whether the economy slips into recession in 2013 will have little to do with whether the $503 billion is kept or cut, but will be based on more fundamental forces like declining household real income and, therefore, consumption; a continued contraction in business investment spending; a continuation of decline in government spending at all levels; whether the European economies slide into a deeper recession; and whether global trade continues to contract as China, India, Brazil and other key sectors of the world economy continue to weaken further. Cutting the $503 billion or not cutting it makes little net difference to these much greater forces within the U.S. and global economy.

That means the Fiscal Cliff is really about convincing the public to retain the Bush tax cuts. It’s about creating a sense of economic insecurity and fear in order to generate support for the Bush tax cut status quo—and to justify even more corporate tax cuts in addition later in 2013 when both political parties intend to undertake a total revision of the U.S. tax code. The Fiscal Cliff is therefore primarily about tax cuts. That’s the $420 billion of the $503 billion. And an accumulated $4.7 trillion in tax cuts over the next decade if continued as before, which is the CBO’s estimate of the cost of extending the cuts for another decade. As this writer said a year ago, (in November 2011 in an article for ZNet), when the Supercommittee in Congress at the time decided to kick the deficit can down the road for another year: Deficit cutting is all about “The Bush Tax Cuts, Stupid.”

Corporate profits today are at record historic levels and continue to rise. The wealthiest 1 percent households have increased their share of total annual income from 8 percent in 1980 when all the tax cutting began under Reagan, to more than 24 percent today. And their share is projected to grow even further. The same top 1 percent claimed for themselves 45 percent of all annual income growth during the decade of the 1990s. That rose to 65 percent between 2001-08 under Bush. And in latest data for 2010, the 1 percent’s share of the growth of income was an obscene 93 percent of all income gains that year.

Meanwhile, the middle class—those with annual household incomes between $39,000 and $118,000—saw their share of annual total income fall from 58 percent in 1983 to 45 percent in 2011. According to a PEW institute recent survey, the wealth of the median middle class household has also declined precipitously, by 28 percent, since the late 1990s. And the median male U.S. worker’s earnings after inflation has not risen since 1975, even though real GDP has doubled since then. The Federal government’s tax revenues, as a percent of GDP, has fallen from 20.6 percent as recently as 2000, to only 15.4 percent in 2011. Much of that has accrued to the wealthiest 1 percent and their corporations. The problem with the U.S. economy is, in no small part, a problem of the historic, massive shift in income to the wealthiest 1 percent households and the corporations that function as the key conduit of shifting income to that 1 percent from the rest, especially the bottom 80 percent of households which represent more than 100 million families earning annually less than $118,000.

Allowing the Bush-Obama tax cuts to lapse on January 1, 2013 may have little negative economic effect, but doing so may nonetheless contribute to a much-needed rebalancing of income in the U.S. that is undoubtedly choking the economy more than any Bush tax cut expiration would do. Moreover, allowing another $4.7 trillion in Bush tax cut extensions for another decade would require virtually the total destruction of Social Security and Medicare to finance. Which introduces the second face and meaning behind the Fiscal Cliff.

Deficit Cutting Via Entitlements

That Corporate America and the wealthiest 1 percent see protecting their tax cuts as the number one priority does not mean they do not care about deficit cutting. They do. It’s just secondary to the primary goal of defending their tax breaks. Wedged between the tax cut priority and the secondary objective of deficit reduction is the third and strategic factor of entitlement social programs like Social Security, Medicare, and closely related programs like Medicaid, etc.

Cutting entitlements spending is thus the Fiscal Link that enables Corporate America and the 1 percent to get both their primary and secondary objectives (tax cuts and deficits) achieved. In other words, the Fiscal Cliff is also about cutting social wages—sometimes called entitlements. Making entitlements and social programs pay for the deficits enables the continuation and even expansion of the tax cuts. You can’t have the first two—tax cut retention and deficit reduction—without the third: the piecemeal eventual dismantling of entitlement programs.

Both Republicans and Democrats increasingly appear to agree on this point. Obama has indicated that he has a target of August 1, 2013 in which to address both a major revision of the U.S. tax code plus entitlement spending. For him they are linked, no less so than for House Republicans.

Whether protecting the income of the wealthy by preventing the expiration of tax cuts on capital incomes, or cutting social entitlements in order to reduce deficits, it is all just austerity by another name. In Europe they call it austerity for what it is: making workers and consumers pay for the deficits that benefited the wealthy and corporations. In America, corporations and politicians are far more clever with manipulating ideological terms. Here, austerity is hidden behind the curtain called Fiscal Cliff. But Fiscal Cliff is nothing but Austerity American Style. Fiscal Cliff and Austerity is about making the middle class, workers and households earning less than $118,000 a year pay.

Short-Term Scenarios and Predictions

Associated with the Fiscal Cliff as impending crisis theme is the timeframe perspective that if no resolution is reached by January 1, 2013 the economy will fall off the cliff on January 2. But there are no such deadlines, in fact. Congress’s schedule for legislation means it must receive a bill by December 21, in order to ensure passage by January 1. But neither December 21 nor January 1 are necessarily deadline dates.

It is likely some agreement in principal, in part, will be reached before the end of December. Whatever the resolution to the Fiscal Cliff in the end, it will almost certainly come in stages. Any cuts in spending and/or tax hikes that begin on January 1 can be easily adjusted retroactively and thus make up for any fiscal negative effects. All that is required in the interim is the appearance that some kind of agreement is in sight and progress is being made. And as of the end of the first week of December, that appears to be the case.

Despite the rhetoric on both sides, Obama has clearly signaled major concessions, among which are hundreds of billions in entitlement cuts, a clear position he is willing to cut corporate taxes from 35 percent to 28 percent, and even an indication he might give up on raising the top personal income tax rate for the wealthiest 2 percent in exchange for some proof of revenue increase.

So, too, does it appear the Republican House leadership is willing to adjust its hardest positions. Like Obama, House leader Boehner has signaled both a deal is possible this time and that revenue increases might be acceptable so long as the top tax rate on the 2 percent is not raised. In other words, both sides are very close on the tax hike issue in principal. The revenue increases will be achieved by a combination of tax bracket manipulation and by token reductions in deductions and credits, impacting the top 2 percent first and in later years extending toward the middle class. Republicans have thrown out a token offer to cut social security benefits by raising the age limit and reducing the cost of living adjustments. But it is likely they will drop that, and return to it later in the year when both sides return for the real grand bargain, changing the entire tax code in exchange for major entitlement cuts in the second half of 2013.

The cuts in the first phase, in early 2013, will focus on some Medicare and Medicaid cost reduction. Medicare benefits will not be cut, but the out-of-pocket costs for retirees for Parts B and D coverage will be raised—as will the introduction of some kind of means test—but limited to the wealthy first as a way to establish a principle that will be extended to the middle class later. Both parties are in agreement already on not significantly reducing defense spending, but allowing token cuts based on attrition and the winding down of the war in Afghanistan which both have already agreed on some time ago. Total spending cuts and tax revenue hikes will likely not exceed $2 trillion over 10 years in any final agreement.

In other predictions, the cuts and revenue will not concentrate in the 2013 or even 2014 years, but will be significantly backloaded to 2015 and beyond. The mix between revenue and spending cuts will be likely around 5 to 1—for every $1 in revenue there will be $5 in spending cuts.

The parties will have until at least March 27, 2013 to forge such an agreement. That’s when the Federal government runs out of money. That is the closest to a true deadline date, not January 1 and certainly not December 21.

Whenever agreement is reached, and it will be sometime between January 1 and March 27, 2013, it will be only partial in content and magnitude. It will not be the full $3 trillion plus in total deficit reduction over the coming decade (added to the already $1 trillion, for a total of more than $4 trillion—the amount all parties have agreed upon as the target since 2010). The first phase of an agreement may come before January 1, though not likely. But if so, it will be marginal and mostly in principle. A second phase, from January 1 to March 27, will be larger and more substantive. But the real grand bargain will be left for a third phase later in 2013, as previously noted. That will be a true quid pro quo, trading entitlements for major tax code revisions. It is in that major revision that Corporate America will benefit significantly by getting a large reduction in the top corporate tax rate, an understanding on not having to repatriate most offshore subsidiaries profits, and other key corporate tax provisions. But the first-second phases of a deal must come first.

The most salient strategic fact about the current negotiations that make them fundamentally different from past deficit cutting deals is that Corporate CEOs are largely aligned with the Obama administration. Their influence will force the Tea Party radicals in the House to conform to House leadership requirements that will follow the corporate lead and recommendations. There will be a deal this time because the political equation has changed. Only 25 votes switching in the House are needed for a deal. Corporate election campaign cash can find at least that number to swing a deal that Obama has offered them: token personal income tax revenue increases now in exchange for major corporate income tax rate reductions later in 2013. And as part of the deal Obama will give House conservatives and Tea Party radicals a big dose of entitlement cuts, especially Medicare and Medicaid.

The U.S. Version of an Austerity Program

In summary, three stages of deals, each larger than the preceding, continuing into 2013. No real deadline for another three months. Cuts in spending and entitlements backloaded to the out years of a ten year agreement of about $4 trillion. Revenue hikes, but not tax rate increases, on the wealthy, achieved by bracket adjustments and deduction limits on the wealthy, with the precedent established for “broadening the tax base” by means of deductions and credit limits later—i.e. a code word for reducing deductions and credits now enjoyed by the middle class after they have been first introduced on the wealthier households. More out-of-pocket costs for Medicare. Age eligibility, disability eligibility, and cost of living hits to social security retirement benefits. Defense cuts limited to Afghan war drawdowns that were going to happen anyway by earlier agreement (later perhaps replaced by defense spending increases for a western pacific naval and air buildup).

But as all this takes place it will become increasingly and abundantly clear that all the hype and talk about a Fiscal Cliff was just a cover for what will be the introduction of America’s version of an austerity program.

But whatever the shape and form, it will not constitute a further economic stimulus to an economy chronically unable to get on its feet for the past four years and enter a self-sustained recovery. The feeble and ineffective fiscal policies of the past four years are now entering a second phase of retraction and reversal. The first culminated with the $1 trillion debt ceiling deal of August 2011. A hiatus occurred in the 2012 election year. Now an even more aggressive phase two is about to begin in 2013. The outcome, however, cannot represent anything positive for a U.S. economy stumbling along at a stop-go pace, which is also increasingly confronted by a slowdown and growing crisis in the global economy. 

Z

Jack Rasmus is the author of Obama’s Economy: Recovery for the Few, and host of Alternative Visions on Progressive Radio Network. His blog is jackrasmus.com and his twitter handle is #drjackrasmus.