The Fiscal Cliff

The “fiscal cliff” is the economic plunge that will occur in the U.S.A. if Congress does not change the big tax hikes and spending reductions that will otherwise start on January 1, 2013. The income tax rate cuts enacted at the beginning of the ozo years (2000 to 2009), as well as the payroll tax cuts that followed the Crash of 2008, were temporary and are scheduled to expire at the close of 2012.

Congress enacted the Budget Control Act of 2011 to require “sequestration” – automatic sharp spending reductions in 2013 – unless it enacted the recommendations of a “supercommittee,” which then failed to achieve a consensus on raising revenues and cutting spending.

Now in mid November 2012 the economy is a train heading towards the cliff, and if Congress does not lay down a track to make the train veer off to the side, the economic train will plunge into another depression.

The redistributionists seek to sharply increase taxes on high incomes while leaving the reduced tax rates in place for lower and middle-income people, but merely taxing the rich will bring in much less revenue than needed to plug the deficit, and over the long run the high tax rates will shift ever more enterprise and employment out of the country.

Most politicians agree that government spending has to be cut, but few are proposing specific programs to cut. The scheduled cuts include less military spending, and it would be sensible to greatly reduce U.S. military bases in Japan, South Korea, and Europe, but conservatives have opposed reductions in alleged “defense spending.”

Another good candidate for spending cuts would be the elimination of the federal war on drug use. Colorado and Washington have now legalized the use of marijuana, but the possession remains illegal by federal law, despite any Constitutional authority for federal prohibition.

The best short-run remedy for the fiscal cliff would be the elimination of excessive spending such as for foreign military bases and the failed war on drugs, allowing the payroll tax cut to expire, and most of all, the removal of massive subsidies to land-rent seekers.

The public goods provided by government make territory more productive and attractive, which increases the demand for land, which generates higher land rent and land value, as the goods are paid for mostly by workers rather than landowners. The greatest of all subsidies is this increase in land value that subsidizes the owners of land and induces the excessive land speculation that results in real estate bubbles followed by economic collapse.

The optimal long-run remedy would be the replacement of all taxation with levies on pollution and land value. These levies would in substance not be a tax but the prevention of subsidy, by having those who receive this unearned value pay it back. This tax shift should be combined with the elimination of government programs that do not generate land rent, such as the failed wars on victimless acts, and the reduction of military bases that originated in the occupations of Japan and Germany and the subsequent Cold War with the USSR that no longer exists.

The optimal long-run remedy would also phase out mandatory Social Security and offer workers the alternative of enhanced private retirement plans that would provide triple the retirement income while greatly increasing the supply of the savings that fuels investment and growth.

Congress could simply continue its current spending and tax rates while eliminating the legal obstacles to borrowing more funds. The “lame duck” session of Congress during November and December 2012 could postpone action to January 2013, when Congress could make retroactive changes. One of the most urgent needs is to again patch up the alternative minimum tax, a second calculation of taxes that increasingly burdens the middle class, as the previous patch expired at the close of 2011.

Another source of damage would be the scheduled sharp increase in taxes on dividends, as dividend income would be taxed at the same rate as most other income. The problem there is that this income comes from corporate profit that is already taxed at rates up to 35 percent. Although some corporations avoid taxation with various exemptions and deductions, the corporate tax rate does affect many companies, and the result, including state taxes and steeper taxes on dividends for higher-incomes, could be a total tax rate of up to 90 percent on dividend income. Because cash dividends are the foundation of sound financial investing, this capital punishment would stifle investment, growth, and innovation, and increase the use of risky debt, even more than has already been done.

Given the divided party control of Congress, the action with the least political resistance is the continuation of trillion-dollar federal deficits. That could avoid the fiscal cliff of 2013 but make that much worse the coming fiscal crisis, crash, and depression of 2026.

[Editor’s note: this essay first appeared on Dr. Foldvary’s blog, the Foldvarium, on November 18 2012]

2 thoughts on “The Fiscal Cliff

  1. My question is if the US went over the cliff but an agreement was reached in January, then would it have any negative impact on the country’s economy?

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