On Jan. 1, 2013, tax increases and spending cuts – commonly known as the “fiscal cliff” – will force austerity on the United States’ still recovering economy. Democrats want to keep some of the tax increases and Republicans want to keep some of the spending cuts, but keeping everything will be bad for economic growth.
Many tax cuts expire on January 1. They include the extended 2001 and 2003 income tax cuts and deduction expansion – the Bush Tax Cuts. The 2009 Obama Tax Cuts, the Alternative Minimum Tax reductions, the 2 percent payroll tax reduction, and the extension of unemployment benefits are also set to expire. Taxes will increase on nearly every American.
The budget cuts – “sequestration” – are immense and total almost $1 trillion over the next 10 years. Discretionary defense spending, including military bases and research will be cut by 9.4 percent. Mandatory defense spending will be cut by 10 percent. Discretionary spending on non-defense programs will be cut by 8.2 percent. Mandatory programs will be cut by 7.6 percent, but Medicaid, SCHIP and Social Security are exempt. Finally, Medicare cuts are limited to just 2 percent.
According to Secretary of Defense Leon Panetta, the defense cuts would result in the smallest Army since World War 2, the smallest Navy since World War 1, the smallest fighter force in the history of the Air Force, and the smallest civilian workforce in the history of the U.S. Defense Department.
The Congressional Budget Office says that under these conditions, the deficit will fall by over $500 billion next year; however, this will reduce real GDP by 0.5 percent in the fourth quarter of 2012 and push unemployment above 9 percent by mid-2013.
However, budget deficits would shrink to 0.4 percent of GDP by 2018 from 6.5 percent. Federal debt would shrink, revenues would increase to historical levels around 21 percent of GDP, and expenditures would remain flat. Real GDP would begin to grow again in 2014, but the unemployment rate would remain above 8 percent throughout 2014 and would be just below 6 percent in 2017.
If we avert the fiscal cliff and continue on our current path, the 2013 deficit will be $1 trillion, and the economic recovery would continue with 1.7 percent GDP growth and unemployment at or below 8 percent. However, deficits would be significantly higher, federal revenues will remain below 19 percent of GDP, and expenditures would increase, which would lead to, “a level of federal debt that would be unsustainable from both a budgetary and an economic perspective,” according to the CBO.
Neither one of these paths is sustainable. The first path demolishes economic growth, increases unemployment, and hurts a great majority of Americans, especially the poor and middle class. The second causes unsustainable debt that would crush the economy down the line. That is why compromise is key.
First, federal revenues must increase, which means ending the special tax benefits for the wealthy. Income taxes on people making over $250,000 must return to the Clinton-era rate of 39.6 percent. Capital gains must be taxed at the progressive income tax rates, instead of the current 15 percent. Finally, the government must stem the tide of environmental degradation and institute a carbon tax.
Second, federal spending must decrease by reforming Social Security and cutting defense spending. The high military spending levels of the 2000s are no longer necessary for the safety and defense of the U.S. Military spending must decrease, not as quickly as sequestration cuts mandate, but it must decrease. Elderly wealthy people receive Social Security even though they do not require the supplemental income; Social Security is paying out unnecessary benefits. Means-testing Social Security would improve solvency, reduce cost, and eliminate waste. The Social Security retirement age must slowly increase to accommodate for increased lifespans.
A recent New York Times article by Ross Douthat advocates for the elimination of the payroll tax and the payment of Social Security and Medicare through normal federal taxes such as the income tax. This is exceptionally foolish and eliminating this tax would create uncertainty that would damage the reputation and security of both programs.
The true inequity of the payroll tax is that the Social Security Wage Base caps taxable income (in 2012 at $110,100). (http://www.ssa.gov/pressoffice/factsheets/colafacts2012.htm) This means that even if you make $1 billion, you only pay the payroll tax on the first $110,100. By removing this cap and having a 6.2 percent payroll tax on total income, Social Security and Medicare would remain solvent for much longer.
As a staunch believer in macroeconomic theory, I find no justification for raising taxes or cutting spending in the short-term due to our tepid economic growth and stagnant wages. However, conservative political forces believe that balancing the deficits created by the Bush Tax Cuts and the Wars in the Middle East should happen now, rather than allowing for a proper recovery.
Without growth, the U.S. government will not be able to repay the national debt, and broad tax increases and broad spending cuts will demolish growth. The Council of Economic Advisors determined that tax increases on the bottom 98 percent of American families would reduce consumption by $200 billion next year and cut GDP growth by 1.4 percent. The CBO also determined that GDP would decrease by 1.3 percent.
To protect the economy, any spending cuts or tax increases on American workers and middle class families must wait until U.S. GDP growth is above 2.5 percent and unemployment is below 6 percent. Deficit reduction is important and the debt burden placed on our generation is unfathomably large; however, the financial security of the average American and confidence in the American economy must come first.
Zac Bears is a Collegian columnist and can be reached at email@example.com.