The clock is ticking. Massive tax hikes are threatening to push America’s already declining economic freedom over the “fiscal cliff,” a politician-made economic catastrophe.
President Obama’s proposal to avert the fiscal cliff is a $1.6 trillion tax hike plus new stimulus spending, along with expanded power for himself to raise the debt ceiling without congressional approval. The House Republican leadership has offered a counter to the President’s frivolous proposal, but the counterproposal appears to cave on tax increases and punt on entitlements. Heritage’s Alison Fraser and J. D. Foster point out that “the Republican counteroffer, to the extent it can be interpreted from the hazy details now available, is a dud. It is utterly unacceptable. It is bad policy, bad economics.”
Such bad policies and economics will have a drastic impact on our economic freedom, which is already in trouble after four years of the “Yes, We Can” Administration’s programs and spending. Since 2008, America’s economic freedom has been declining at alarming rates: America has fallen from fifth freest economy in the world to 10th freest. (continues below chart)
As the Heritage Foundation’s Index of Economic Freedom demonstrates, economic freedom is the path to prosperity. The decline of America’s economic freedom means that our economy is losing its capacity to achieve dynamic and sustained economic growth. That’s bad news for American individuals, families, and entrepreneurs, who will reap fewer rewards for their hard work in the future.
Waning economic freedom means lost opportunities for average Americans. The opportunity cost of bigger government is paid for in the loss of economic vitality. A future with fewer jobs and lower incomes can wait at the bottom of the fiscal cliff, or it can follow just as surely from ill-designed policies to avoid it.
There is a better way. The Heritage Foundation has proposed Saving the American Dream, a sweeping pro-growth tax and spending reform roadmap designed to grow the economy and restructure entitlement programs to provide real economic freedom and long-term security for the American people.
As Heritage’s Kim Holmes noted in Understanding American Prosperity, “All of us—not just our politicians—must be vigilant, determined to safeguard liberty and the American Dream. And that means understanding that the foundation of American prosperity rests in economic freedom.”
Posted in Enterprise and Free Markets
By: Peter Schiff Tuesday, July 10, 2012
The media is now fixated on an apparently new feature dominating the economic landscape: a “fiscal cliff” from which the United States will fall in January 2013. They see the danger arising from the simultaneous implementation of the $2 trillion in automatic spending cuts (spread over 10 years) agreed to in last year’s debt ceiling vote and the expiration of the Bush era tax cuts. The economists to whom most reporters listen warn that the combined impact of reduced government spending and higher taxes will slow the “recovery” and perhaps send the economy back into recession. While there is indeed much to worry about in our economy, this particular cliff is not high on the list.
Much of the fear stems from the false premise that government spending generates economic growth (for stories of countries experiencing real growth, see our latest newsletter). People tend to forget that the government can only get money from taxing, borrowing, or printing. Nothing the government spends comes for free. Money taxed or borrowed is taken out of the private sector, where it could have been used more productively. Printed money merely creates inflation. So the automatic spending cuts, to the extent they are actually allowed to go into effect, will promote economic growth not prevent it. Even most Republicans fall for the canard that spending can help the economy in general. But even those who don’t will surely do everything to avoid the political backlash from citizens on the losing end of any specific cuts.
The only reason the automatic spending cuts exist at all is that Congress lacked the integrity to identify specifics. Rest assured that Congress will likely engineer yet another escape hatch when it finds itself backed into a corner again. Repealing the cuts before they are even implemented will render laughable any subsequent deficit reduction plans. But politicians would always rather face frustration for inaction than outright anger for actual decisions. In truth though, only an extremely small portion of the cuts are scheduled to occur in 2013 anyway. If it comes to pass that Congress cannot even keep its spending cut promises for one year, how can they be expected to do so for ten?
The impact of the expiring Bush era tax cuts is much harder to assess. The adverse effects of the tax hikes could be offset by the benefits of reduced government borrowing (provided that the taxes actually result in increased revenue). But given the negative incentives created by higher marginal tax rates, particularly as they impact savings and capital investment, increased rates may actually result in less revenue, thereby widening the budget deficit.
In reality, the economy will encounter extremely dangerous terrain whether or not Congress figures out a way to wriggle out of the 2013 budgetary straightjacket. The debt burden that the United Stated will face when interest rates rise presents a much larger “fiscal cliff.” Unfortunately, no one is talking about that one.
The current national debt is about $16 trillion (this is just the funded portion…the unfunded liabilities of the Treasury are much, much larger). The only reason the United States is able to service this staggering level of debt is that the currently low interest rate on government debt (now below 2 per cent) keeps debt service payments to a relatively manageable $300 billion per year.
On the current trajectory the national debt will likely hit $20 trillion in a few years. If by that time interest rates were to return to some semblance of historic normalcy, say 5 per cent, interest payments on the debt would then run $1 trillion per year. This sum could represent almost 40 per cent of total federal revenues in 2012!
In addition to making the debt service unmanageable, higher rates would depress economic activity, thereby slowing tax collection and requiring increased government spending. This would increase the budget deficits further, putting even more upward pressure on interest rates. Higher mortgage rates and increased unemployment will put renewed downward pressure on home prices, perhaps leading to another large wave of foreclosures. My guess is that losses on government insured mortgages alone could add several hundred billion more to annual budget deficits. When all of these factors are taken into account, I believe that annual budget deficits could quickly approach, and exceed, $3 trillion. All this could be in the cards if interest rates were to approach a modest five per cent.
If the sheer enormity of the red ink were to finally worry our creditors, five per cent interest rates could quickly rise to ten. At those rates, the annual cost to pay the interest on the national debt could equal all federal tax revenues combined. If that occurs we will have to either slash federal spending across the board (including cuts to politically sensitive entitlements), raise taxes significantly on the poor and middle class (as well as the rich), default on the debt, or hit everyone with the sustained impact of high inflation. Now that’s a real fiscal cliff!
By foolishly borrowing so heavily when interest rates are low, our government is driving us toward this cliff with its eyes firmly glued to the rear view mirror (much as the new French regime appears to be doing). For years I have warned that a financial crisis would be triggered by the popping of the real estate bubble. My warnings were routinely ignored based on the near universal assumption that real estate prices would never fall. My warnings about the real fiscal cliff are also being ignored because of a similarly false premise that interest rates can never rise. However, if history can be a guide, we should view the current period of ultra-low rates as the exception rather than the rule.
Peter Schiff’s new book, The Real Crash: America’s Coming Bankruptcy – How to Save Yourself and Your Country is now available. Order your copy today.
For in-depth analysis of this and other investment topics, subscribe to Peter Schiff’s Global Investor newsletter. CLICK HERE for your free subscription.
- Democrats to Risk Fiscal Cliff by Targeting Top Earners (bloomberg.com)
- Lawmakers signal deep ‘fiscal cliff’ deadlock in Congress (mercurynews.com)
- Fitch Ratings keeps US at top ‘AAA’ credit rating (seattlepi.com)
All of this noise out of Greece has taken attention away from the fastly approaching U.S. fiscal cliff: the end-of-year deadline that threatens to lop off an estimated 3 to 5 percentage points off of GDP growth in 2013.
Reinhart’s note discusses the timetable regarding the fiscal cliff:
Unfortunately, there is no clear timetable for action. Congress will deal with the situation when it is good and ready to do so. And, the lessons from similar experiences in recent years suggests that such action will occur at the last minute.
But as an economist who’s getting paid to make forecasts and opinions, he shares with us the key dates that he’ll be watching. Here’s his assesment:
[T]here is a strong likelihood that there will be a lame duck session of Congress following the November election. Ideally, legislators will reach agreement on a plan which avoids the 2013 fiscal cliff and, at the same time, addresses the unsustainable longer-term course of US fiscal policy. However, given the elevated degree of gridlock in DC and the likelihood that some degree of gridlock will remain no matter what the election outcome (it is mathematically impossible for either party to achieve a filibuster proof majority in the Senate), this is an awful lot to expect during a post-election session of Congress that may last six weeks or so at most. A more likely scenario might involve a short-term extension of the major budget provisions or delayed action until debt ceiling constraints help to force a compromise agreement in early 2013. Of course, the longer the delay, the greater the likelihood that policy uncertainty will negatively impact the real economy.
- Morgan Stanley Just Slashed Its US GDP Forecast And Warned Things Could Get A Lot Worse (businessinsider.com)
- CBO Warning: Recession Will Follow 2013 ‘Fiscal Cliff’ (theatlanticwire.com)
- Fiscal cliffs, multipliers, and the myth of central bank independence (economist.com)
Mamta Badkar | May 17, 2012, 10:54 AM
Unless Congress acts, more than $600 billion in tax and spending provisions will change at the end of the year. And this will impose fiscal restraint at a time when the U.S. economy is growing very gradually.
But what is the fiscal cliff? What impact could it have on the economy? What are the most likely scenarios? And which companies most exposed to government spending stand to take a hit?
- Ben Bernanke says Euro crisis, ‘fiscal cliff’ threaten U.S. economy (calgaryherald.com)
- What the Fed fears (economist.com)
- Here’s A Calendar For Fiscal Cliff-Mageddon (businessinsider.com)