Avoiding the Cliff: Thelma and Louise In Reverse

by PETER HUESSY December 21, 2012

The fiscal cliff can be avoided. The solution is before us. It involves a one-step process now and a two step process in 2013. Let us start with some principles upon which the two parties are far apart and then explain how we can come together..

First, let's look at the administrations assumptions.

They believe economic growth and recovery is generated largely through greater consumer consumption. And you increase consumption by getting money into the pockets of the broad middle class--thus the stimulus package and food stamps and unemployment compensation are often described as a stimulus for the economy.

They also believe that any reductions in the future debt must not be from those programs that are causing the debt but from those who have the most money to help pay for the debt. And the "rich", defined as a $200,000 salary for individuals, are going to get it the tax hikes, along with couples making over $250,000, because that is where the "easy" money is. . Now those folks earning a ,living are thus treated no differently than those receiving poverty program assistance. I disagree that these are the same, but I understand the position.

The administration here pulls a sleight of hand; it claims spending cuts must by necessity require the middle class to sacrifice, as if for example, these poverty programs are somehow all middle class, so we cannot cut them alone without tax increases "on the rich" because to do otherwise that would not be fair. Even though the "rich" are paying most of the cost of the poverty programs to begin with.

To some extent, there is some truth to the administration's claim that Social Security and Medicare are largely middle class programs. Here, the administration says they cannot expect folks who paid into Social Security and bought Medicare as an insurance program to suddenly see their "benefits" cut unless those who are better off--the rich--also pay "their fair share" toward debt reduction. Thus the administration talks about "shared sacrifice". (Even though the tax increases do not even pay for 10% of the entitlement shortfall we face over the next few decades).

Second, let us look at the House and Senate Republicans and their assumptions. They believe economic growth and thus revenue increases are largely driven by investment.

Investments in the private sector drive economic growth and recovery, a point missed by many Democrats, although the Treasury Secretary acknowledged the overwhelming majority of revenue must come from new job creation flowing from investment. Unfortunately, most liberals believe what is being spent by the rich is that they buy a few more yachts, (which they do not need), then the yacht builders hire a few more workers, and thus the wealth "trickles down" from the rich plutocrats to the slubs who work for a living.

Liberals and progressives then go on to say that the "rich" do no need to spent such money and do not "need" more "stuff". Thus the argument to take from the rich and give to the government. Then the government takes the money and gives it to those it deems deserving or the government promises, as the administration has, to "pay down the debt" and thus continue to spend money on poverty programs and stimulus packages, but instead of borrowing the money they will take it from the "rich".

Reality does not work this way. A recovery is driven by investment. In 1983, 1997 and 2003, the last three previous recoveries saw investment into the US economy in those three years increase over $500 billion from a base of roughly $2 trillion. That is a 25% increase. These funds came largely from small business and investors.

Here is where the drive-by media and their progressive 3-yrear olds miss the boat. The funds used to invest hire new workers. These new workers in new small business are the first to get paid. They then become new consumers, having previously been unemployed. They also become new tax payers. This has nothing to do with the notion that "trickle-down economics" is the basis of an investment led economy. Just the opposite. The workers get paid first, then make a business work, and then profits and income trickles-up to the owners!

In 1983-4, 1996-7 and 2003-4, jobs increased by over 10 million year over year. That is over 3.5 million annually, a number almost as large as all those hired on a net basis between June 2009-Novembner 2012, nearly 3 1/2 years into the current recovery.

In 2003-7, revenue to Uncle Sam went from $1.7 trillion $2.5 trillion. That was the most spectacular growth in revenue to the US government in history. For reference sake, the recession cut revenues down to roughly $2.1 trillion and they have now recovered to the $2.5 trillion level, but only 5 years after previously peaking, but all the while government spending has increased by nearly $1 trillion annually.

Here the drive-by media and their progressive strap hangers also get confused. They think the prescription drug benefit, the two wars, and the "tax cuts" all either spent money or lost revenue--the phrase "not paid for" is to what we refer--and thus that is why we have annual deficits of $1 trillion or more.

The tax rate cuts actually grew the economy and thus revenue to Uncle Sam. The spending on the two wars and the prescription drug benefit did increase spending. But together that current cost is now about $118 billion a year. One could argue the drug benefits also saves other Medicare costs and the war in Afghanistan was necessary and hardly capable of "being paid for" up front, anymore than the billions borrowed for World War II were somehow magically "paid for" up front.

To be fair, the surge in Afghanistan, the TARP II package, the stimulus package, the tax rebates and Obama Care were not paid for either--except for the $100 billion in taxes to be collected annually to pay for Obama Care which CBO tells us will cost $270 billion a year when fully implemented.

Before we get to our fiscal cliff solution, another note is important. No US recovery since World War II has been accomplished in the face of rising energy costs. In 2008, a barrel of oil cost $28. It is now over $110 in terms of North Sea oil, $92 for west Texas crude. A robust US recovery, needed to close the deficit and grow jobs, must reconcile an energy policy that appears pulling the economy in the opposite direction from growth and jobs.

Furthermore, every recovery except the mid 1960s, was accomplished with a decline in the percent of the US economy of GDP spent on the Federal government, including the Reagan and Clinton recoveries of the 1980s and 1990s. Reagan climbed out of 10% unemployment, 14% inflation and a 21% prime rate. Clinton inherited 4.2% growth in 1993, although unemployment was over 7%, but the Gulf War was the major reason for the slow Bush economy in 1990-1, as well as the tax increases in December 1990.

This recovery has serious head winds besides energy costs. Regulatory prospects are estimated to increase by $100 billion or more per year; health care costs are not under control but escalating despite the promise made about Obama Care, and the increase in overall debt of $6 trillion now since 2008 and the prospects of $8-10 trillion more over the next ten years all together is dramatically reducing business confidence and investment prospects.

These are not easy ideas for the progressives in our country to digest. One letter to the Wall Street Journal claimed since Microsoft and Federal Express were started in the 1970s, the then top marginal rate of 70% on income was obviously no big deal.

But few people paid that amount because few people hit that income level. One recent study indicated all of 254 people paid the 81% rate and above during the Truman and Eisenhower administrations out of 35 million or more taxpayers.

Plus the fact the 1969-1981 period saw four recessions, and a stock market that was 825 when President Johnson decided not to run for President again and 825 at the end of the Carter administration. Finally, the entire 1970s were known as the period of "stagflation", hardly an advertisement for growth!

So the two parties remain miles apart on their philosophies about how to grow the economy and deal with debt simultaneously.

In addition, Congress faces not one but two cliffs. The first is to avoid tax increases of close to $500 billion a year. And as well to avoid major cuts of $100 billion a year in defense and other domestic programs some of which are critical to our nation's welfare. This first cliff can be avoided with a relatively simple agreement.

But avoiding the second cliff is not so easy, and this cannot be done between now and the end of year. The second cliff is the long term health of the economy. As Senator Rubio eloquently pointed out in an interview with Sean Hannity, the only means to reduce the debt is to spur economic growth and hire the 12-20 million Americans who remain unemployed, underemployed and so discouraged they have given up looking for work. If the same number of folks were looking for work today as in June 2009, at the start of the recovery, the official unemployment rate would be over 14%, even taking into account those leaving the work force to retire or to have children. And such a strategy cannot be adopted before the end of the year, but nonetheless given its critical importance, we should not move to avoid the first cliff in such a way that makes the second cliff impossible to avoid.

So the House has to do two things. Get into next year. And then nail down in statute a requirement of what needs to be accomplished next year. There is no time between now and the end of the year to develop, amend, properly score, debate and then vote on tax reform, entitlement reform, and spending reform. But there is time to adopt a framework to do so.

The administration may have set up this cliff in order to avoid an extended and open budget process that would accomplish these three goals. They knew that if they won re-election, which they did, they would corral the drive-by media to hammer the conservatives and republicans into caving into White House demands for real tax increases and phony spending restraint.

That is why immediately after the election, the media mavens demanded that the House raise tax rates as the "American people" wanted. Note, as we have explained above, tax increases of the magnitude the administration wants for high earners alone, roughly $80 billon including tax rate changes and adjustments to deductions, would not make a dent into the deficit and would if anything slow economic growth and investment.

The administration proposal looks like the right way to go to some. After all, they have continually claimed the deficit spending of the past administration caused the crash of the economy. And that the tax cuts for the rich--but not for the middle class--were unaffordable. Although the tax cuts for the rich "cost" $80 billion a year and the middle class tax cuts "cost" $350 billion, according to the administration's math, the larger figure of $350 billion was affordable but the lesser amount of $85 billion was not.

The 2007-8 deficit was $160 billion, hardly the reason the economy tanked. The failure of advocates of lower tax rates and restrained spending is we never fully explained what happened and why in 2008. Just a few months ago, Treasury Secretary Geitner correctly noted the 2008 recession was triggered by $145 oil per barrel, which occurred on July 4, 2008; that in turn triggered a sharp decline in the housing and real estate market which unmasked the massive subprime mortgage bubble, which in turn was initially engineered during the Clinton administration and their accomplices in HUD, FHA and Fannie Mae and Freddie Mac, and an accommodating Federal Reserve.

Add an energy bubble to a housing bubble, and the economy crashed as the investment banking sector of the economy came close to becoming insolvent.

So while the conservatives wonder why they lost the last election for the White House, it is obvious. They never explained why the economy crashed in 2008 and why the economic collapse was precisely because the country failed to follow conservative principles of growth, investment, cheap energy, restrained government spending and prudent regulatory policies which had been the hallmark of virtually every previous economic recovery.

We now face prospects of no future welfare reform; no balanced budget proposals; non additional tax reform; and no spending restraint from the administration if we cannot avoid the fiscal cliff.

Already built-into the law is $1 trillion in new Obama Care taxation, coupled with a proposed increase of $1.2 trillion in additional taxes on the so-called "rich" now on the table, down from $1.6 trillion.

But this in turn is also coupled with even more Administration proposed spending, including more unemployment compensation, more payroll tax cuts, another infrastructure pork program, and a reversal of the sequestration cuts of $100 billion a year, all of which amounts to close to a $160 billion annual increase in spending even over and above what was projected for the budget in entitlements and poverty programs already in the administration's last budget.

Medicaid alone has increased annually by $193 billion, as have other means tested poverty programs which have, parenthetically, been increased dramatically as eligibility as been expanded. For the first time in the post World War II era, an economic recovery has been associated with a simultaneous dramatic expansion in the use of poverty programs, rather than the reverse. When added together, we see taxes and spending increasing by trillions over the next decade, with very little associated spending restraint.

What then should the House do?

First, pass a tax bill and spending bill which leaves tax rate levels as they are but which also increases rates above $400-500,000 (or whatever rate deemed appropriate) and reduces spending 1-2% from current outlay levels.

But the bill will put everything on hold for 9 months, until October 1, 2013. So no tax increase goes into effect.

But if no deal in 2013 is reached, then the tax changes and spending restraint would go into effect permanently unless Congress passes an alternative package.

Thus the fall back package if no deal is forthcoming, contains two poison pills-- for the House (tax rate hikes) and the Senate majority (real spending cuts). But until we see how the economy is doing, and give the Congress time to act on a new package, we do not do anything rash now such as major tax hikes or spending cuts.

As part of the package to get beyond the cliff, the House should also pass a bill not unlike one the House and Senate passed in 1984 which fenced a key nuclear weapons program favored by the Reagan administration unless the next Congress voted in the authorization and appropriations process within defined dates in the affirmative in every vote to release the funding.

Here is what you do.

Taking their cue from Simpson Bowles, the US Congress should send to the President in addition to the tax increase and spending cuts--(but on hold until October 1, 2013)-- an additional companion statute. This would require the House by May 1, 2013, and the Senate by July 1, to pass in their respective chambers bills to accomplish no less than $4 trillion and a goal of $6 trillion in real independently scored debt reduction, to be accomplished in whatever way each chamber of the Congress can pass by the date certain. An agreement also will include no filibuster.

After each chamber passes such legislation, they proceed to conference and must bring a conference report back to the House and Senate by September 1, 2013. Just as in 1984-5, the agreement will stipulate no filibuster will be in order.

Also during initial floor consideration of each bill, a substitute bill can be offered by the minority in each chamber, with rules adopted that allowed for wide-ranging amendments to be offered.

Here we come to the real deal. Each side has professed to want to secure real deficit reduction. Both have said such a deal needs to be balanced. Both sides must agree to no less than $4 trillion in real debt reduction.

My proposal is also that the 1974 budget act be waived for this battle.

I propose that revenue increases from whatever source be counted, but only independently and properly scored and vetted revenue increases.

These could include growth from further economic expansion, tax reform, regulatory reform or a new energy policy. Such estimates would be reviewed and scored prior to floor consideration by CBO, OMB and one outside group, (such as Simpson-Bowles themselves) with dynamic scoring one of the tools--but not the only one-- used for scoring.

The assessment will review from whatever source tax revenue comes--from changing the tax rate structure ("tax increases on the rich") and/or tax reform, the latter which both sides have endorsed as a means of growth the revenues from which the US government will be funded.

Each bill will contain at a minimum five elements: tax reform, entitlement reform, spending reform of the discretionary accounts, and a reformed health care regulatory and energy policy bill that has as its goal the employment of no less than 12 million more Americans over the next 4 years and a maximum or further goal of 20 million new jobs as soon as economically possible. The bills can retain the status quo.

But in the absence of an agreement by September 30, 2013, and a new agreement being signed into law, the following will take place:

(1)All tax rates will go back to their current(2012) level except for incomes above $400-500,000;

(2)All spending drops in FY2014 two percent from FY13 outlays, with outlays dropping every year thereafter by 1%, or until a level of $4 trillion in debt reduction has been achieved for the decade.

That implies a reduction from $3.7 trillion spending today of $74 billion in the first year, and by year ten no less than $250+ billion a year until a minimum of $4 trillion in debt reduction has been achieved, an amount that can be increased in each subsequent year through the annual and regular appropriations process..

Unlike the fiscal cliff, Congress can determine where to cut the 2% at first and every cut thereafter to reach $4 trillion in reductions. But we get rid of the phony baseline budgeting that leads to phony budget cuts.

Why this proposal? Well, no one will like any of the alternatives, but they have all professed they are in favor of the deficit reduction goals of Simpson Bowles. So here is a chance to reach that goal and protect those programs each side professes the need to protect. In short, can you get to where you say you want to go? With no deal, tax rates go up on the rich, but real spending restraint goes into effect. If Congress passes no new spending bill, a CR is automatic at a 1-2% spending outlay cut.

The House will not support tax rate increases, but they need not go into effect if a debt reduction and pro-job growth package is agreed to. The tax rate increase could be set differently, but the agreement could also result in House legislation to duplicate or exceed the Simpson Bowles commission goal of $4 trillion in spending restraint for every $1 in revenue increases, with the latter from tax reform or revenue increases from economic growth.

This will test the seriousness of each side. If one does not want tax rate increases but supports tax reform, well here is your chance.

On the Senate side, if you want to protect middle class entitlements and programs for the poor, here is the chance to reduce the deficit, promote growth and achieve those goals you profess to support. And such goals can be achieved within the framework of at least meeting the requirements of the Simpson Bowles Commission. This also allows room in a Senate bill for reform of the budget process, the entitlement nature of our government spending, and real pro-growth tax reform. So each side has to man up.

These bills can also include major corporate tax reform which could have as its goal the return of nearly $1.7 trillion in overseas corporate profit that could readily be invested in the US economy. And add to this major health care reform which could eliminate some of the $825 billion in annual unnecessary health care expenditures identified by the Institute of Medicine, (and discussed by Bret Baer recently on Fox News and Special Report) of which one third is US government spending. Add to this major energy policy reform, and an additional $400 billion annually can reach the US economy as well as billions in new tax revenue over the next decade as a number of new reports have projected.

Senator Sessions, the ranking member of the Senate Budget Committee, has argued that no agreement of this import should be done in secret or behind closed doors. It should also be done not only in the open but through the regular budget process. Too often has the US government substituted secrecy for transparency. And C-Span should cover the entire process. We should not legislate in a crisis environment, each with a gun to our heads.

Democrats will not want spending cuts. And Republicans will not like tax rate hikes. Both will occur if an alternative is not found. But both a House and Senate bill must be a "test", and that is the Bowles-Simpson test of at least $4 trillion in real debt relief.

Peter Huessy is President of GeoStrategic Analysis of Potomac, Maryland , a defense and national security consulting firm.


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