Fiscal Cliff


#1

Now that the 2012 elections are over, remember the looming fiscal cliff.

Substantial changes to tax and spending policies are scheduled to take effect in January 2013, significantly reducing the federal budget deficit. According to CBO’s projections, if all of that fiscal tightening occurs, real (inflation-adjusted) gross domestic product (GDP) will drop by 0.5 percent in 2013 (as measured by the change from the fourth quarter of 2012 to the fourth quarter of 2013)—reflecting a decline in the first half of the year and renewed growth at a modest pace later in the year. That contraction of the economy will cause employment to decline and the unemployment rate to rise to 9.1 percent in the fourth quarter of 2013…

On the basis of its analysis, CBO concludes the following:

Eliminating the automatic enforcement procedures established by the Budget Control Act of 2011 that are scheduled to reduce both discretionary and mandatory spending starting in January and maintaining Medicare’s payment rates for physicians’ services at the current level would boost real GDP by about three-quarters of a percent by the end of 2013.
Extending all expiring tax provisions other than the cut in the payroll tax that has been in effect since January 2011—that is, extending the tax reductions originally enacted in 2001, 2003, and 2009 and extending all other expiring provisions, including those that expired at the end of 2011, except for the payroll tax cut—and indexing the alternative minimum tax (AMT) for inflation beginning in 2012 would boost real GDP by a little less than 1½ percent by the end of 2013.
Making all of the changes described in the two preceding bullets—which captures all of the policies included in the first two years of CBO’s alternative fiscal scenario—would boost real GDP by about 2¼ percent by the end of 2013 (as CBO estimated in August). Thus, of the total difference in the projected growth of GDP next year under current law and under the alternative fiscal scenario, about two-thirds owes to changes in tax policies and about one-third owes to changes in spending policies.

CBO | Economic Effects of Policies Contributing to Fiscal Tightening in 2013


#2

Harry Reid is planning on raising the debt limit, does that sound like more taxes are going to cover existing debt? It looks like any new revenue will be used on new spending.


#3

and the stock market came tumbling down. This regime will print more paper, this regime will go back and prop up the stock market, this regime will raise the debt ceiling and borrow more, and the world will be further unsettled and China may own more worthless paper, and call their notes. And nobody will stop them.


#4

The impending fiscal cliff refers to sequestration and expiring tax cuts. Federal debt was the motive for sequestration. Refusing to increase the debt limit was the tactic used to legislate it. The tax rate increases will be more economically damaging than the spending cuts.

There will be debate about the debt limit but it will be increased to avert default. The real debate will be whether to extend all the tax cuts or extend the cuts except on the top two income brackets. Regarding this debate, CBO concludes:

Extending all expiring tax provisions other than the cut in the payroll tax and indexing the AMT for inflation—except for allowing the expiration of lower tax rates on income above $250,000 for couples and $200,000 for single taxpayers—would boost real GDP by about 1¼ percent by the end of 2013. That effect is nearly as large as the effect of making all of those changes in law and extending the lower tax rates on higher incomes as well (which CBO estimates to be a little less than 1½ percent, as noted above), primarily because the budgetary impact would be nearly as large (and secondarily because the extension of lower tax rates on higher incomes would have a relatively small effect on output per dollar of budgetary cost).

CBO | Economic Effects of Policies Contributing to Fiscal Tightening in 2013

Special Note: US Treasury bills, notes and bonds cannot be “called.” They can be bought and sold on secondary markets.


#5

#6

Unfortunately the Nation as a whole is looking like the same scenario as California, the only plausible “fix” will be to destroy the currency through massive spending and printing and then rebuild on sound principles once the Welfare rats/Public Employees are out of the equation.

The wise will prepare for this eventuality, the GOP is not a firewall that can be trusted and they will not allow any Conservatives to gain influence so they can become a firewall.

It is time to focus on creating a Conservative Political Party so when this mess runs its course there will be a viable alternative ready.


#7

This is why we should advocate measures promoting competing currencies so that not all of us have to be subject to debt monetizing.

Repeal legal tender laws so that banks can issue notes like they do in prosperous Hong Kong. Private clearinghouses would help keep the value of the currency high. Repeal restrictions on precious metals like capital gains taxes. States can create depositories for specie and issue debit cards based on the value of the specie in your account. In fact, states are only supposed to make payments in gold and silver per the Constitution anyways.


#8

Speaker Boehner cites an Ernst & Young report that states 700,000 jobs would be loss if the top two income brackets are increased. The time horizon, ie. the long-run, is not clearly indicated.

The confluence of fiscal policy changes scheduled to occur at the end of 2012 – sometimes referred to as the “fiscal cliff” – poses serious challenges for policy makers. One area of disagreement is the increase in tax rates for high-income taxpayers resulting in part due to the sunset of elements of the 2001 and 2003 tax cuts. President Obama has called for the reinstatement of the higher top tax rates in his budget submission to the Congress, while key Republican members of Congress have called for their extension. The increase in the Medicare tax and its expansion to unearned income for high-income earners under the Patient Protection and Affordable Care Act of 2010 (PPACA) further contributes to the increase in top tax rates…

This report examines four sets of provisions that will increase the top tax rates:
[LIST]
[*]The increase in the top two tax rates from 33% to 36% and 35% to 39.6%.
[/LIST]

[LIST]
[*]The reinstatement of the limitation on itemized deductions for high-income taxpayers (the “Pease” provision).
[/LIST]

[LIST]
[*]The taxation of dividends as ordinary income and at a top income tax rate of 39.6% and increase in the top tax rate applied to capital gains to 20%
[/LIST]

[LIST]
[]The increase in the 2.9% Medicare tax to 3.8% for high-income taxpayers and the application of the new 3.8 percent tax on investment income including flow-through business income, interest, dividends and capital gains.
[/LIST]
Through lower after-tax rewards to work, the higher tax rates on wages reduce work effort and labor force participation. The higher tax rates on capital gains and dividend increase the cost of equity capital, which discourages savings and reduces investment. Capital investment falls, which reduces labor productivity and means lower output and living standards in the long-run.
[LIST]
[
]Output in the long-run would fall by 1.3%, or $200 billion, in today‟s economy.
[/LIST]

[LIST]
[*]Employment in the long-run would fall by 0.5% or, roughly 710,000 fewer jobs, in today‟s economy.
[/LIST]

[LIST]
[*]Capital stock and investment in the long-run would fall by 1.4% and 2.4%, respectively.
[/LIST]

[LIST]
[*]Real after-tax wages would fall by 1.8%, reflecting a decline in workers‟ living standards relative to what would have occurred otherwise.
[/LIST]
Ernst & Young, Long-run macroeconomic impact of increasing tax rates on high-income taxpayers in 2013, pp. 2-3 (pdf)


#9

I doubt that the fiscal cliff will make any long term difference - definitely not more than the debt that would otherwise be incurred.


#10

I don’t know enough economics to make any kind of informed predictions about the timeline, but it’s pretty obvious that the current situation is unsustainable. The debt bomb is ticking away, and the fiscal can that’s been kicked down the road for decades is out of road and in a mine field.


#11

The soundest view on US debt I have read online is:

Rolling Over Government Debt

Nothing about government debt in a fiat money system requires that it be paid off. Of course individual securities must be redeemed as they mature. But the Treasury can roll over its maturing debt indefinitely. Rolling over means selling new securities to pay for the redemption of maturing securities. This involves no new tax revenues.

Treasury securities offer a risk-free, interest-earning alternative to base money spent into circulation by the government. If the private sector has more non-interest-earning base money in the aggregate than it wishes to hold, its only alternative is to buy Treasury securities. Since the Treasury can pay whatever interest rate the market demands, there will always be willing buyers of its securities.

Government Debt as Perpetuities

The debt can be carried indefinitely at no financial risk to either the government or the private sector. Individuals can become bankrupt with too much borrowing, but the government can never become bankrupt if it borrows in the same currency it issues.

Government debt is commonly regarded as a future tax liability of the private sector. However the unique position of the government as issuer of the monetary base enables it to roll over its debt continuously. In doing so, its securities become the functional equivalent of perpetuities, i.e. bonds that never mature and thus are never redeemed. De facto, there can be no net tax liability on perpetuities.

Net Financial Wealth of the Private Sector

Treasury securities are valuable assets for the holders. They can readily be sold for money or pledged as collateral for loans. Together with the monetary base they comprise the net financial wealth of the private sector. By contrast, bank lending does not affect the financial wealth of the private sector because all such credit is matched by an equal amount of borrower debt.

The value of the Treasury securities to the private sector as a whole is not in the interest payments they shed. The interest payments are matched by tax revenues, and are therefore a wash in the aggregate. The value of the Treasury securities is in the principal, just as in the case of Federal Reserve notes. They represent stored financial wealth for the holder. The public trades one for the other, depending on the degree of liquidity it desires at any given time.

Government Debt vs Private Debt

The most relevant measure of fiscal health is net interest outlays as a percent of federal receipts. If it stays under 20%, it is sustainable ad infinitum. Currently, interest rates are extraordinarily low. Rising interest rates present the problem of sustainability.


#12

What happens when the interest rate goes to 5% and there are no buyers for the rollovers? 10%??
We paid about 2% last year so we paid about the same budget interest as we did in 1998. If 1998 comes again…we’ll be paying a trillion in interest on the debt. That is the debt bomb on a SMALL scale without too much inflation. It could be a LOT worse.


#13

The likelihood of no buyers for US Treasuries is 0. All commercial and consumer credit would cease before the federal government could not attract buyers. All publicly traded equities would be worthless before that happened. Finally, the Federal Reserve could monetized the debt. US Treasuries are the most risk-free investments.

The threat to the sustainability of US debt is rising interest rates. To determine the effect of interest rate changes, download the Monthly Statement of the Public Debt (MSPD) (preferably the Excel File for Primary Dealers), go to page 2 - marketable securities - and multiply the maturity values by the changed interest rate. Currently, the highest interest rate paid is 11.25% on 30-year bonds issued in 1985 and maturing in 2015 (MSPD, Excel File for Primary Dealers, October 2012).


#14

He isn’t being literal. Sure some might still be buyers that aren’t stupid enough to run to other markets.

Monetizing the debt is not a situation we want to be into.


#15

I guess we’ll see on the back side of sequestration.


#16

#17

#18

That’s rather disingenuous, given prior statements. The only reason that government debt is being so handily funded now is not low interest rates, but the perceived security of holding US debt. As US debt rises, its perceived security falls, based upon nothing more than the prospects of its being payed off via the taxing power of government versus default. Interest rates may rise to whatever level they may and US government debt may still be a good investment, but only absent other alternatives, a point Post No. 11 overlooks. “Other alternatives” include not only other sovereign currencies but, more immediately commodities, which we see not surprisingly, rising.

We can call that condition inflation or we can call it a devaluing of the dollar, but what we cannot call it is irrelevant to the level of US debt. For the moment, we can be quite glad for fiat currency, and the fact that the world’s fiat currency remains the US dollar, for absent that we’d already be Greece. Demand for US Treasury instruments will reach zero, when the US dollar is the functional equivalent of wallpaper. There is a precedent for that. Fortunately, due to the dollar’s position as a universal currency, we have options before that point is reached, none of which involve an elimination of fiat currency. The limitation on those options is that no fiat currency, the dollar included, can ignore commodity prices, which are free to rise in a world market. Gold prices may reflect the dollar devaluation, but oil prices are probably a better indicator of where we’re really at.

The US must either commit to paying its debt or stop adding to it. Either will work, but one must be chosen.


#19

The choice that must be chosen is reducing current deficits. Deficits need not be eliminated nor the debt decreased.

The US is not on new fiscal ground. Federal debt as a percent of nominal GDP was higher in the '40s than now.

Also, federal deficits as a percent of nominal GDP were more in the '40s.

US debt can be rolled over continuously. It never requires being ‘paid off.’ It must be serviced by paying interest, though. Rising interest rates present a threat to the debt’s sustainability because net interest outlays may exceed a reasonable percent (e.g., 20%) of federal receipts. Deficits that are too large can cause this to happen as well.

Most of the US debt must be rolled over within five years taking advantage of lower shorter term interest rates. The average interest rate on all marketable Treasury securities in October was 2.075 and 2.56 on all interest bearing debt (TreasuryDirect). Since interest rates are remarkably low, now would be a good time to increase the average maturity length to decrease the debt’s sensitivity to interest rate changes.

source: MSPD, October 2012


#20

You’re using expenditures during an existential world war for a comparison basis of sustainability? Please excuse me if I, and world markets, do not take the comparison seriously.