The Fiscal Cliff – Don’t Fall For It!

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by Shawn Messner

The fiasco formerly known as the fiscal cliff has been put off for a couple months, but eventually we will have to come to terms with reality: serious spending cuts are necessary.

In the wee hours of New Year’s Day, Republicans and Democrats reached a temporary agreement to address the nation’s financial troubles. However, the agreement amounted to very little, for  it addressed only revenues and not spending.

It is well-known that individuals making $400,000 and over will see an increase in their taxes to the Clinton-Era 39.6% from 35%, whereas it is less known, and to the chagrin of many Obama supporters,  that workers will see a decrease in their paycheck because of an increase in the payroll tax to 6.2% from 4.2%.

The argument has been repeated ad nauseam that the rich can afford to pay more. Yes, it is true that the rich can afford to pay more, but it is also the case that they can purchase the service professionals that help them find refuge in tax shelters, which is more than likely to occur as a result of these tax increases on higher income brackets. On the other hand, those who earn less but are nevertheless affected by the payroll tax will not be able to avoid these increases. The net effect is that resources are put into less productive uses than they would have otherwise been as people find ways to protect their earnings.

Many believe it is a cold, hard fact that government revenues must always decrease following a tax decrease and increase following a tax increase. However, this is not the case, as proven both empirically and intuitively.

The tax cuts that occurred in the early 1920s and under presidents Kennedy, Reagan, and W. Bush all resulted in increases in government revenue. The intuition behind this is that as tax rates fall, more and more individuals find it more profitable to  invest their earnings into the private economy rather than finding tax shelters. Thus, the result is that a greater amount of earnings fall under taxable income.

Those who oppose this reasoning may argue that revenues tend to increase over time due to advancements in technology, a larger labor force, and increased capital. In short, they argue that a revenue increase following tax decrease is a matter of correlation, not causation. This is a fair argument. However, it would be difficult to hold constant such a thing as technology to observe whether revenues truly increased as a result of a tax decrease or a technological increase.

Whether it be causation or correlation is not what is important though. The fact remains the same that revenues did not decrease.

It too is argued that we should close loopholes and remove deductions so as to get at the earnings of the affluent who find safe haven in tax shelters. This brings us to the crux of our situation at hand.

Should we be obliged to give a greater percentage of our earnings to people who continue to spend it recklessly? The answer is obviously a no. If we cannot even take the first steps to hauling in government spending, there is no use in giving them a greater share of our earnings.

“Budget Cuts”

The fear instilled into the public was that if an agreement was not made on the fiscal cliff in time, we would face extensive budget cuts. This is nothing more than political rhetoric and fear mongering, for these supposed cuts are not true cuts in the everyday sense of the word.

When you or I say that we plan to spend less this year than the previous year, we mean that we are going to spend less than last year. Simple, right? When politicos say the government is going cut spending, as in the case of the fiscal cliff, they mean they are going to spend less than they were initially projected to spend. Now that’s a little more complicated sounding.

The term to know here is baseline budgeting. Baseline budgeting is an accounting method used to develop a budget for future years. Baseline budgeting uses current spending levels as the “baseline” for establishing future funding requirements.

For example, I project that I will be spending more next year than last year because I expect to have a higher income, so I will be more readily able to spend that income on the things I want. Down the road I might hit a bump, such as needing to pay off a debt, and have to spend less than I initially wanted. Even though I will be spending less than I was expecting to, I am spending more than the previous year. These are the “cuts” we are told about. If we want to get serious about paying off the debt, we need some real spending cuts.We are bogged down in military adventures around the world that have zero pertinence to national security. The Social Security system is unsustainable. Public pensions will become a dramatically ever-increasing portion of our debt if not addressed. If we do not undertake serious cuts in these areas and others, we are doomed to default.

Down the Road

I predict that as we approach the debt ceiling for the twelfth time since  former President Bush’s inauguration—there were seven debt ceiling increases under Bush and three so far under Obama—we will hear more partisan bickering, there will be last minute deals, and the ceiling will be raised.

All that we can do in the meantime is demand that current politicians make dramatic spending cuts, and vote out those who do not make the effort. If we do not undertake the current situation seriously, the United States will face bankruptcy. That is when the real fun begins.

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