Cliff or Abyss: Either Way a Disaster

fiscal cliff

Just before the election, I joined Steve McBee of McBee Strategic and David Walker of the Comeback America Initiative for an intimate lunch of 100 or so.  McBee provides inside Washington advice to the financial services industry and Walker, the former Comptroller General of the United States and head of the Government Accountability Office, worries about balancing the nation’s checkbook.

They are not happy people because they understand the financial challenges we face and they have a keen sense of the inadequacy of those responsible for facing them.  On the day before the election, there was some doubt as to who would win (hard to remember that far back, isn’t it) so both speakers had to hedge their predictions based on who would occupy what offices.  Now we know.  Nothing has changed.  Except the Republicans feel a whole lot worse.

The speakers differed on the nature of the financial precipice, with McBee calling it a cliff and a Walker calling it an abyss.  Either term would do fine for the name of a disaster movie.

Whatever you call it, the story begins on December 31 when tax rates are scheduled to shoot up and government spending is to be sharply curtailed.  To varying degrees, both are necessary  — and thus good things — but Keynesian economists would argue they are not good policy for a country recovering from a sharp recession.  In other words, “yes sometime but not now.”

Politicians tend to differ from Keynesians because every economic situation is, to them, appropriate for the words “yes sometime but not now.”  Were that not their response of choice, they would be required to use the hated “no” word, which would cut into their people pleasing efforts.

If any time is a good time for hard decisions in Washington, it is right after election.  About two months remain before the new Congress takes over, not that it differs much from the existing one.  There is no point trying to raise money because donors are tapped out and the winners are partying while the losers are finger pointing.  November and December could be good months for a bit of light legislating.  Don’t bet on it.  Neither McBee nor Walker did.

The crosscurrents are difficult.  Democrats dislike reductions in government spending (except on defense) and anything that would change Social Security or Medicare to reflect prevailing demographics.  Republicans dislike tax increases and social spending so there is little room for compromise.

Since all of these will have to be done, both parties appear to come out the loser and this leads to a strategy of trying to look like the lesser loser.

Walker offered a slightly more encouraging scenario based on a five-part hypothesis: the American people are smarter; they know we’re in trouble; they will accept the truth; they will accept sacrifice; and they are disgusted with Washington politics.  In other words, the people are allied against those who represent them, a situation that might encourage some level of cooperation.

There are two time periods that matter.  Before the end of the year and after.  If the Congress acts now, the draconian events of December 31 never occur.  If it waits, it could then argue that it is cutting taxes from the newly-higher rates and increasing spending from the newly-lower amounts.

This has appeal except for those companies that have to plan their investment strategies for the coming year and have no basis for doing so. Their response is to postpone decision-making and sit on their cash while no jobs get created and the economic recovery is postponed.

There are three possible outcomes.

The big fix would deal with: long-term entitlement reform (changing Social Security so it remains solvent and fixing Medicare so it does not take everyone down with it); overall tax reform to eliminate deductions and broaden the base of taxpayers (perhaps in trade for higher tax rates but not as high as they would have been); government spending for both defense and everything else.  Don’t hold your breath in the near term.

The Band-Aid approach would temporarily extend some or all parts of existing law for three months to a year to enable the Congress to work on the big fix items. The better bet before year-end.

The train wreck.  Neither speaker described this in detail but I suspect it involves emigration.

Combining all these could be extremely difficult, but Walker suggested six principles upon which an agreement could be reached.

  1. The resulting policies must be pro growth
  2. The solution must be socially equitable
  3. The solution must be culturally acceptable
  4. It must be mathematically accurate
  5. It must be politically feasible
  6. It must have bipartisan support meaning at least 15 to 20% of the opposing party must vote for it

Both speakers agreed that the most significant deficit is leadership. Those who chose the leaders might do well not to put up with it.

 

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Haven Pell

At the conclusion of the Constitutional Convention of 1787, a woman asked Benjamin Franklin, “Well, Doctor, what have we got, a republic or a monarchy?” Without hesitation, Franklin replied, “A republic, if you can keep it.”

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  • Barron’s this weekend has a scary cover but the message I received is just the opposite…. there are multiple articles and editorials about the Cliff, which to me make the fiscal cliff less “scary”… and maybe even desirable?!?!?!?

    1) The “cliff” is kind of a crude Simpson Bowles. Some cuts and some tax increases.
    2) The cliff forces the decisions that popularly elected officials cannot make… i.e. take short term pain (reduced GDP growth) in exchange for long term benefit. At some point we must accept short term pain for longer term stability. There has never and will never be a time that voters and politicians get together and say “now is the time to take the pain.”
    3) I love the forced military cuts.
    4) Recession may not be so bad… We’re only growing at 2% right now. So what if we go to 0%?
    5) If you watch last night’s 60 minutes, one could be convinced that there are $12/ hour manufacturing jobs available, for those who are willing to go get skills training.