The Fiscal Cliff Is Dead! Long Live the Fiscal Canyon!

by James A. Bacon

Rejoice! The fiscal cliff has been averted.

Fret! There is more political turmoil to come as Washington mud wrestles with sequestration spending cuts and the cap on federal borrowing in the next two months.

Despair! Washington’s inability to enact serious budget reform means that Boomergeddon, once only a strong probability, is now a virtual certainty. The fiscal canyon looms in the mid-term future.

Congress has passed legislation that will raise an estimated $737 billion in new revenues over the next 10 years — less than a single year’s budget deficit — mainly by hiking the income tax on couples making $450,000 or more and by letting the payroll tax expire. The payroll tax was always seen as a temporary stimulus measure, so those revenues cannot properly be counted toward a long-term deficit resolution. At the same time, Congress offset some of its anticipated revenue gains from taxing the rich by dispensing $77 billion in tax loopholes for lobbies ranging from Wall Street banks and NASCAR racetracks to Hollywood film makers and Native American tribes.

Oh… and the deal provided no spending cuts!!

Meanwhile, the federal government will continue to run $1 trillion-a-year budget deficits, despite happy babble that it is destined to decline to a mere $600 billion to $700 billion within 10 years (a level that would have been regarded as obscene and unsustainable only a decade ago).

The happy-talk projections will never materialize, for they are based upon an economic forecast that assumes another 10 years of steady economic growth — on top of the previous three-and-a-half years of economic recovery. In other words, the claims of Washington officialdom that deficits will diminish by the end of the decade assume that the U.S. will have achieved at least 13 1/2 years of uninterrupted economic growth, even though the longest economic expansion in United States history lasted only nine years and the average expansion since World War II has been only five years.

Indeed, Washington’s fantasy-land projections are predicated upon the proposition that economic growth will rebound from its current 2.0%-or-so rate to 4.0% by 2014 and 2015. Somehow, the rate of economic growth is expected to double despite the fact that the nation is already running the most aggressive fiscal-monetary stimulus since World War II. The Federal Reserve Board has already driven real interest rates down to zero. How much lower can they go?

The Fed’s super-stimulative rate policy is goosing the current, less-than-adequate growth rate faster than it otherwise would be, but it sets a booby trap for future growth. As Martin Feldstein explains in today’s Wall Street Journal, the Fed’s purchase of bonds and mortgage-backed securities have put $1.4 trillion more reserves into the hands of commercial banks than legally required. At present, the banks are content to leave that money at the Fed in exchange for a low rate of interest. But if the economy actually shows signs of life, they will begin lending again…. with the result that inflationary pressures will build. Unless Ben Bernanke has discovered a monetary perpetual motion machine, the Fed will face the decision either of tolerating higher inflation, which is bad for economic growth, or raising the interest rate, which is bad for economic growth…. and even worse for federal deficits.

You see, when the nation carries more than $16 trillion in debt, increasing interest rates by a single percentage point implies an increase in interest payments of $160 billion a year. (Insofar as some of the debt consists of a mix of short-, medium- and long-term notes, the full impact may take several years to be felt. But the increase in interest payments will be inexorable.) When the nation continues to pile up deficits at the rate of $1 trillion a year, reaching $20 billion in another four years, a one percentage-point increase will add $200 billion a year to the deficit by the next presidential term — that’s far more than we can possibly cut programmatic spending.

When faced with such a dilemma, the political class is most likely to tolerate higher inflation because it erodes the burden of the national debt and takes them off the hook… for a time. But that is a short-term expediency at best, for investors will not long tolerate the silent expropriation of wealth. They will demand higher interest rates to compensate for the inflation, or capital will flee the country. Meanwhile, inflation will distort the allocation of capital, creating even more havoc. Pick your calamity. There is no free lunch. There is no way out. Boomergeddon is coming.

Bacon’s bottom line: What does this mean for public policy in Virginia? It means that we must deal with continued turmoil in Washington as national  politicians try desperately to wriggle out of the ropes with which they have bound themselves. While national leaders may delay the reckoning for a decade or more, the collapse of federal government finances is pretty much foreordained now. Virginia has a few years to brace itself for the inevitable storm, which will entail national economic chaos and massive federal spending cuts — cuts that will fall disproportionately on the commonwealth.

Virginia’s leaders are understandably focused right now on sequestration spending cuts, mandated by previous budget negotiations, which will eviscerate defense spending. This immediate crisis cannot be ignored. But our leadership cannot neglect the long-term structural reforms of our broken institutions — K-12, higher ed, health care, transportation and land use — without which we cannot sustain our global economic competitiveness. Sadly,Virginia’s political class shows no more signs than Washington’s political class of understanding, much less dealing with, the fundamental issues before them.

I’m thinking this is looking like a good hedge right now.

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13 responses to “The Fiscal Cliff Is Dead! Long Live the Fiscal Canyon!

  1. We’re here, where we are, because of the dysfunctional GOP that have abandoned their fiscal conservative roots and now, instead of them, advocating for SPECIFIC cuts – to include both entitlements AND DOD, now say that it’s up to the other side to specify cuts.

    Mr. Reagan and his GOP Congress had no problem what-so-ever specifying what he wanted cut. Neither did Mr. Gingrich under Clinton but under Bush – the so-called fiscal-conservatives of Congress pronounced that NeoCon wars meant that “deficits do not matter” and proceeded to blow up the budget with 2 wars, doubling the DOD budget AND doubling the Medicare subsidy.

    Now the same yahoos have spent the last 4 years saying we have a spending problem (no guano!) BUT.. GET THIS – not a PEEP from them on rolling back the things they blew up the budget with under Bush.

    Nope. Not a peep about Medicare Part D nor DOD nor the war on “terrorism”.

    they want Obama to name the cuts instead.

    What can I say other that feckless hypocrites!

    But there are more ironies here.

    The sequester? It was a GOP insistence, the fruit of their previous war on the debt limit. NOW.. they say that what they originally insisted on will be “devastating”. Now get this, we’re talking about 100 billion out of a 1 trillion deficit and the GOP says this is “unacceptable”.

    so now we’re bumping up against the Debt limit again and the GOP in their usual comically incompetent way (these days) is saying that they have “leverage” to force cuts.


    What if Obama agrees and says, let’s go forward with the across-the-board cuts in the sequester and be done with it?

    I predict.. the GOP will then proceed to pull out a machete and start chopping off it’s own limbs in retaliation.

    Isn’t it truly ironic that Bacon’s Buddies – the self-avowed fiscal conservatives who regularly blather about boomergeddon cannot even chew gum and walk straight these days when it comes to fiscal policy?

    DJ calls the GA in Richmond the Clown Show.

    No.. those guys are Mensa members compared to the National GOP these days.

  2. Blame Republicans all you want, but in 2008, Democrats controlled the presidency, the House and a near-fillibuster proof Congress. What did they do? They expanded the size and scope of government. If you don’t think both parties are culpable, you’re living in la-la land.

  3. More to the point, Larry, I consciously avoided assigning partisan blame in my post. No mention of Obama. No mention of Republicans or Democrats. My purpose is to understand how the policy options are rapidly narrowing no matter which party is in control, and to examine the implications for Virginians.

    If you had been on the Titanic, your top priority would have been apportioning blame amongst the captain and crew while the ship was going down… instead of looking for a life boat.

  4. And in Bacon’s Universe, the lifeboats would be tolled. With dynamic pricing. Although there might not be any lifeboats because they hurt the environment….it would be better to deal with land use issues on the ship than to build lifeboats to escape…

    The exercise in Washington was/is so discouraging. It is painful to discuss. They are all at fault. Messrs. Simpson and Bowles provided a very useful blueprint. I largely agree with what I’ve heard Mark Warner saying. But the pain that is necessary will be severe and immediate and the Congressmen love their jobs and will not risk them. My taxes should have gone up more. And I wouldn’t have minded at all if they were accompanied by real spending cuts, that Diet COLA for Social Security, and if the pain was spread more evenly. This obsessive hatred for “the rich” (meaning half of Fairfax County working households) has ended any appetite on my part for shared sacrifice. I think Obama would have celebrated a tax hike even half that size, as long as he could keep his promise to the Envious Class to lay it on those who have more than they do.

    The Republicans financed two overseas adventures with borrowed money. The Democrats have financed a massive expansion of welfare benefits for that who cannot/will not make it on their own with borrowed money. Hard to decide who gets more blame.

  5. here’s a pretty good view of how we got to 16T in debt and a big hint, it did not happen in 2008:

    but looking forward as Jim suggests – what should we cut?

    I would EXPECT the folks who are saying we have a spending problem and who are essentially the same folks who voted for increased spending for 2 wars, DOD, and doubling Medicare – yes the same folks – to say the first step is to roll back the spending increases that they voted for.

    but not a peep out of them about that. Instead they want to cut any/all entitlements RATHER THAN … AT LEAST say they made a mistake with Medicare Part C&D and that they should be the first to be rolled back.

    I’m not for assigning blame but I do think if we are going to be responsible about our “spending” problem that we be honest about how it happened and approach the cuts – that way.

    this is why the GOP is feckless hypocrites. For all the sound and fury that we have a spending problem, they:

    1. – wont acknowledge how we got to the debt we have

    2. – they refuse to name the specific cuts of which if they had backbone, they’d admit the first rollbacks ought to be the last increases they voted for.

    the problem with the so-called “fiscal hawks” these days is they
    they argue ideologically and in general against any/all “evil” entitlements and cling tenaciously to their nation defense spending.

    you want to know who is in the way of cuts – it’s the GOP.

    they’re simply not serious about it. It’s all about evading responsibility for their role and refusing to roll back to pre-Bush spending.

  6. to give a simple example:

    Paul Ryan, the GOP VP nominee who voted for doubling the DOD budget, two wars and Medicare Part D says we now have a ‘spending” problem but what does he advocate?

    He advocates cutting Medicare, MedicAid and Social Security but not DOD and he “balances” the budget by making up the difference between the entitlements share of the deficit and DOD’s share by claiming that supply-side tax cuts will generate increased growth to pay for the increased DOD spending.

    this is the kind of thing we are getting from the GOP on the budget.

    We can say we want BOTH the Dems and the GOP to do “better” but unless you’re willing to actually take a hard look at what the GOP is proposing and how feckless and hypocritical it is – we’re whistling Dixie.

    We got past the Cliff because the feckless GOP lacked the backbone to name specific cuts they were in favor of and instead claimed that those cuts were Obama’s job.

    Now, I’d ask – how can we go forward when one party is this dysfunctional?

    they simply are not engaged in real solutions – at all – and they’ve been this way since the Bush administration.

    Obama did not create but a small part of the spending that is now the deficit. He did the stimulus which is basically a two-year, 1 trillion debt – yes.. and yes.. he kept the unemployment benefits but other than that take a look at how we got here.

    And one final thing – the GOP makes a big deal about the fact that no budget has been done in over 1000 days.

    Very True.

    Now tell me how we are funding government?

    we are funding government with what is known as CRs – continuing resolutions – to continue spending at the levels down in the last budget.

    And guess who votes in favor of those CRs in addition to Dems?

    that’s right – the GOP… they raise hell about the spending and the debt but then they vote FOR the CRs.

    Now someone explain to me how this is a principled action on their part when they are saying we have a “spending problem” but they also vote in favor of continuing the spending.

  7. I’m optimistic because I think both sides will now be serious about Medicare reform, tax reform, and defense cuts.
    The truth is that the Republicans have not been serious about the deficit. They lowered tax rates, got us into wars, and added new entitlements (Medicare pharmacy). They insist on ever increasing defense expenditures. They resist changes in the medical system that would reduce the cost of health care in this country while improving health outcomes (this would lower the cost of Medicare). They’ve been grandstanding instead of addressing real solutions.
    But now that they’ve lost (or won) their only real issue – lower taxes – they have to actually negotiate on the big ticket items instead of demagoguing them (“death panels”, “789 billion Medicare cuts,” “homeland defense”).

    Obama has tried to bring these items in the discussion but any attempt at a grand bargain (such as in the summer of 2011) has been shot down by the tea party (and that Richmond congressman who I will not name) on the basis of taxes – but now that that’s gone they will have to follow through the deficit.

  8. the big 3 in entitlements are:

    Social Security

    Social Security is self funded through FICA and although it needs some adjustment, FICA generates almost 900 billion a year which pays for benefits 100% until 2030. so despite the GOP saying it is “broke”, it is not.

    Medicare is REALLY 4 Medicares
    A – funded through FICA and solvent for another 10 years
    B – 75% funded from taxes – about 230 billion a year
    C – “gap” coverage subsidized with taxes
    D – drugs – subsidized with taxes

    instead of “cutting” Medicare, the premium rates should go up – especially for those of means. Right now – you can have retirement income of 70K a year and hold assets such as a primary residence and a vacation home and several cars and pay the bargain basement rate of $100 a month.

    similar changes should be made to Part C and D.

    but this is going to knock only about 200 billion off the entitlements.

    what about MedicAid? MedicAid costs taxpayers about 300 billion.
    Table S-7 on page 12

    our deficit is a trillion.

    you can get maybe 1/2 of that from entitlements.

    but the dysfunctional GOP is so feckless that they are unwilling to specify what to cut and by how much – in part because they are afraid of the American people and in part because they realize that we cannot balance the budget by cutting only entitlements.

    so they are MUTE on the specifics of cuts…

    but they are not mute on saying that it’s up to Obama to name the cuts.

    I mean… WTF? the self-proclaimed fiscal conservatives who have spent the last 4 years saying we have a “spending problem” cannot lay on the table a simple list of cuts they support?

  9. Cuts I as a fiscal conservative can support:

    1) Plenty of potential cuts in defense spending. Plenty to cut that will not weaken our defense. Congress adds programs the DoD doesn’t ask for, keeps open facilities the DoD wants to close. We maintain too many overseas facilities where they are no longer logical. Who are we ever going to fight with those new F-22s and 35s? New and improved F-16s would defeat any other air force in the world.
    2) Premiums could go up or be means tested not just on Medicare but also on military retiree health care, federal retiree health care.
    3) The adjusted COLA for Social Security and other programs is fine with me and over time will make major progress against the deficits. Social Security is off budget but plenty of on budget programs are tied to a COLA.
    4) Extended unemployment benefits. There is no reason for more than 26 weeks. After that it is a welfare program and there are many, many people who linger on the UI rolls who would find a job if necessary. Call me heartless but I believe it. I’ve seen it. Why work for $8 an hour if you are giving up UI? I understand the temptation.
    5) The entire Food Stamp (sorry, SNAP) boondoggle needs to go. Please. It is as much for the farmers and the retailers as it is for the recipients. WIC can stay.
    6) Leave Afghanistan as of 9 am tomorrow and bring out every weapon, every piece of electronics we took in there. The Taliban will get anything we leave in country.

    If anybody got serious it would be easy to go through the budget. But the caterwauling would be spectacular. And then there is the revenue side of the equation, including increasing the take from mineral and petrochemical leases and expanding the areas open to such activities. Those are federal “expenditures” too if the royalties are too low. And did you read through the special interest “tax expenditures” protected and extended in that bill this weekend?

    You are right that Republicans have been too reluctant to put out specifics, but Paul Ryan has and others have shown some leadership. But then there was Peter King in the last couple of days, demanding federal handouts for Sandy storm victims, with Christie cheerleading from the sidelines. Both parties are guilty. And both are guilty of hypocrisy because I heard Nancy Pelosi talking today about deficit reduction. Oh, please. We have met the enemy and he is us.

  10. I applaud Breckenridge list. I have a minor quibble with the SNAP and a major one with the Ryan statement but it’s a real list with real cuts and exactly what the GOP won’t do despite their “spending problem” talk.

    re: Ryan – Ryan voted for all the increases in the budget spending under Bush to include DOD and the Part C/D entitlements but Ryan’s subsequent voucherized “budget” cuts only entitlements and claims supply-side tax cuts will spur enough growth to pay for the additonal DOD spending.

    That’s not fiscal conservatism. That’s idiocy, the same kind that we already did under Bush and it blew up and when it did – the GOP had no Plan B for the extra spending not covered by the growth they expected from the tax cuts and worse – there is no plan C if revenues fall below spending and then the economy tanks.

    What was the GOPs response to that circumstance? ” It’s not our fault, it’s the follow-on POTUS that caused it”

    beyond that, why does Ryan count on “growth” to pay for increased DOD spending and but capped vouchers for entitlements?

    so he’s counting on increased revenues for increased spending – is that real fiscal conservatism?

    this is the bizarre ideologically-driven agenda of the GOP these days.

    It would be regrettable but acceptable if it actually did work – we could complain about priorities (DOD over entitlements) but not about a balanced budget …. but it did not and does not work…. we do not get to a balanced budget that way because Ryan’s basic premise about tax cuts and growth essentially assumes that we have even less tax revenues than before. At some point, you go past the point where you can fund even fund basic govt. the supply-side revenues never maintain parity with spending and at some point they actually crater.

    All of the supply side stuff is based more on wishful thinking than proven, “it always works” facts and the worst part of it is that there is no answer to what happens if the cuts do not produce enough revenues to pay for spending – i.e. the Bush tax cut conundrum.

    it’s just a “belief”. it’s an ideology. it’s out of touch with easily verifiable realities.

    What it is – is a neanderthal version of “starve the beast. The problem is it ends up with deficits then debt and the GOP refuses to acknowledge that we have to pay the debt – because that would mean tax increases which screws up the whole supply-side ideology.

    this is not a “fiscal” plan – this is an ideology – pure and simple and a fatally-flawed one at that.

    this is no plan for govt. it is a plan to basically decimate it in as many and any ways possible by “starving” it. This is like curing the patient of Cancer by withholding food.

    this is the GOP approach to “fiscal conservatism” and Govt these days. They do not subscribe to the scalpel approach – it’s the machete.

    The Sandy Disaster Aid is emblematic of this thinking.

    What would be the other legitimate purpose of govt beyond national defense if not to respond to disasters – round-robin style as they strike different geography of the country and everyone who pays taxes expects some level of national insurance / aid when their locale is struck?

    Would the GOP be honest enough to say that we should get rid of FEMA and get rid of disaster relief/national disaster insurance?

    If they would say that – I’d certainly give them full credit for following their recently-acquired neanderthal-like principles but they’d get voted out of office in a heartbeat – and they should – and they know that – so instead of being honest and standing up for their principles and let the representative government work the way the Constitution intended – they LIE . They are unwilling to face the American people with their true agenda.

    Essentially the GOP does not believe in representative govt any more. You can hear it in their “taker” language.

    They truly believe that govt “is the problem” and that their job is to dismantle it but sticking as many sticks as they can in the spokes.

    Here’s what I believe:

    I believe that we have a Constitution that enshrined the ability of citizens to form and elect the govt they want even if that govt does provide entitlements.

    What fiscal conservatism means is that you do this but you insist on fiscal balance and responsibility – as the states and the localities now do.

    Every year throughout Va – localities go through the same budget process where they look at tax revenues and they look at their needs and they make the painful decisions as to what they can afford.

    You don’t see localities closing schools and shutting the sheriffs office. You don’t see them turning libraries and parks over to the private sector. The schools may end up with 30 kids in a class in a building that is older than it should be or there may not be true 24/7 EMS coverage but you make these decisions – and we do it every year.

    The state does it also – and perfect is the perennial enemy of good – over and over but …

    …. this is the important part :

    this is how govt works. this is how the Constitution intended it to work – to be representative of the citizens with regard to taxes and expenditures BUT fiscally responsible.

    we do not vote to dismantle govt.

    we never did.

    until now.

  11. “I’m thinking this is looking like a good hedge right now.”


    Wait, you didn’t mean for that to be funny, did you.

  12. The GOP is thinking that the threat to shut down govt is their leverage at the debt ceiling limits.

    One might think that one or two errant yahoos would stumble onto a deadly wrong strategy on something like this – but when the whole dang party thinks this is a good idea – you know that the GOP as a party is not only dysfunctional, not only in denial, but just plain dumb – or desperate – pick your version.

    This is the party that promotes themselves as “pro-business” and their primary strategy is to threaten a govt shutdown if Obama does not make cuts – cuts the GOP won’t even really specify – to demonstrate some scintilla of leadership since they have spent the last 4 freaking years blathering incessantly about a “spending problem” but NOW… the GOP says.. that if Obama does not make the cuts that the GOP is thinking of but won’t specify that they’ll shut down the govt.


    Jim Bacon implies that this is a problem with both parties and we should not be into “blame” – that his wonderful GOP guys are trying but just not being successful.

    Jim Bacon. What they HEY are you thinking Boy?

    why can’t you admit the GOP is a bunch of screw-ups these days?


    Remember, Obama, nor the Dems have ever claimed to be fiscal conservatives, yet the GOP has insisted this is their heritage.

    Ronald Reagan had no trouble naming the cuts he wanted. Newt Gingrich never had any trouble laying out the cuts he wanted. But the GOP right now – can’t lay out their cuts and instead threaten to shut down govt if Obama does not?

    come on Jim Bacon… the least you can do here is weigh in on this.

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