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Turning the "Fiscal Cliff" to our advantage

by Frank Schnittger Tue Nov 13th, 2012 at 04:15:14 AM EST

The Bowles-Simpson Commission sequestration of expenditures and the expiration of the Bush and Obama payroll tax cuts present President Obama not only with the greatest challenge, but also the greatest opportunity of his Presidency. The threatened economic melt-down could also be an historic opportunity to reverse the 30 year long trend in increasing income in-equality in the USA. Follow me below the fold for an analysis of how the President can turn this crisis to America's advantage and achieve one of the greatest progressive transformations of the political and economic landscape since the New Deal and Great Society of FDR and LBJ:

The US Congress must approve any increase in the US debt ceiling on a regular basis because, even when the debt is not rising as a % of GDP or adjusted for inflation, it is still rising in nominal terms. Debt as a % of GDP is the standard way of measuring the sustainability of debt, and so increasing the debt ceiling is no big deal in economic terms as long as the economy is also growing just as fast over the medium or long term.

Increases in the debt ceiling used to be routine, but in recent years Republicans have used them as an opportunity to force the Obama Government to make swinging cuts in Government expenditure and thus achieve the conservative aim of limited Government. Indeed, this is a major change from their attitude when a Republican President is in power.

"Reagan," Vice President Dick Cheney famously declared in 2002, "proved deficits don't matter." Unless, that is, a Democrat is in the White House. After all, while Ronald Reagan tripled the national debt and George W. Bush doubled it again, each Republican was rewarded with a second term in office. But as the Gallup polling data show, concern over the federal deficit hasn't been this high since Democratic budget balancer Bill Clinton was in office. All of which suggest the Republicans' born-again disdain for deficits ranks among the greatest - and most successful - political double-standards in recent memory.

Last year negotiations on a debt ceiling increase became so fraught that a default on US debt was threatened and the US credit rating was reduced for the first time in US history. Agreement was eventually reached to raise the ceiling pending further negotiations on expenditure reductions, and the Bowles-Simpson Commission was set up to come up with proposals to do so. The Bowles-Simpson Commission proposed a "sequestration of expenditures" - swingeing cuts in defense and other expenditure to come into effect in January 2013 if no agreement is reached.

In addition, the Bush tax cuts are due to expire in January 2013 unless they are further extended by congress. President Obama proposed extending them for all families earning less than $250,000 p.a. but Republicans insist they should be extended for all tax payers regardless of income. The combined effect of the tax cuts coming to an end (thus raising income tax levels) and the Bowles-Simpson Commission sequestration of expenditures coming into effect at the same time would be so deflationary, than many economists predict that the US economy would lurch back into recession.

There is thus a huge game of bluff and counter bluff being played out between the President and the Republican dominated congress at the moment, as to whether the Bush tax cuts should be extended to all (as the Republicans want, and as to whether the debt ceiling will be raised again to avert the Bowles-Simpson cuts in expenditures many of which - particularly those in defense - Republicans do not particularly want either.

Many progressives are urging the President to call the Republican's bluff and let the Bush tax cuts lapse and the defense expenditure reductions kick in - in other  words, to let the economy fall off the "Fiscal Cliff" -  in the belief that Republicans would then quickly cave in and agree to a raising of the debt ceiling in return for no reductions in military expenditure and at least some extension of the Bush tax cuts beyond what the President proposed and campaigned on.

However Republicans have shown a willingness to allow the US economy to deflate by opposing the Stimulus Plan, the Auto-bailout, the previous attempt to raise the debt ceiling, and the President's Jobs Bill - aimed at increasing employment. Indeed it was a key part of their plan to prevent the President's re-election by painting him as unable to manage the economy. Whether they will change their tune now that he is re-elected for the next four years, is open to debate. It is possible that their financial backers in Wall Street and industry more generally will tell them that the price of any further political opposition to the President on this issue is simply too high in terms of corporate profits forgone.

But what if Congressional Republicans simply dig in and refuse any further raising of the debt ceiling and approval for any Budget the President proposes which doesn't include even more swingeing expenditure reductions in social and health care entitlements? The early indications are that they are digging in for a long war against the President, and Democrats more generally, in an effort to retain as much political power as possible. What if no agreement is reached, and the President is faced with a situation where the tax cuts lapse and the Bowles-Simpson Commission proposed a sequestration of expenditures kick in resulting in the US economy sliding into recession?

I would like to propose a strategy the President might use to avert recession and circumvent the debt ceiling, or at least force the Republican's hand to come up with a proposal more acceptable to Democrats. Suppose the President were to do the following early in 2013 once the Bush tax cuts have lapsed, and the  Bowles-Simpson Commission cutbacks have kicked in:

  1. Announce immediate and huge reductions in future US military procurement. Military procurement cycles tend to be long, so there will be little immediate effect on military capabilities, and any deflationary effect will be very gradual - but the political effect of announcing the future cutbacks will be immediate. Republicans, and their financial backers in the Military Industrial complex will be absolutely furious.

  2. Announce a significant reduction in US forces and bases worldwide including an accelerated withdrawal from Afghanistan. Democrats would not be unduly alarmed, for the most part, progressives would be pleased, and Republicans would be aghast. The effect on the US economy however would be minimal as the expenditure reductions are in external markets, and bringing more troops home might actually increase domestic consumption.

  3. Announce a US Government zero interest "loan" program for middle class families who are effected by the cessation of the Bush tax cuts at least equivalent to the additional taxes they might have to pay - but also available to the poorest families who are not liable to pay income tax at all - to help reduce the impact of other non-military expenditure reductions forced by the Bowles-Simpson Commission sequester. The fact that it is a loan program means that the debts are technically in the names of those families, and do not increase the US Government's debt.

The effect of these loans would be to enable these families to maintain (or in the case of the poorest families to increase) their disposable "income" and thus their levels of consumer expenditure. The overall economic effect would be to negate the deflationary impact of the tax increases and maintain and increase the consumer expenditure component of GDP. In addition, because lower income groups tend to spend a greater proportion of their income domestically, the multiplier effect of such domestic expenditures would be much greater than if that same "loan" had been given to top earners who would spend a greater proportion of that loan on imported goods or indeed spend it directly abroad. The net effect of these loans would then actually be to grow the economy more and counteract the deflationary effect of the ending of the Bush tax cuts and the reductions in Military expenditure.

Of course Democrats would promise that these loans would be forgiven and made permanent as soon as Democrats managed to achieve control of Congress. If Republicans opposed these proposals, they would effectively be campaigning for tax increases. The effect of the loan program would be far more progressive than any tax reduction, because even low income families who do not qualify for income tax would qualify for the loans. In addition the Republican threat to "tank" the economy would be negated, and many of their favorite military spending programs would be cut. Some of those military expenditure reductions would have been enabled in due course by the ending of the Afghanistan war in any case, so President Obama can present them as "responsible", even if they ended up happening sooner than planned.

President Obama would only agree to terminate the loan program in return for republican agreement on a long term debt reduction plan which meets his targets for employment creation and health and welfare benefits. Any tax reductions would have to be progressive and help even the poorest families. The public option (which could arguably be introduced by Executive Order) would be back on the table, and the Republican threat to destroy the economic recovery averted.

What's not to like?

Sounds like a plan to me! The 'loans' could be presented as self-liquidating, as the boost to the economy they would provide would likely result in tax revenue increases that would more than cover their cost. And it could be presented as a 'fairness' issue - QE for the people. At least the people will spend the proceeds, unlike the banks, who still cannot find creditworthy borrowers for the largess they have received, and, even if they could, the big banks would be afraid to loan the money out as they need it to prop up their balance sheets, in case old loan loses become undeniable.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Nov 13th, 2012 at 05:04:12 PM EST
self-liquidating loans as opposed to self funding tax increases?

Index of Frank's Diaries
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue Nov 13th, 2012 at 06:44:39 PM EST
[ Parent ]
Looks like a dream to me...Obama is not "socialist" as Republicans presented him in this election.Not at all.

Kevin Rudd here in Australia gave us about $1000 to spend in 2008 (I think) when this crises started. He wanted to tax mining industry properly later and...he was ousted over night by Julia, his deputy...  
by vbo on Tue Nov 13th, 2012 at 11:00:09 PM EST
It doesn't really matter a whole lot what Obama "is". It's what the realities of relative power allow him to do that is in question...

Index of Frank's Diaries
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Wed Nov 14th, 2012 at 06:14:36 AM EST
[ Parent ]
No, that is only one question. What he wants to do within that frame also matters a great deal in the US system. Since he is a neoliberal, the "responsible" thing to do in his mental model is an irresponsible level of austerity.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Sat Nov 17th, 2012 at 01:47:39 AM EST
[ Parent ]
I think the jury is still out as to whether he is truly a neo-liberal. Of course he doesn't challenge their framing - he didn't challenge Romney in the debates when he said "the Government can't create jobs" - but I suspect that may be merely tactical. He had other smaller fish to fry (and win on) without taking on the entire paradigm hat is conventional wisdom in the US and which includes most of the Democratic party at this point. In politics, as in community organising, you go for the battles you can win and pay for a draw on the battles you can't. No point in fighting on their turf.  Changing the conventional wisdom will take decades, and I suspect Obama is playing a good long as well as as a good short game.

Index of Frank's Diaries
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sat Nov 17th, 2012 at 06:50:26 AM EST
[ Parent ]
Agreed.  If he were truly a neo-liberal at heart, I don't think there would have been a stimulus package at all - lord knows he has gained little but flack over that.
by Zwackus on Sat Nov 17th, 2012 at 10:21:33 PM EST
[ Parent ]
It's always hard to tell if a politician is pandering to his base, doing what he wants or going along with institutional reality. The stimulus might have been the former.

Naked Capitalism recently linked this from 2007:

Eschaton: There Is No Crisis

I imagine some readers who haven't been hanging around these parts for all that long might have justifiably been puzzled at the reaction to Obama's decision to try to make dealing with Social Security his signature attack on Clinton. It's true that Obama didn't assert that there was some huge crisis. But the fact remains that he put the idea out there that Social Security had a "problem" which needs to be fixed and that any serious presidential candidate needs to address the issue in clear detail.
by generic on Sun Nov 18th, 2012 at 07:00:41 AM EST
[ Parent ]
Many of the serious neo-liberals were calling for Stimulus in 2008/2009, and the stimulus itself was far more in line with the size and structure of what they were calling for than what real world economists were calling for.

Its hard for me to credit that the jury is still out on evidence that was already out there for public consumption from his Illinois Senate and Democratic Presidential primary campaigns. It would, for instance, have been the easiest thing in the world for Obama to oppose the corporate trade agreements when running in Democratic primaries in 2008, and yet he was willing to take the heat for supporting them.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Sun Nov 18th, 2012 at 12:21:05 PM EST
[ Parent ]

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