Friday, July 8, 2011

The Debt & Tax Debate in the US

Here are some bits from a good article by Simon Johnson in his Economix blog on the NY Times. I've bolded a key bit:
Three views emerge on whether the United States will default on its government debts, as I talk to people on and close to Capitol Hill. The first is, hopefully yes, and this August offers a good opportunity. The second is, possibly yes, but this would be bad, so we need some form of fiscal austerity. The third is, under no circumstances, and any talk of a need for austerity is a hoax.

The first view is mistaken. The second view hides a dangerous contradiction. And the third view borders on complacency. So how can we find our way to fiscal responsibility? We need tax reform.

People in the first camp think that the United States government has become too big and the only way to cut it down to size is to limit its ability to borrow. A constitutional amendment to limit the size of government relative to gross domestic product or to require a balanced budget could work, but experience suggests a future Congress could always find a way to escape any such constraint.


So, in one interpretation of this view, the only way to remove the ability of the federal government to borrow is to miss some payments, thus convincing the financial markets that the government is not really a good credit risk.

Such thinking is part of the strategy to threaten not to extend the debt ceiling for the federal government. That would lead to defaulting on some debt. But default, as the Greeks are finding out, is an all-or-nothing enterprise. Doing just a little default is not possible, because, in the view of the market, your country pays its debt in full and on time, or it does not.

The consequences of a United States default would be severe, not just for world markets but also for the ability of every American business and household to borrow, lend or make just about any financial decision. So threatening to blow up the current government debt system is not a credible threat, unless you sincerely believe that this would be a good thing ultimately for all concerned.


The second camp represents the mainstream of American politics today. Genuinely worried about future insolvency, people on both sides of the aisle propose ways to cut future budget deficits. On the Republican side, people prefer spending cuts; the Democrats would rather raise taxes.

Everyone in this camp fully intends to allow the government to pay its debts. Yet increasingly it appears that some people on the left and the right might be attracted to the idea of a government shutdown, at least for a while, assuming that they can effectively blame the other side.

The point is not to change the nature of government or its ability to borrow, but rather to position ideas and personalities for the 2012 presidential election. The government will be able to make its debt payments, but only if it does not pay wages or keep some nonessential parts of government functioning.

The good part of this thinking is that mainstream politicians are increasingly talking about budget constraints and the need to live within our means. The bad news is that these same people extended the so-called Bush tax cuts at the end of 2010, at a stroke not just refusing to deal with the deficit but also significantly contributing to what they now say is our most pressing problem.

The net impact on debt in 2018, relative to what it would have been otherwise, is an increase of $3 trillion. The Congressional Budget Office says in that year nearly a quarter of total outstanding federal debt will exist because these tax cuts were extended last December.
(In these pages, James Kwak and I have made the case for opposing the extension.)
What a disaster. And most Americans are bystanders with no clear role to play. They elected representatives to act on their behalf, but the legislators are showing no interest in their constituents needs or wishes. Instead, they are caught up in the grand "sport" of political infighting. Tragic.

Rather than accept the need for a deficit in the short term until recovery from the Little Depression, these fanatics want to play their favourite game of political bashing with no concern for the national interest. The US is one of the most lightly taxed countries on earth but they are bellowing as if they are dying from "over-taxation". Nuts. The deficits will disappear once the economy recovers and they remove the idiotic Bush tax cuts and maybe pass a few new tax increases. It won't require anything drastic. But rather than accept this reasonable option, the crazies are prepared to push the country over the cliff by defaulting on their debt obligations.

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