The Cliff Hanger: Fiscal Policy and the Planets Lining Up (But Not for an Eclipse or a Comet)

The planets are lining up—and we are not talking about a beautiful comet or a spectacular eclipse, but rather a large meteor impact coming, in economic terms, due to the U.S. House of Representatives, Senate and the President just kicking the can down the road rather than taking leadership positions regarding the country’s fiscal dilemma.  Fiscal policy relates to the taxation, government spending and related borrowing of the federal government.  Altering these can impact investment and consumption decisions by businesses and consumers alike, ultimately impacting the economy. 

The debt ceiling is the legislatively-imposed maximum debt that the U.S. government can borrow.  Federal law requires an authorization from the House and Senate to approve borrowing to finance all programs they have passed and the President has either signed or has had his veto overturned—yet the U.S.  Senate has failed to pass a budget in the past three years.  Funding of the U.S. government can only come from collected tax receipts and borrowing by the U.S. Department of Treasury.  In August 2011, as the U.S. approached the limits on the amount of we could borrow, Congress merely kicked the can down the road, agreed to increase the U.S. government maximum borrowings (which now stands at $16.394 trillion), and at the same time established a Joint Select Committee on Deficit Reduction that was commissioned to come up with a combination of spending cuts and tax increases to limit future deficit growth.  The committee of six Democrats and six Republicans concluded that there was no way to come up with a partisan agreement  This triggered predetermined spending cuts as of midnight, December 31, 2012.  This set the stage for automatic spending cuts of $1.2 trillion across-the-board (known as sequestration).  These cuts are not equally distributed, as defense spending will bear one-half the total cut.

The estimated 2012 GDP (as of Q2, 2012 by the Bureau of Economic Analysis) was $15.6 trillion.  For the first time in more than five decades, U.S. government debt exceeds the total value of all goods and services produced in the entire country.  [These are fiscal year numbers which run from October 1 through September 30.] 

We now approach the so-called fiscal cliff where spending cuts automatically will occur unless the lack-of-leadership in the District of Columbia does something. At the same time, multiple tax cuts are scheduled to expire, resulting in a significant impact to consumer and business America’s spending abilities, which will further stifle economic growth. 

Assuming the D.C. gang does nothing (or even if they just once again kick the can down the road), here’s what will happen as of 12:01 a.m. on January 1, 2013 (or some pending date):

  • Terms of the Budget Control Act of 2011 are triggered, which will see $600 billion in reduced defense spending alone over the next 10 years–and remember that an estimated 70 cents of every defense dollar goes to small- and medium-sized supply and service firms in the United States.  Not only will the number of military personnel be impacted, but businesses across the country will see a significant retraction in revenues.  Just for Massachusetts alone, this cut is estimated to cause a loss of 30,000 to 40,000 defense-related jobs.  Secretary of Defense Leon Panetta calculates the total cut to defense spending of $1 trillion in next ten years as he includes cuts already pending in future budgets given planned withdrawals from existing military operations.
  • An added $600 billion in spending cuts (again over 10 years or $55 billion per year—these cuts also reduce interest on the debt) will impact all other federal government domestic spending programs—but not necessarily equally.  Exempt are Social Security, Medicaid, food stamps, federal employee pension funds and veteran health care.  Medicare is limited to a 2 percent cut—but with a current budget of $500 billion for 2012, a 2 percent cut tallies $11.1 billion per year, or more than a trillion dollars in the coming decade—and that’s a lot of money.

Since no partisan solution was available, it is expected that the President would veto any extension of the tax cuts, resulting in increased taxes as follows:

  • Elimination of the temporary payroll tax cut of 2 percent from every employed American.  That is really substantial—but Social Security is eventually headed to insolvency, so the tax itself merely expedited that track.
  • Elimination of the 2001 and 2003 Bush tax cuts which benefitted both individuals and business America (costing a combined $265 billion per year in increased tax collections—or $2.65 trillion in the coming decade).

Macro Economic Advisers and Citi Research have estimated the following impact on reduced spending by the government (read that as increased taxes and/or reduced revenues to individual and business America). These are annualized since the spending cuts plus tax increases commence on January 1 while the fiscal year starts October 1.

 

 

 

 

 

 

 

 

What these numbers indicate is that, given a U.S. value of all goods and services in 2012 of approximately $15.6 trillion, individuals and businesses in America in the 12 months following the fiscal cliff would keep $808 billion less in their pockets or what they would received in top-line revenues.  That means that GDP would decline by 4 to 5 percent.  Since GDP growth in the past 12 months was 2 to 4 percent (depending on which data series you select), then the U.S. would be, by definition, back in recession.   [I think we are still in a recession as I do not buy into the argument of the jobless recovery—but that’s a blog perhaps for another day.]

While the predictions are dire if the fiscal cliff is reached (ranging from a slide back into recession to a 20 percent sell-off in the stock market), few truly believe that, regardless of the election outcome, Congress and the President would allow this to happen.  But no change means a continuing growing debt.  The current  estimate by the Congressional Budget Office is that the annual interest expense on the debt could reach $1.3 trillion by 2022 (compared to $438 billion in fiscal year 2011),

Add to that that an estimated 47 percent of tax filers this past year either having paid zero taxes or paid zero taxes and got money back, tax reform is critical.   But that would take leaders in Washington, DC, and, unfortunately, I simply see few there today.

In real estate terms, we are becoming less credit worthy (and eventually will not qualify for a loan even though we could have in the past), and our loan modification is more cosmetic than substantial—and we hope it does not re-default.

Tell me what you think.

I wrote this in response to a wave of questions.  If you have a solution, please comment back.

Ted

Comments

  1. David Martyn

    Enjoy the blog, and your talk in Chicago. I was left with 2 very related thoughts. First – Care to address the private vs. public sector employment issue? From what I understand, currently the substantial drag on overall employment is in the public sector, meaning government jobs (which include teachers, police, fire). So reducing government spending will lead to less government employment, which will in turn continue to have a negative impact on overall employment figures and contribute to the so-called jobless recovery. (I’m not arguing good or bad on all this, just recognizing it as a factor).

    Second – I’m not an economist, but based on what I’ve seen in my lifetime, it’s a rare occurrence that the rising water lifts all boats. The mantra that reducing taxes spurs the economy, which in turn will generate more revenue for the government than the taxes did, seems to have not been borne out by real world experience. My guess is that it did happen in the 90′s when Clinton was president, but I would also guess that had more to do with the tech bubble than with anything the government did. Isn’t the answer to the debt problem glaringly obvious: Raise taxes and reduce spending? And both are necessary?

    Thanks.

    1. Joan Hicklin

      Thank goodness (watching FOX and weighing against main line UGH media) a lot of what you write we follow. Your giving more information of the actual change we will see (going over the cliff) is great and the debt ceiling and the US credit rating.
      My question from a broker-owner of the office and for my clients (important for sellers and buyers) What is bottom line taxable income to affect Capital gains tax and what is the tax table “IF” we go over the cliff and my understanding from taxes prior to the Bush Tax cut, the seller paid this with their annual taxes for that year. 2013 Cap. Gain paid April, 2014.

      2nd question: When will Stewart start collecting the sales tax on property sales and at what rate???

      3rd Question to you great information source. Throwing around the $ 250,000 amount all over the place but not once have I heard – Is that Gross Income or bottom line – Taxable income Net? Everyone filing long form still using the various loopholes out there.

      Thank you so much – sorry for the epistle, Joan Hicklin, concerned citizen and R.E. broker in CO since 1981 (many ups and downs!) (10 years in California Bay area)

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