WSJ Video: David Wessel On The Fiscal Cliff

OK, enough naval gazing.  Now that the dust has all but settled on the election and all the races … federal, state, local … grind down to finality, we can all get back to business.  And there is not a moment to spare.

Political discourse is already taking a sharp turn to budget deficits, rapidly mounting national debt and the fiscal cliff, a conversation in which politicians with different views often use the same words but mean different things.  The issues are daunting enough without the verbal sludge of ideological spin bogging down the debate.  Clarifying the language will do much to clarify the problems and simplify the range of possible solutions.

The Wall Street Journal’s David Wessel reports.  Sorry, but a 15 second commercial may run first.

If you need a “decoder” to all the political gibberish, this one from the Wall Street Journal is pretty good.  It was written just prior to the election so ignore the references to Romney.  Think instead about how the Democrat Senate and Obama’s White House will manage a compromise with the Republican House.  Think for a long moment about what happens if that compromise turns into a standoff.

Here’s a decoder:

Tax Increases

Barack Obama (and Democrats in general) favor raising taxes on the top 2% of American taxpayers. Raising their marginal rate—the additional tax on every additional dollar of income—would increase tax revenue flowing to the Treasury, he says.

Mitt Romney (and Republicans in general) oppose raising tax rates. He would lower them and offset the forgone revenue by curbing deductions and loopholes. That overhaul of the tax code, he argues, would yield faster economic growth. The more growth, the more tax revenue for the Treasury.

Here’s a way to think about it: This year, you earn $1,000 a week. Let’s assume the economy picks up and you get a raise. Next year you earn $1,050 a week. You pay, say, $12.50 a week more in federal income taxes because you had more income. That means more tax revenue for the government. It doesn’t mean that the government increased your taxes. This is what Mr. Romney has in mind when he talks about boosting tax revenue.

 

Table 1: Tax Changes Taking Effect January 1, 2013

Tax Change

Tax Increase (2013 over 2012)

Expiration of the 2001-03 tax cuts (not including estate)

$156 billion

Expiration of the payroll tax holiday

$125 billion

Failure to patch the Alternative Minimum Tax

$88 billion

Expiration of business expensing

$48 billion

Expiration of other “tax extenders”

$40 billion

New PPACA (Obamacare) taxes

$36 billion

Expiration of the 2009 stimulus

$11 billion

Estate tax increase

$10 billion

Total, Tax Increases

  $514 billion

Source: Tax Foundation; Congressional Budget Office; Joint Committee on Taxation; Office of Management & Budget.

 

Consider an alternative: This year, you earn $1,000 a week; next year, the same. But Congress increases tax rates, and you end up paying $12.50 a week more in income taxes. By any definition, that is a tax increase. Mr. Obama wants to raise tax revenue, too, and undoubtedly hopes that business picks up so that you will get a raise. But for those with annual incomes above $250,000, he favors a tax-rate increase, raise or no raise.

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Debt and Deficits

The federal deficit is the difference between government spending in a given year and the revenue it collects. It is akin to a family spending more than it earns, and putting the difference (its deficit) on the Visa card. The federal deficit for the 12 months of fiscal year 2012, which ended Sept. 30, 2012, was $1.089 trillion. To compare with the past, economists measure it as a share of the gross domestic product, the value of all goods and services in that period. The 2012 deficit was 7% of GDP, less than in each of the three previous years but more than any other time since the end of World War II.

The federal debt is the sum, on a given date, that the government owes, the accumulation of past annual deficits. It is the balance on the national Visa card. At the end of fiscal 2012, total government debt outstanding came to $16.07 trillion, or 103% of GDP, including the Treasury bonds in the Social Security and Medicare trust funds. (That’s a bit like putting IOUs in your kid’s college account and counting them as part of your total personal debt. You may consider that money you owe, but it’s qualitatively different from what you owe on your mortgage.)

To gauge the economic impact of the federal debt, most experts exclude the sum that one arm of the government (Treasury) owes another (the trust funds).

This metric, “debt held by the public,” at the end of fiscal 2012 came to $11.27 trillion, or 72.5% of GDP—higher than at any time since the end of debt-financed World War II. Just 10 years ago, it was 33.6% of GDP.

A basic test of any deficit-reduction plan: Does it stabilize debt as a percentage of GDP?

Fiscal Cliff

In August 2011, Congress and Mr. Obama promised to find a way to reduce projected deficits by $1.2 trillion over 10 years. To compel themselves to act, they passed a law that cuts spending across-the-board in January 2013 unless they agree to an alternative. This date coincides with the expiration of a slew of tax cuts, which would mean tax increases for nearly everyone. This is the “fiscal cliff.” Federal Reserve Chairman Ben Bernanke often is credited with this description. He said the words in congressional testimony in February, but a Reuters story published before he spoke said “some on Capitol Hill” beat him to it.

For 20 years or more, budget wonks have used “fiscal cliff” in a different sense, referring to longer-term deficits caused by an aging population.

A big post-election question: Will Washington steer away from the fiscal cliff before year-end?

Baseline

Deficit commissions and politicians often talk about their plan to cut the deficit by, for instance, $4 trillion over 10 years. The cognoscenti ask: Compared with what?

What “baseline” projection for spending and taxes are you measuring your plan against? Do you assume that the Bush tax cuts will expire at year-end, bringing in lots of revenue, or do you assume that they will be extended, leaving a big revenue hole?

In these arguments, the choice of baseline matters.

The deficit-reduction plan crafted by Alan Simpson and Erskine Bowles, they say, calls for $3 of spending cuts for every $1 of tax increases. They began, though, by assuming Mr. Obama prevails and boosts tax rates on the over-$250,000 crowd—and then proposed tax increases on top of that, which makes the tax-increase-to-spending-cut ratio look smaller.

Savvy observers frequently ignore often-inflated multiyear deficit-reduction boasts, and instead look at the deficit any proposal projects, say, five or 10 years out. That is less susceptible to baseline finagling.

When the talk turns to the federal budget, listen very carefully.

 

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