US Politics & Economy: Explaining Washington's Dangerous Game of Chicken on the Debt (First, Look at the Tax Cuts)

Photo: Jewel Samad (AFP)The game of chicken is underway, thanks to US President Barack Obama (Democrat) and Speaker of the House of Representatives John Boehner (Republican). Last night, Obama and Boehner both pointed fingers, talked about the dangers of default, and claimed that the other is reckless and not working hard enough to pay off the Federal Government's deficit. At the end of the day, these two men are really the drivers of speeding cars set to collide, and neither is willing to serve

Boehner represents the newest version of the philosophy that trickle-down economics creates jobs and taxes should not be raised on the "job creators" of corporations and those making more than $250,000 a year. Obama embodies the attempts to reverse tax cuts for the wealthiest 2% of the population, since those tax cuts have expanded the deficit, have not created jobs, and have widened the wealth disparities.

At the end of the day, while liberals will push back against deep cuts in "entitlements" and conservatives will complain that cuts are not deep enough, these issues are not the reason why we have not seen compromise. The debate on taxes is the singular issue that is almost solely responsible for the stalemate that could lead the US to default on its debt.

The first question: "Can we afford to pay off this debt without raising the debt ceiling, the maximum amount of debt that the US Government can borrow?" The debate has already almost assured that our credit rating will be reduced, as Doug Holtz-Eakin, former economic adviser  to John McCain and currently President of the right-wing American Action Forum, explains why the debt ceiling needs to be raised:

So why hasn't the debt ceiling been raised already? The Republicans in Congress have refused to raise the debt ceiling without making substantial cuts to government spending. The Democrats refuse to make substantial cuts without also increasing revenues --- by closing tax loopholes, by ending subsidies to certain industries like the big oil companies, by raising taxes on the wealthiest Americans, or by a combination of those options. The President refuses to pass a short-term bill that puts off the debate, and he refused to invoke the 14th Amendment ("the validity of the public debt of the United States, authorized by law ...shall not be questioned") or make a move that would raise the debt ceiling without also making the cuts.

In other words, for better or for worse, this debate has come down to the wire because of taxes.

Let's crunch some simple math to find out how we got here. The chart below depicts the result of new-initiatives under both George W. Bush and Obama. It is not designed to be partisan (it was created by the Congressional Budget Office), but to show that Washington's accounting has been deeply flawed for many years:

So, the chart shows that the Wars in Iraq and Afghanistan are as expensive as all of Obama's spending (even if we ignore the report from the Eisenhower Research Project that calculated that the true cost of the wars is over $4 trillion, not $1.5 trillion).  However, the further distinction is that George W. Bush is the first president in the history of the United States who went to war without passing a special tax to pay for it. The Bush tax cuts are even more expensive than the war.

Obama's contribution to the debt is limited by comparison. On his watch, the stimulus was the single biggest line-item, and that is not a continuing program.  Health reform is a tiny line on this graph, is smaller than the prescription drug plan passed under Bush, and is almost entirely paid for by cuts in defence. And Bush's stimulus spending, passed by many Republican members of the current Congress, accounts for more than 50% of the expenditure since 2001.

These facts are not to blame Bush or pass the buck but rather to learn from his record and to advance the discussion. Combine these factors with the loss of revenue due to the recession and the interest payments on the debt, and we get our current budget reality.

The Atlantic features a chart that clearly shows that if we could erase the wars in Iraq and Afghanistan, the Bush-era tax cuts, the economic downturn, the TARP-Fannie-Freddie bailouts of the financial sector, and the recovery measures, then the current deficit --- and most of the deficit projection for the next 8 years --- would be zero or close to zero. In other words, the deficit does not have much to do with some sort of socialist-spending binge, but is the result of bad ideas (two unfunded wars, tax cuts for the wealthy) and bad times (the economic collapse and the efforts to stabilise the economy).

So, the question now is what to do with this information. The first step in this process is to ask whether the tax cuts actually created jobs:

There is no real evidence that the tax cuts for those making over $250,000 has increased the amount of money in the US economy or created jobs at home. Furthermore, from 1980-2011, the tax burden has shifted, the middle class has paid more, the rich have paid less, and wealth disparities have increased dramatically. And still, no job creation.

The next important thing to realize is that no matter who you blame (Bush, Obama, Clinton, Reagan, terrorists, bankers, or aliens from space) there is only one realistic path towards getting rid of the deficit. Decrease costs and spending, and increase revenue:

A few lessons can be drawn from the numbers. First, the Bush tax cuts have had a huge damaging effect. If all of them expired as scheduled at the end of 2012, future deficits would be cut by about half, to sustainable levels. Second, a healthy budget requires a healthy economy; recessions wreak havoc by reducing tax revenue. Government has to spur demand and create jobs in a deep downturn, even though doing so worsens the deficit in the short run. Third, spending cuts alone will not close the gap. The chronic revenue shortfalls from serial tax cuts are simply too deep to fill with spending cuts alone. Taxes have to go up.

It is important to note that, while taxes are the current dividing line, these two political parties have been on a collision course for quite some time, and this debate is unlikely to end this problem.  Philip Balboni of the Global Post sums it up concisely:

There is a growing realization here in the United States that as a result of all of the above factors (a near-recession economy, unfunded wars, an aging population, and a revenue drought) the United States has failed for too long to invest in the country’s infrastructure — both physical and intellectual. As a result, America is losing much of its future competitiveness in the global economy. Is something fundamentally wrong with America? Yes. Will a resolution of the current debt ceiling crisis resolve the real problems facing the country? No, it will not. America has a deep political malaise. Seldom before in the nation’s history have the two main parties been so bitterly divided and so unable to find common ground in the national interest. Average Americans are worried and deeply frustrated. Many are angry.

The bottom line is that the US needs to cut debt, raise revenue, and increase jobs.

To take this a step further: the US economy has undergone a fundamental shift from manufacturing to technological development. However, amidst tax cuts, war, and recessions, funding for science has been cut significantly. This in turns the US position as a developer of new technology, one important factor for the future American economy, as teachers are laid off and the costs of higher education rise.

The private sector has failed to pick up the slack. The rest of the developed world has moved towards increased subsidies for innovation --- not oil wells but green tech, not tax breaks but funding for science --- and higher education. It has invested in government-supervised health care to control costs because the private sector has failed to limited rising health care expendtiures, and it has increased investment in "infrastructure", broadly described as systems that benefit the entire country (bridges that don't collapse, internet and cell phone networks).

These programmes work. In the 1950s, ancestors of these programmes built the United States into the leading power in the world. But these programmes require money, and that money needs to come from the people who can most afford it.

This, however, is logic, and right now the American conversation is being driven by fear, creating a further crisis in the attempt to solve the initial one.  That fear is embodied in the idea that Obama is driving a far-left social agenda and a tax-and-spend socialism, and in the belief that taxes cannot be raised without killing the American economy. But President Reagan raised taxes 11 times, including during a recession, and Obama has cut taxes. Reagan raised the debt ceiling 18 times, and Obama is trying to pass a plan that will only require him to do it once. President Eisenhower stimulated the economy by subsidizing higher education and by building infrastructure, but today he would be considered a socialist for his initiatives. Fifty years later, taxes are at an unrealistic historic low, much lower than they were under all Republican administrations.

The fear is unfounded. The taxes are too low, the debate has gone on too long, and it is time that the Republicans compromise on revenue so that the nation is brought into line with what all of the facts are telling us.