Fiscal Cliff, What Fiscal Cliff? The Hot Button Issue Obama and Romney Refuse to Touch in Election 2012

Monday’s presidential debate was the last pitch to voters from both President Obama and Governor Romney on who they should vote for in November. In the first two debates, both offered economic plans which focus on shoring up the tax base and reducing wasteful government spending; however, the means in which these plans would be accomplished couldn’t be more different. It is important for voters to consider how these plans differ. The final debate outlined each candidate's view on foreign policy and the future of the nation’s defense program. Regardless of who wins the White House, voters will feel the effects of Washington as they attempt to scurry together in the final hour to avoid a plummet off of the not-so-distant fiscal cliff the United States economy is headed toward. So watch closely, the decision that voters will make in a few short weeks will determine the direction of the economy.

Governor Romney seems to believe that spending cuts, including tax deductions such as the earned income credit and mortgage deduction, along with a slew of other cuts, can save enough revenue to extend the Bush ear tax cuts. The Governor believes that a smaller government is better government. It would therefore be safe to assume that no government agency would be off the chopping block.

On the other hand, President Obama is proposing tax increases for the top 3% of taxpayers who, according to Governor Romney, already pay 60% of all federal tax revenue. The President's plan is much heavier on investment in infrastructure, clean energy, and education while cuts in defense, rather than popular social programs, will be used to fund these policies. This is yet another case of the battle between differing economic philosophies.    

A Lesson Learned

In my last article titled Obama vs. Romney: The Economic Debate They Do Not Want to Have, I offered an argument on how legislators here in the United States could learn from the fiscal policy mistakes of Greece, Italy Spain, and the broader currency union of Europe, commonly referred to as the euro-zone. The analysis helped illustrate the effects of fiscal austerity measures on the broader economies of Europe through which a reduction in government spending and increased taxes damaged overall domestic demand and magnified Greece’s economic turmoil, which resulted in a spike in unemployment and significant reductions in GDP for the period between 2010 to August of 2012. Moreover, I also described the self-inflicted harm induced by the European Central Bank’s focus on debt, rather than growth and stimulus which played a central role in Greece’s intensified economic downturn. The takeaway from the article is the importance of avoiding tax increases and simultaneous spending cuts during an anemic economic recovery, which will likely lead to a European-style reduction in growth.

To help compare Europe’s problems with those of the United States, I turned focus to the lack of integration between the European Central Bank and the governments of Spain, Italy, and Greece, and how much of the need for effective political direction mirrored closely what we saw in last year’s debt crisis debacle. While acknowledging the fact that the European debt crisis has some important differences, it remains unclear how severe the effects of cuts in government spending and increased revenues were on Europe, more specifically Greece. Yet, much of these realities remain relatively unfamiliar to voters and the broader American public. The larger issue of our advance toward a “fiscal cliff” still remains ill addressed in today’s minute-by-minute news coverage.

The term “fiscal cliff,” said to have been coined by the current Chairman Federal Reserve Chairman Ben Bernanke, refers to the spending cuts and expiration of the Bush era tax cuts, extended by president Obama, which will be triggered early next year as a result of the terms set forth in the Budget Control Act (BCA) of 2011. The BCA was a policy was supposed to compel lawmakers to work together and solve the country’s increasing debt burden. Instead, the policy bought Washington enough time to focus on their reelection campaigns. This ‘kicking the can down the road’ strategy has become all too characteristic of Washington in recent years. As the ever-expanding reality of Washington’s policy paralysis spreads, the Federal Reserve appears to be the only adult in the room in recent years.

In his statements earlier this year, Chairman Bernanke outlined the lack of initiative on the part of Washington to come together to implement much needed fiscal reforms:

“The most effective way that the Congress could help to support the economy right now would be to work to address the nation’s fiscal challenges in a way that takes into account both the need for long-run sustainability and the fragility of the recovery,” Bernanke said at a Senate Banking Committee hearing in July.

Since then, Bernanke continues to reassure markets by openly acknowledging that interest rates will remain low for the near term and that the Fed’s continuing purchases of treasury and mortgage backed securities, also known was quantitative easing (QE). Positively received by the private sector, markets continue to hold strong and growth in investment appears to be relatively stable as the S&P 500 inched closer to its 5-year high in early October.

Today

It’s no secret that lawmakers on both sides of the isle have punted their policy initiatives until this year’s election results are in. With each of the presidential campaigns in full swing, it’s no surprise to see representatives clamoring for last minute donations. Making sure they ascend every soapbox, shake every hand, our politicans are focused on votes for the moment. Naturally, the idea of governing seems much less urgent, even with a potential crisis looming in the nation’s periphery.

For some, hoping to capitalize on the tightening of the score resulting from President Obama’s lackluster performance in the first of three presidential debates appears to have rejuvenated Romney camp and its supporters. However, recent polling data suggests that the presidential race is in a dead heat. These debates appear to have succeeded in attracting increased attention to our country’s political discourse. But rather than seizing the moment in an attempt to offer a genuinely new platform, both candidates reverted back to their cold war era arsenals of pre-rehearsed policy responses, rhetorical scuds, and their fair share of –albeit – old ideas at a time when new ideas seem to be the only hope. Most of the debate was effectively reduced to stock responses aimed at the run-of-the-mill issues like Medicare, Social Security, taxes, energy, and defense. The fiscal cliff debate has yet to be had. It’s true; one of them will be behind the wheel after November, but which one has to ability to unite congress and avert the plummet off the cliff?

Tomorrow

If these measures are left unaddressed, there’s no doubt that it will jolt the economy in such a way that could likely plunge the United States back into a recession. A report published by the Congressional Research Service in September titled, "The “Fiscal Cliff”: Macroeconomic Consequences of Tax Increases and Spending Cuts,” outlines some of the potentially dire consequences resulting from a lack of action. Based on the report’s estimates, the projected unemployment rate for the fourth quarter of 2013 could reach 9.1%, reversing the gradual downward trend in our nation’s unemployment rate which currently stands at 7.8%. The report goes on further, acknowledging the fact that much of the political stalemate is a product of disagreement over what to cut in the Federal Budget and where to find new sources of revenue.

Further, the International Monetary Fund’s World Economic Outlook (WEO) Report released earlier this month revised their global outlook and reduced their global growth projections for next year. This report points to severe risks associated with the potential materialization of draconian cuts and tax hikes mandated in the BCA, and its likely effects on the broader global economy. The WEO report remains cautiously optimistic in there prognosis of the global economy:

“A key issue is whether the global economy is just hitting another bout of turbulence in what was always expected to be a slow and bumpy recovery or whether the current slowdown has a more lasting component. The answer depends on whether European and U.S. policymakers deal proactively with their major short-term economic challenges. The WEO forecast assumes that they do, and thus global activity is projected to reaccelerate in the course of 2012; if they do not, the forecast will likely be disappointed once again.”

Reiterating much of what the Fed had to say, the ball remains clearly in the court of policy makers in the United States and abroad. It’s no secret that in years past Washington has prided itself on coming together in the final hour. With two battling economic ideologies, voters will have to make a choice and decide who they would be more comfortable with behind the wheel.

The Take Away

The central problem in this political conundrum is that both Democrats and Republicans have failed in prior attempts to be bipartisan in recent years. Spending cuts and tax lower taxes seem to be a desirable outcome for the Romney camp and conservatives, although, Democrats will likely oppose such measures. Conversely, a more tested Keynesian approach, like increased government transfers and spending on infrastructure, a forgotten approach ever since the emergence of Friedman’s freshwater “market efficiency,” would also be off the table unless Democrats somehow squeeze out a majority in both the House and Senate in November. Of course, neither of these approaches would ameliorate our bloated debt problem resulting from the financial crisis, amongst other things.

Both candidates have clearly communicated their ideological differences throughout each respective campaign. While President Obama is offering somewhat of a middle of the road approach, preserving the 2% payroll tax cut for Americans making under $200,000 per year and families under $250,000 annually, allowing marginal tax rates to revert back to Clinton era levels, and emphasizing on the need for more infrastructure and education spending, his opponent is offering something much different. Romney’s approach seems to be much heavier on cuts in social programs, tax deductions, and education.

The question remains: “Who would you prefer behind the wheel of a U.S. economy that is rapidly approaching a fiscal cliff?” With Greece in the rear view mirror, we must not forget how lack of action will only result in a heavier foot on the gas pedal.