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FISCAL “CRISIS”: POLITICS AND ECONOMICS

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FISCAL “CRISIS”: POLITICS AND ECONOMICS

Dancing to the music of time

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TAGS: ***** usaonly. policy politics. economy, Fiscal Crisis.national. shortrun, midrun, longrun. commentary, analysis. background. [Asterisks indicate importance. Small caps indicate general categories. Within them, Initial Caps indicate a specific topic.]

FISCAL “CRISIS” 1

Scenarios 1.1

Accomplishments 1.2

Failures 1.3

POLITICS 2

Shortrun partisan strategy 2.1

Midrun “regime shift” 2.2

Longrun Constitution 2.3

ECONOMICS 3

Shortrun recovery 3.1

Midrunchange 3.2

Longrun growth 3.3

GREETING

HAPPY NEW YEAR to all readers. THANK YOU to Caixin for inviting this Blog to its website.

I will strive to achieve the MISSION of this Blog:

First, call the attention of Chinese readers to the best COMMENTARY on American politics in the American media.

Second, relate that Commentary to the best ANALYSIS in academic research on American politics, particularly explanations.

Third, relate both of those to relevant EVALUATION, whether through elite frameworks or mass sentiments.

THIS POST

This week we focus on America’s turn-of-the-year fiscal crisis, relating much media Commentary to a little academic Analysis. The first section on FISCAL CRISIS summarizes the basic fiscal and political problems involved and how they were or were not solved. The second section unravels some of the POLITICS involved, at varying time scales. The third section provides some of the ECONOMIC background of America’s fiscal difficulties, again at varying time scales.

America’s fiscal crisis is a complex subject, so this is a long Post. It provides BACKGROUND, not only for the partisan battle over how to avoid the recent “Fiscal Cliff,” but also for more battles over the same issues in coming months and years. The many media comments on this episode add up to a detailed account, but are difficult to assemble and are subject to partisan simplification. Accordingly, this Post begins by summarizing that journalistic Commentary and only gradually shifts toward more academic Analysis. Readers are welcome to proceed only as far as their interest carries them. (For further BACKGROUND, readers may wish to consult a previous Post on this Blog: 121201 “The politics of “fiscal crisis.”)

A first theme of this Post is that partisan POLITICS drives policy-making more than does the substance of policy. In economic policy-making, political logic often overwhelms economic logic. A second theme is that the particular current configuration of American politics tends to turn problems into CRISES. In American policy politics, “crisis” is becoming the new “normal”. A third theme is explicit attention to TIME as a dimension of policy politics. Time is intrinsic both to the substance of policies and to the strategies of politics through which policies are formed. Both policy and politics involve interactions between shortrun, midrun, and longrun (“inter-temporality”). Overall, the main temporal contradiction is between shortrun political advantage and longrun economic benefit. However, we also note temporal contradictions within politics and economics.

(The New York Times collects its articles on the Fiscal Cliff – along with links to relevant resources – under Federal Budget in its Times Topics at topics.nytimes.com. For general literature on American fiscal politics, an expert and accessible introduction is David Wessel 2012 Red ink : inside the high-stakes politics of the federal budget. New York : Crown Business, 204 pages (using 2011 as example). A competent textbook is the similarly titled Gary Evans 1997 Red ink : the budget, deficit, and debt of the U.S. government. San Diego CA: Academic Press, 297 pages. An incisive analysis is Simon Johnson and James Kwak 2012 White House burning : the Founding Fathers, our national debt, and why it matters to you . New York NY: Random House, 268 pages. An history is Dennis S. Ippolito 2003 Why budgets matter : budget policy and American politics. University Park PA: Pennsylvania State University Press, 329 pages. On a formative period, see Jonathan Kahn 1997.Budgeting democracy : state building and citizenship in America, 1890-1928. Ithaca NY: Cornell University Press, 222 pages. On recent decades see Iwan Morgan 2009The age of deficits : presidents and unbalanced budgets from Jimmy Carter to George W. Bush. Lawrence KN: University Press of Kansas, 375 pages.)

FISCAL “CRISIS” 1

As readers know, approaching the end of 2012, America was approaching a “Fiscal Cliff”: an already scheduled combination of sharp rise in taxes and sharp fall in spending. Those drastic changes did not result from a crisis in the real economy. They were an artificial punishment that in 2011 American political leaders had scheduled to force themselves to compromise on fiscal policy in 2012. Nevertheless, failure to meet this artificial challenge would put the real economy back into recession. (For an acerbic critique of this episode, see Paul Krugman 121230 “Brewing up confusion” at nytimes.com. Also Clive Crook 130102 “When governing means lurching between phony crises” at bloomberg.com.)

Most liberal commentators deplore both the political process and its policy outcome. Some very liberal commentators say the policy outcome is not too bad but that strategic situation in which the negotiating process leaves Obama is disastrous. Most conservative commentators deplore the policy outcome (higher taxes but not lower spending) and defend the confrontational political process as necessary – in the face of potential future fiscal catastrophe – for pursuing any and all possible means to cut spending. A rare positive view of the legislative process that produced the Cliff Deal sees democracy prevailing over usually anti-democratic conduct of congressional business (Steven Pearlstein 130102 “Congress tries democracy for a change!” on Wonkblog at washingtonpost.com.)

Before plunging into details, let’s OVERVIEW both policy and politics. On the POLICY side, the main argument is between radical conservatives and moderate liberals over how to manage America’s longrun TOTAL DEBT. Conservatives call for drastic action in the shortrun, liberals for gradual adjustment over the midrun.

The radical-conservative analysis views America’s longrun total debt with deservedly great alarm. Debt is currently about 23% of GDP and currently growing faster than GDP. So the DEBT/GDP RATIO is rising. If debt continues to grow at the current rate, within a few decades it could reach 40% of GDP. That will make us into “Greece,” the current exemplar of an unsustainable situation from which there is no easy escape. Any current strategies to avoid such a future national catastrophe are justified. These include using any and every issue in the current fiscal crisis as leverage to force reduction in spending. Conservatives should demand spending cuts in exchange for again raising the Debt Limit and, if it does not get such cuts, should threaten to allow the country to DEFAULT on its debt obligations. Obama and the Democrats have already raised taxes, so all further debt reduction should come from decreasing spending. As quickly as possible, the USA should totally restructure existing social programs to remove them from the national government budget. (Such arguments, much data, and other specifics are available at a website of the very conservative Cato Institute, downsizinggovernment.org.)

The moderate liberal response is that what the USA needs to do is, over the next ten years, achieve a sustainable relationship of total debt to GDP. Getting there requires that debt grow slower than GDP, so that debt gradually falls as a proportion of GDP. That requires a total of about $3.3 trillion in debt reduction over the next ten years, during which total GDP will be about $200 trillion. Of the $3.3 trillion needed reduction, $2.1 trillion have already been achieved: $1.5 trillion in spending cuts during the August 2011 negotiations over raising the Debt Limit and $0.6 trillion in tax increases in the Cliff Deal just passed. So we need only another $1.2 trillion in debt reduction, notionally half from spending cuts and half from tax increases. Although that will be painful and difficult, a rational congress should be able to do it. If so, of the $3.3 trillion in debt reduction, $2.1 trillion will have come from spending cuts, and $1.2 trillion from tax increases. If, as the Republicans now demand, all further debt reduction comes from spending cuts, then $2.7 trillion will have come from spending cuts and only $0.6 trillion from tax increases. (See Jared Bernstein 130106 “A little table (or two) showing why we’re neither Greece nor in need of default” at jaredbernsteinblog.com. That Post contains links to longer analysis supporting that argument and that Blog contains earlier Posts on the Fiscal Cliff crisis. Jared Bernstein formerly was economic advisor to Vice President Joe Biden and is now at the liberal Center for Budget and Policy Priorities.)

On the POLITICS side, a main disappointment is that it took American politicians so long and such effort to arrive at a policy outcome on which they all agreed from the beginning: taxes should not rise on the American middle class. Commentators expect policy outcomes to be even harder to reach about issues on which the parties actually disagree, such as whether to cut spending on defense or on social programs. To understand why political conflict over the Fiscal Cliff exceeded the actual extent of policy disagreement, commentators use a variety of explanations.

Most commentary involves an IDEOLOGICAL EXPLANATION: That Republicans have become increasingly radical in their conservatism and are not interested in compromise. Politicians in both parties have become more uncompromising because, through redistricting, their constituencies have become safer and more homogenous. Some commentary also involves a GENERATIONAL EXPLANATION. When formerly the views of the two parties overlapped, older politicians experienced the advantages of compromise. Now that the views of the two parties do not overlap, younger politicians have not had experience at compromise and perhaps never will. Most commentary relies also on an INSTITUTIONAL EXPLANATION: to prevent rash action, American institutions deliberately fragment and delay decision-making. Most observers think the Fiscal Cliff takes that too far. A more STRATEGIC EXPLANATION is that the various sides were exploring all possibilities for taking apart or putting together the various policy elements involved. Of course they were doing that for their own partisan purposes, but the effect was to consider a lot of alternatives. The strategic explanation may be paralleled by an ANALYTICAL EXPLANATION. The most advanced formulations in American political science argue that, under certain analytical conditions, decision processes are inherently chaotic. Under those conditions, the main things that makes any decisions possible at all are institutional rules.

With that overview in hand, we continue by noting the range of possible scenarios that the recent Cliff Crisis involved. The same range will apply to the several more fiscal crises that will erupt in coming months and years. Indeed, that range of scenarios could apply to any policy crises that American politics creates. That includes crises that result from linking resolution of fiscal crises to solving other problems – such as the upcoming issues of gun control, energy, and immigration. In other policy domains, the specific policy items will be different, but the range of policy packages and political processes will be similar. A classic academic formulation of this range of scenarios contrasted “synoptic” policy-making – which overviews all aspects of a matter at one time – with “incremental” policy-making – which addresses problems piecemeal over time. That author thought incremental policy-making more feasible and effective. (See Charles Lindblom 1959 “The science of 'muddling through'. Public Administration Review 19, 2 (Spring) 79–88.)

Scenarios 1.1

In late 2012, the range of SCENARIOS for avoiding the Fiscal Cliff included the following.

(See Carrie Budoff Brown and Jake Sherman 121112 “5 fiscal cliff scenarios” at politico.com.)

At one end was a comprehensive agreement in late 2012 on all the main fiscal issues for early 2013: increasing TAX, cutting SPENDING, raising the DEBT LIMIT, authorizing the annual BUDGET and, in the long run, reducing America’s cumulative TOTAL DEBT. A comprehensive agreement would have been an exemplary policy process, hopefully leading to wise policy.

At the other end of the spectrum of possibilities was simply “going over the cliff” of the arbitrary 31 December deadline, without resolving ANY of these issues in 2012 or establishing ANY common FRAMEWORK for solving them in 2013. That would have revealed a completely DYSFUNCTIONAL policy process that produced no policy at all.

In between were various possible combinations of (1) resolving some issues but not others and (2) for the unresolved issues, creating or not creating a framework for addressing them. There was also the possibility of aggregating issues into packages and treating them together, versus the possibility of disaggregating packages into single issues and treating those sequentially.

Most observers of the current congress predicted a relatively dysfunctional policy process that would, nevertheless, produce some policy result in the end. Congress would do what it usually does: as little as possible until as late as possible, then do the minimum necessary to avoid crisis. Expecting congress to try to do just that, a few canny observers added that the only way the USA would actually “go over the cliff” was through one side or the other making a tactical miscalculation in the final stages of bargaining. Nevertheless, as it became clear that the “cliff” was only a “slope,”an increasing number of observers predicted that the deadlocked sides would simply “go over” it.

Those observations correctly anticipated the PROCESS that actually occurred. Policymaking remained deadlocked even until shortly AFTER the deadline had already passed. The process was made even more messy and uncertain because key actors DID made tactical miscalculations, For example, approaching negotiations with Obama, House Speaker Boehner miscalculated the firmness of Obama’s determination to raise taxes on the rich – in Obama’s plan, all income over $250,000. Attempting to adjust for that miscalculation, Boehner proposed an alternative plan, but miscalculated his ability to obtain House Republican support for it. Breaking recent Republican principles, Boehner’s plan allowing taxes to rise, but only on income over $600,000.) The final compromise in the Cliff Deal was to allow the Bush tax cuts to expire on all income over $400,000 ($450,000 for couples) – effectively the USA’s new definition of “the rich.” (On the overall process, see Jennifer Steinhauer 121231 “Grand deals give way to legislative quick fixes” at nytimes.com)

Accomplishments 1.2

Despite the messiness of the process, the resulting POLICY was a solid accomplishment on TAX matters. It avoided tax increases of more than $200 billion a year that might have driven the economy back into recession. It replaced “temporary” Bush policies with notionally permanent ones. That somewhat reduced economic uncertainty and thereby should promote economic growth. Taken as a whole, the Cliff Deal probably reduced government taxation of the economy by about 1-1.5% of GDP, most of the contraction in the first half of the year. So on balance, despite continuing tax cuts for the middle class, the Deal probably had some “austerity” effect. (A good short summary of the fiscal details and their likely economic effects is 130105 “Nothing to be proud of” at economist.com. A particularly positive view of the policy substance of the deal is E.J. Dionne Jr. 130102. “The cliff deal is better than it looks” at washingtonpost.com. A particularly negative view is Dylan Matthews 130102 “Everything is terrible” on Wonkblog at wasingtonpost.com.)

To understand why this tax accomplishment was a “big deal” in American politics we must briefly review the tax policies of recent administrations. The Republican Reagan administration significantly lowered tax rates in 1981 but, when that produced deficits, endorsed tax increases that took back about half of the cut. Under Reagan, nominal marginal rates on the highest incomes began at about 50% and ended at about 28%. Famously breaking a campaign pledge, the Republican first Bush administration raised top marginal rates to 31%. The Democratic Clinton administration raised the top marginal rate to 39.6%, which helped balance the budget and evidently did not harm economic prosperity. The Republican Bush administration repeatedly LOWERED taxes, including top marginal rates to 35%, until 2012. This was accompanied by budget deficits and, in the end, the Great Recession. One expected the Democratic Obama administration, once past the Great Recession, to RAISE taxes to prevent cuts to social programs while reducing deficits. Obama had long promised to raise taxes on very high incomes from their Bush 35% back to their previous Clinton 39.6%. With the Cliff Deal, he has succeeded in doing that. (Throughout all this, effective rates differed from nominal rates.)

Nevertheless, Obama has also always advocated making permanent the tax cuts that Bush Republicans granted the “middle class.” Those middle class cuts were more important, both politically and fiscally. Bush lowered taxes on the middle class in order to secure broad electoral support. Now, politically, Democrats cannot afford to approach the American electorate as the party that raised taxes on the middle class. Meanwhile middle class Americans are not contributing as much as they must to fund the social programs they expect.

Thus, in the Cliff Deal, the main accomplishment of Obama and the Democrats was to fulfill a campaign promise to raise taxes on the rich. In addition to raising the rate on high income, the Cliff Deal raised taxes on the wealthy by other means as well. The increase in the tax on capital gains and dividends was one. Earners of $250,00 or more will lose some tax deductions. The wealthy will contribute more to funding Obama’s health care reform (currently about $24 billion per year, as previously scheduled). Obama emphasized his accomplishment in raising taxes on the rich in his announcement of the Cliff Deal.

The Cliff Deal left income taxes on the middle class low. Another tax favor to the middle class was fixing the “alternative minimum tax” (at a cost in foregone revenue currently about $105 billion a year). This tax was originally an attempt to ensure that the wealthy paid at least SOME taxes. However, inflation made it gradually impact more and more middle incomes. The Cliff Deal permanently “patched” that by pegging the threshold for having to pay the tax to inflation, protecting about 30 million middle class taxpayers. In addition, in 2009 Obama had enacted expansions of tax credits for families, workers and college students. The Cliff Deal extends those for five more years. Extra-long unemployment benefits were extended for one year (at a cost of about $30 billion). (On the history of the “alternative minimum tax,” see 130103 “The phantom tax that made the deficit look better” at npr.com.)

Emphasizing tax increases on the rich obscures the fact that the Cliff Deal DOES, to some extent, raise taxes on the middle class as well. The deal lets a temporary 2% reduction of the tax on wages expire, returning the payroll tax to its previous 6.2% (generating additional revenues currently about $115 billion a year). That tax funds a program that is a favorite of the middle classes, the government’s retirement program, Social Security. The longterm solvency of Social Security is already in doubt, so evidently Democrats did not want to jeopardize it further.

Emphasizing tax increases on the rich also obscures the fact that, in the bargaining over the Cliff Deal, Republicans managed to secure some significant tax breaks for the rich. For example, the Cliff Deal did raise from 15% to 20% the taxes on capital gains and dividends (money made from money). However, that rate remains lower than before 2001. Similarly, the Cliff Deal did raise from 35% to 40% the tax on the portion of inheritances over $5 million. However, that is lower than the 55% that would have gone into effect without the Deal. Luckily the amount of inheritance that can be bequeathed tax free was not raised from $5 million to $7, as conservatives had proposed. Mostly the USA does not tax inter-generational transfer of assets within rich families, a tax that is a logical means of progressive taxation for funding a socially democratic regime. The Cliff Deal also contained some specific favors for specific companies. (Bob Greenstein 121218 “Further estate tax cut would be a disgrace” at huffingtonpost.com. On favors see Matt Stoller 130101 “Eight corporate subsidies in the Fiscal Cliff bill, from Goldman Sachs to Disney to NASCAR” at twitter.com/matthewstoller [of the Roosevelt Institute].)

Failures 1.3

Although the Cliff Deal was a significant tax accomplishment, it did not much address any of the other fiscal problems that constituted the Fiscal Cliff and that the Fiscal Cliff had been created to force congress to solve. This leaves the congress looking INCOMPETENT, both economically and politically. The unresolved issues remain in at various time horizons of the American fiscal policy agenda. That leaves a great deal of UNCERTAINTY, both economic and political. (On unresolved issues, see Neil Irwin 130202 “Get used to more fiscal cliffs” on Wonkblog at washingtonpost.com.)

The Cliff Deal did not address SPENDING, except by simply postponing the automatic cuts ($110 billion a year) from the beginning of January until the beginning of March. On spending reduction, the Cliff Deal did enact cuts in discretionary spending (currently worth $60 billion a year, totaling perhaps a trillion dollars over the next ten years). Obama had agreed to those cuts (which were not to entitlements) in August 2011 during the negotiations to raise the debt limit. Republicans now claim that, because Obama had agreed to that cut in the PAST, it does not count as a new spending cut in PRESENT negotiations. (An interesting temporal argument: imagine if you could not claim credit for having lost twenty pounds over the past six months, only the few ounces you lost this week.) Some Republicans even claimed that that trillion did not count because it was merely a promise not to spend that money in the FUTURE. (Another interesting temporal argument: ALL spending cuts are decisions not to spend money in the future!)

In striving for a comprehensive deal, Obama had demanded that congress raise the DEBT LIMIT (the total amount that the congress authorizes the national government to borrow). At first Obama had demanded a five year extension, then only a one year extension: eventually he got none. Correspondingly, the Republicans did not get the main concession that evidently Obama was willing to make in return, a change in the method of calculating Social Security benefits that would lower them gradually over time (“chained CPI”). Technically on 31 December 2012 the USA actually did hit its $16.4 trillion borrowing limit. The Treasury can use “extraordinary measures” to avoid a government default, but only for a couple of months. (Joseph J. Schatz and Patrick Reis 130101 “Enjoy the fiscal cliff debate? Just wait for the debt ceiling” at politico.com. For the two sides already squaring off against each other, see Zachary A. Goldfarb 130102 “Lawmakers clash over federal debt ceiling” at washingtonpost.com, in its Fiscal Cliff series. On Obama’s strategy going into the forthcoming debt limit crisis, see Carrie Budoff Brown and Manu Raju 130104 “Obama's debt ceiling gambit” at politico.com.)

Another fiscal issue that will arise in early 2013 is reauthorization of the ANNUAL BUDGET for the current fiscal year. A 1921 Budget and Accounting Act specifies that the president must submit a budget to Congress each year and that Congress should process it expeditiously. Nevertheless, in recent years, Congress has not passed all of the appropriations bills before the start of the fiscal year (1 October). Instead, Congress has passed “continuing resolutions” authorizing temporary funding. The government is currently operating under a continuing resolution – signed by President Obama on 28 September 2012 – that provides funding through 27 March 2013. So, by then, the USA will need another continuing resolution, providing another opportunity for fiscal politics and even fiscal crisis. (On authorization as a policy tool, see Thad Hall 2004. Authorizing policy. Columbus : Ohio State University Press, 147 pages.)

The Cliff Deal made an only marginal contribution to reducing America’s longrun TOTAL DEBT. Raising taxes on the rich raises revenue by about $42 billion a year (current value) or $600 billion over the next ten years, which should reduce the cumulative debt by that amount. “However, that represents just 7% of the projected increase in the national debt over that time. Instead of a $25.4 trillion debt in 2022, the debt would be $24.8 trillion. Little wonder that bond-rating agencies, not to mention both Democratic and Republican budget experts who have worked on deficit deals in the past, are unimpressed.” (Susan Page 130102 “ 4 lessons for round 2 of 'fiscal cliff' fight” at usatoday.com. Also Matthew Yglesias 120102 “The next Fiscal Cliff “ at slate.com.)

To most commentators, even bigger than economic failure was political failure. The politicians involved seem to have quite different versions of what is happening. The divisions are not just between the two parties, but also between factions within them: radical versus moderate conservative Republicans and a moderate president versus the more liberal Democrats. Commentators note the divergence of views and wonder what their clash would produce in early 2013. (See Ezra Klein 121231 “Why the White House thinks it’s winning the ‘fiscal cliff’” and “Why Republicans think they’re winning the ‘fiscal cliff.”“ Also 130102 “The lessons of the fiscal cliff.” All on Wonkblog at washingtonpost.com.)

POLITICS 2

This section treats the interaction within politics of shortrun partisan strategy, midrun regime shift, and longrun institutions. Here the main inter-temporal contradiction – already strongly manifest in the present – is between the present shortrun configuration of American politics (which will probably persist into the midrun) and the USA’s longrun constitutional design. We discuss that contradiction below under 2.3, longrun institutions.

There is no longer any ideological overlap between Republicans and Democrats. Moreover, there are strong forces driving them further apart – or, at least, driving Republicans ever further to the Right. Now among the fiercest battles in American politics are those within the Republican party, between what used to be considered quite conservative conservatives (now called “moderate” or “establishment” conservatives) and truly radical conservatives (the young Republican insurgents). The radical-Republican opposition to raising taxes even on the very rich further polarized American politics and reduced the capacity of partisan sides to cooperate with each other in resolving future fiscal crises.

Both parties face a political contradiction between shortrun and midrun. Most directly relevant to fiscal politics is the Democrats’ dilemma. In the shortrun, they remain committed to maintaining and even extending the liberal social policy regime that they have put in place. They want to maintain it not only for those already enjoying it (shortrun), but also for the next generation (midrun) and generations to come (longrun). At the same time, Democrats cannot show how, in the longrun, they are going to pay for this. With relatively minor adjustments, Social Security is sustainable. In contrast, even with proposed measures for economizing, health care is not. Particular liberal Democrats may understand this, but the policy positions taken by the liberal wing of the Democratic party do not reflect such understanding.

For example, during the “cliff” negotiations, Republicans proposed, and in principle Obama accepted, a method of fiscal adjustment that is politically easy. Instead of guaranteeing generous regular increases in welfare payments to compensate for inflation, government social programs could still make such adjustments, but adopt a less generous formula for calculating the rate of inflation (“chained CPI”). The cumulative longterm effect on seniors would be substantial. Nevertheless, this form of fiscal adjustment is politically easy now because the cost will be imposed only in the future – even then in an incremental and relatively invisible way. Presumably understanding that, “chained CPI”is one concession that Obama was willing to make to Republicans in exchange for raising the debt limit. Liberal Democrats denounced Obama for offering even this.

Republicans face an even sharper contradiction than Democrats between their shortrun positions and midrun adjustments. Their present ideology is a free market one of self-reliance. Their present political base is, disproportionately, prosperous white people, particularly in the South. In the shortrun, Republicans cannot deeply offend that base. Nevertheless, in the midrun, that base is declining as a proportion of the American electorate, even within the regions where, historically, it has been most dominant (the South and mountain West). So. Somehow, Republicans must adjust their ideology and base.

Shortrun partisan strategy 2.1

Most media commentary focused on shortrun strategy. Did Obama play his hand as well as he could have? How about Boehner? As Speaker of the House of Representatives, he was the main Republican leader and negotiator with Obama until near the end of the cliff process. How about the radically conservative Republicans in the House, who gradually destroyed Boehner’s effectiveness?

In turning to the attitudes of various commentators toward these questions, let us note a wise qualitative piece by Nate Silver, the New York Times’ quantitative analyst of electoral politics. Silver notes another interaction between politics and policy: how you evaluate the Cliff Deal depends not just on overall partisanship but also on your priorities among particular policy objectives. For example, some Democrats might prioritize redistribution, some the relationship between taxes and spending, still others the effect of expansionary or contractionary fiscal policy on the economy. It becomes extremely difficult – even for a skilled quantitative analyst – to assess the Cliff Deal as a whole. There are too many policy components, too many substantive objectives, and each component has different implications for different objectives. (Nate Silver 130102 “Why it’s hard to score the fiscal deal” at nytimes.com.)

Liberal Democrats appear genuinely divided. Some regard the Fiscal Deal as a great victory for OBAMA: after all, he did fulfill his campaign pledge to raise taxes on the rich. Evidently that was Obama’s own evaluation, since it was the first thing he said after victory. Republicans too were eager portray Obama as inordinately successful: He won this round for Democratic tax increases, so Republicans deserve to win the next round for Republican spending cuts. (For a roundup of liberal Democratic reaction and an argument for a positive evaluation, see Ezra Klein 130102. “Calm down, liberals. The White House won” on his Wonkblog at washingtonpost.com. Another roundup is 130104 “Liberals in a dither over whether Obama blew it, or nailed it” at npr.com.)

Other liberals blame Obama for once again proving to be a poor negotiator. The Fiscal Cliff deadline was his moment of maximum leverage for his entire remaining time in office, and he failed to make the most of it. The Cliff Deal was not as good a result as he could have obtained by being willing to “go over the cliff.” Nevertheless, the fiscal result was tolerable. What was disastrous was the political result. Obama “caved” on some major issues and offered concessions on other issues in an effort to achieve a bigger deal. All confirms Republicans’ assumption that not only does Obama make too many concessions too early, in the end he does always cave. (For polite concern about the strategic situation in which the Cliff Deal leaves Obama see David Leonhardt 130102 “For Obama, a victory that also holds risks” at nytimes.com. For stronger statements see Noam Scheiber 121231 “Democrats' cliff compromise is bad; but the strategic consequences are disastrous” at tnr.com. Also Paul Krugman 121231 “Conceder In chief?” and 130101 “Perspective on the Deal,” both on Krugman’s blog The conscience of a liberal at krugman.blogs.nytimes.com.)

Personally, although I greatly admire Obama, I can’t understand his approach to this episode and its upcoming sequels, perhaps because I don’t have access to the “inside” political information that he does. I would agree that the Fiscal Cliff deadline gave him leverage that he did not use and that that is important less for the content of the Cliff Deal than for his negotiating position in future policy crises. Going forward, I do not see anything equivalent to the leverage that the Fiscal Cliff gave him. This is particularly so because he has already renounced the idea of raising the Debt Limit himself, by declaring that the Constitution gives him the responsibility to protect the “faith and credit” of the USA. Evidently he does see alternative sources of leverage, presumably his ability to bring popular pressure to bear from outside Washington on inside Washington Republicans.

As for CONGRESS, because the House is constitutionally responsible for deciding fiscal affairs, during the Fiscal Cliff negotiations, the Senate and McConnell had deferred to the House and its leader Boehner. From the moment Obama was reelected, Boehner knew he would have to adjust Republican positions to accommodate that victory. Moreover, with the 2014 elections in mind, Republican leaders did not want Republicans to stumble further into the pro-rich position in which their failed presidential candidate Romney had put them. Insisting on continuing tax cuts for millionaires would allow Democrats to continue to pillory Republicans. ((On the fate of Boehner’s plan for dealing with a reelected Obama, see the very detailed John Aloysius Farrell+ 130102 “The GOP's failed 'Plan O': Inside the fiscal-cliff Saga.” at nationaljournal.com.)

(For background on congressional budgeting, see Lance T. LeLoup 2005. Parties, rules, and the evolution of congressional budgeting. Columbus OH: The Ohio State University Press, 250 pages. On budgeting by state legislatures, see Glenn Beamer 1999. Creative politics : taxes and public goods in a federal system. Ann Arbor MI : University of Michigan Press, 179 pages.)

As negotiations began over a Cliff Deal, to his surprise Boehner discovered that Obama intended to keep his campaign pledge to raise taxes on the rich. So eventually Boehner adjusted the Republican position, from refusing to raise taxes on anyone or anything, to accepting the resumption of higher taxes only on the VERY rich. That adjustment was intended to protect Republicans, politically. Nevertheless, young radical-conservative House Republicans rebelled against Boehner, declaring their principled opposition to any compromise with Democrats, particularly over allowing taxes to rise on anyone, including millionaires. The young radicals rejected not only Obama’s proposals but their own leader Boehner’s as well!

The negotiation process eventually broke down, not least because Boehner – no longer able to deliver Republican support for anything that he and Obama negotiated – could no longer act as the main Republican negotiator vis a vis Obama. McConnell watched in increasing dismay at the collapse, not only of responsible public policy but also of Republican unity and effectiveness. Finally, at the last minute, McConnell took the initiative of calling his old friend Joe Biden and offering to negotiate some deal. Biden got permission from Obama to answer the call, and Biden and McConnel negotiated a compromise. The compromise passed the Senate at 2am in the morning on 1 January (89-8, only three Democrats and five Republicans against). That bill then went to the House, where radical Republicans threatened to amend it, which would have required sending it back to the Senate, where reportedly Democratic Senate leader Harry Reid would have refused to bring it up for Senate consideration. (For a detailed narrative of the McConnell-Biden interaction, see David A. Fahrenthold, Paul Kane and Lori Montgomery 130102 “How McConnell and Biden pulled Congress away from the fiscal cliff” at washingtonpost.com.)

Passing the unamended bill in the House required some delicate maneuvering. Normal Republican House procedure has been to bring bills up for a vote only if the bill was approved by “a majority of the majority.” That rule gives a minority of Republicans a veto over the work of the whole House. Boehner broke that rule in order to bring the Senate bill up for a vote. Probably the radical Republicans in the House could have prevented that if they had been determined to do so. By allowing the bill to come to a vote they in effect indicated that they were willing to accept it. But then, evidently not willing to go on record as accepting it, most of them (151) voted against the bill, which passed (257-167) only with support from Democrats (172). Only 16 Democrats opposed the bill.

Midrun “regime shift” 2.2

From the point of view of possible incipient “shift” in America’s political-economic “regime,” the current fiscal crisis is the main current battleground: between a liberal-Democratic regime and a conservative-Republican regime. In policy terms, the liberal-Democratic regime is the legacy of Roosevelt’s New Deal and Johnson’s Great Society, as moderated, defended, and even extended by Clinton and Obama. The Republican Reagan Revolution in the 1980s inaugurated a shift away from that liberal Democratic regime toward a “neoliberal” one (free markets), a shift mostly continued by Bush senior and Bush junior.

In political terms, the classic New Deal was achieved and attacked through two strong political parties, both run mostly by professional politicians and both containing a wide range of views. The Democratic side relied on considerable mass mobilization by labor. Both parties are now greatly transformed. It is not professional politicians who choose their party’s candidate but popular primaries in which extremists within both parties have an advantage. Redrawing of congressional districts has produced more and more districts that are “safe” for an incumbent from one side or the other, making those incumbents more independent of the national leaders of their parties. Finally, even the population has “sorted” itself into districts that are increasingly either Republican or Democratic. All of these processes have produced the polarization and indiscipline that plagued the Cliff Deal. And, in turn, the Cliff Deal has aggravated polarization and accelerated the transition from old to new styles of politics.

These changing partisan alignments reflect changing political geography. In the 1960s the Democratic party over-rode its Southern faction and finally unequivocally supported the rights of African Americans in the South and elsewhere. In response, Southerners began shifting from Democrat to Republican. The Republican party, whose base was long in the North, has now shifted largely to the South, Midwest, and Mountain West. The crucial last-minute votes on the Cliff Deal reflect this. (See Alex Isenstadt 130102 “Why 85 House Republicans said ‘yes’ to taxes: The biggest dividing line within the Republican conference was geography” at politico.com.)

The reappearance, late in the Cliff process, of two “senior statesman,” McConnell Biden, embodies the difference between the old and new political styles. “Adults” from the older political generation had to step in and pick up the pieces of what “kids” from the younger political generation had smashed. This highlights that some “regime shift” may be occurring in American politics and highlights the uncertainty that prevails during such a transition. Going through the normal channels of formal institutions (on fiscal matters, negotiations between President and House) failed to produce a solution. Personal networks had to intervene to save the day – networks between persons other than those managing the formal channels. No one any longer knows exactly how American national policy making works. (On Biden see Michael Hirsh 121231 “Biden May Be the Most Influential Vice President Ever” at nationaljournal.com.

For a rebuttal, see Timothy Noah 130105 “Stop acting surprised by powerful Veeps” at tnr.com.

On political uncertainty, see Karen Tumulty and Peter Wallsten 130102. “Has the ‘fiscal cliff’ fight changed how Washington works?” at washingtonpost.com, in its Fiscal Cliff series.)

Longrun Constitution 2.3

Our theme here is the confrontation between recently polarized American politics (midrun) with the institutional design of the American Constitution (longrun). Most readers will already know that this combination is not working well.

The American political system has worked quite well during periods when politics was “multi-polar”: more than one issue dividing political actors in more than one way, so that opponents on one issue often allied on another. For most of the period after the Civil War between North and South, the Republicans who had won the war dominated the North, while Democrats sought support in both North and South. There were many liberal Republicans in the progressive North and many conservative Democrats in the conservative South. There was much ideological overlap between the two parties. Diverse politicians formed diverse alliances with each other on diverse issues.

Beginning in the late nineteenth century, many American political scientists expressed disgust at America’s ideologically “confused” parties. They admired “programmatic” British parties, which embraced relatively consistent conservative or liberal principles and were highly disciplined in pursuing those principles. In the centralized British parliamentary system, if a party won an election, it controlled all branches of government. Now, however, both the Republican and Democratic parties have become much more ideologically consistent: virtually no liberal Republics, fewer and fewer conservative Democrats. Democrats vote mostly with Democrats and Republicans vote almost exclusively with other Republicans. Party discipline has increased. The result is that the decentralized American bicameral presidential system is now run by the parliamentary-type parties for which American political scientists once longed. And it doesn’t work. (See Thomas E. Mann and Norman J. Ornstein 2012 It's even worse than it looks : how the American constitutional system collided with the new politics of extremism New York : Basic Books, 226 p.)

ECONOMICS 3

We now turn to the interaction of fiscal policy with economic performance, particularly with the economy’s still slow recovery from the Great Recession. (For academic analysis, see Richard W. Kopcke, Geoffrey M.B. Tootell, Robert K. Triest eds, 2006.The macroeconomics of fiscal policy. Cambridge MA: MIT Press, 383 pages.)

Here the main temporal contradiction is between shortrun and longrun. In the shortrun one must maintain spending in order to propel recovery. Nevertheless, somewhere in the midrun – in a “timely” fashion, as soon as possible – one must reduce spending in order to balance annual budgets and reduce cumulative longterm debt. This problem is sufficiently nuanced – requiring timely optimization among contradictory goals – that it would challenge even a single smart human. Unfortunately, in politics, this sort of problem lends itself to tendentious framings and partisan demagoguery.

Thus the question of timing is central to partisan disagreements over American fiscal policy – or at least to how those disagreements are argued in public. Democrats want to continue to spend and invest in the immediate future in order to restart the American economy and generate more revenue. Republicans look at the longrun consequences of continuing current practices and demand the complete reform of those practices – evidently even at some cost in shortrun economic growth. To Republicans, the Democratic insistence on current “stimulus” and investment is just an excuse (in the name of an uncertain future benefit) to continue their irresponsible “tax and spend” ways. To Democrats, the Republican invocation of longrun disaster is just an excuse to demolish the liberal Democratic Welfare State as quickly and completely as possible.

Shortrun economic recovery 3.1

One question about the shortrun interaction between fiscal policy and economic performance is what the impact on the economy would have been of “going over the fiscal cliff.” Higher taxes and lower spending would have kicked in only gradually, over the course of 2013. However, spending would fallen immediately, reducing funding for all government agencies and programs. Further loss of confidence in American decision-making would also have been immediate. Evidently markets expected American politics to reach some sort of Cliff Deal, and would have been unpleasantly surprised if it had not.

The other main question about the shortrun interaction between fiscal policy and economic performance is what the impact of the Cliff Deal will be on the economy. After the Deal, stock markets rallied – but moderately, knowing that more Fiscal Cliffs lay ahead. But the Deal did not meet the requirements of the prescriptions of at least three rival economic theories: Keynesian stimulus, conservative reduction of both spending and debt, and reduction of uncertainty. The best any of these theories could say about the Cliff Deal was that things could have been worse. (See Jim Tankersley 130101‘Fiscal cliff’ deal falls short under three economic theories” at washingtonpost. Also Zachary A. Goldfarb 130103 “How the fiscal cliff deal will affect the economy and deficits, in six charts” on Wonkblog at washingtonpost.com

On any economic theory, fiscal and economic affairs interact. Decline in government spending would slow recovery. The speed and extent of economic recovery greatly affects both government revenues and government spending. Of course, liberals and conservatives have different theories of the connection. Liberal Democratic economic policy is based on Keynes’ insight that, in order to prevent recessions from deepening into depressions, during recession governments must combat them by spending money to stimulate the economy. When severe economic downturn threatens to occur, deficit spending is not only prudent but necessary. Unfortunately, the American political leaders who ran the liberal regime – both Democrat and Republican – failed to heed the other side of Keynes’ advice, that during periods of prosperity governments should run budget surpluses and save the money, so that they would have the resources to engage in deficit spending when necessary. The result was a gradual accumulation of total American national debt, during both recession and prosperity.

In fact, along with the Bush tax cuts, the Great Recession has been the main explanation for persistent annual government deficits during the Obama administration. Downturn in economic activity produced both downturn in government revenue and a rise in government spending to combat the downturn (by stimulating the economy and relieving unemployment). Perfidiously, Republicans portrayed all this spending – that Obama had to do in order to rescue the country from the financial and fiscal disaster that Republican Bush had allowed – as just further proof of Democrats’ incurable preference for “taxing and spending.”

It therefore became imperative for Democrats, both economically and politically, that the USA recover from the Great Recession as quickly as possible. The postwar American economy experienced periodic recessions, most of them cycles in inventories or inflation. The American economy regularly recovered from those recessions within two or three years. As Obama took office in 2009, the mainstream expectation among both economists and politicians was that this would occur within two or three years. Accordingly, Obama unwisely promised a quick recovery. When it did not occur, Republicans demanded to know why. Their answer was that “big government” taxing and spending depressed economic activity.

Liberal Keynesian economists provided an opposite answer, in advance. Around 2009, their calculations showed that the shortfall in demand caused by the Great Recession was well over a trillion dollars. Therefore a “stimulus package” to combat the Great Recession effectively needed to be about that size. Liberal economist Paul Krugman even warned that if the initial stimulus were not that large, it would fail to restart the economy, increasing congressional opposition to any further stimulus spending and jeopardizing Obama’s reelection. Obama judged that such a large expenditure was not politically feasible and instructed that the stimulus package be kept under a trillion dollars. As Krugman had predicted, this failed to do the job – though towards the very end of Obama’s first term signs of recovery began to appear. Overall, one of Obama’s most amazing short-term accomplishments has been to achieve reelection despite that problematic economic record. (For a critical liberal account of Obama economic policymaking, see Noam Scheiber 2012 The escape artists: How Obama's team fumbled the recovery. New York NY: Simon and Schuster 368 pages.)

Midrun economic change 3.2

We now turn to the midrun interaction between fiscal policy and economic performance.

Here one question is the exact nature of the Great Recession. During 2009, a deeper answer to that question emerged from economists and quickly spread within the Obama administration. On this academic analysis, the Great Recession was not an ordinary recession but a rare and deadly FINANCIAL form – in the past, financial “panics” that frequently turned into depressions. Recessions precipitated by financial crises are usually deeper and longer than ordinary recessions. It takes a long time for a capitalist economy to get back on track when its basic mechanisms for savings, investment, and commerce have been disrupted. (Carmen M. Reinhart and Kenneth Rogoff 2009.This time is different: Eight centuries of financial folly. Princeton NJ: Princeton University Press, 463 pages.)

Another midterm issue with a somewhat longer time scale concerns INTER-GENERATIONAL TRANSFER, in particular between the generation currently in or near retirement and the next generation or two. All Americans pay to maintain the social security system, but not by saving to pay for their own benefits. Instead, each working generation pays for the benefits that go to the previous, now retired generation. This can be a sound system. However, one problem is that – in America, over the past several generations – each generation has collected more in benefits than it had paid into the system in payroll taxes.

Other problems are demographic. People are living longer and retiring earlier. Successive generations have produced fewer children than the one before, shrinking the population of young people relative to the population of old people they are supporting. For example, in 1950, average life expectancy was 68 years and 16 workers supported one retiree. By around 2000 the average life expectancy reached around 78 and three workers support one retiree. The ongoing retirement of the large “baby boom” generation will straining the system. (On interactions between fiscal policy and demography, see Alan J. Auerbach, Ronald D. Lee eds. 2001. Demographic change and fiscal policy. New York NY: Cambridge University Press, 446 pages.)

The Northwestern University economist Bob Gordon, an expert on American labor productivity (and my college roommate) notes six “headwinds” that may slow American economic growth in the midrun, even if the Great Recession had never happened. We just mentioned two of them: overhang of debt (consumer and government) and the end of the “demographic dividend” (a high proportion of productive young people). Other domestic headwinds are rising inequality, deteriorating education, and government burdens (environmental regulations and taxes). A global headwind is “factor price equalization stemming from the interplay between globalization and the Internet.” Meaning that, increasingly, workers everywhere compete equally.(Robert J. Gordon 2012 “Is U.S. economic growth over? Faltering innovation confronts the six headwinds.” Cambridge MA: National Bureau of Economic Research. (NBER working papers, 18315, August. At nber.org/papers/w18315)

Longrun economic growth 3.3

Finally, we turn to longrun interaction between fiscal policy and economic performance.

Gordon’s headwinds may amount to a midrun structural shift that produces longrun structural change in the American economy. Between 1860 and 2007, per capita real GDP in the USA grew by an annual rate of about 1.9%. In the future, the six headwinds might reduce that to half or less, as low as 0.5% for the bottom 99 percent of the income distribution! Slow economic growth will increase fiscal problems and constrain their solution, which will in turn contribute to slow economic growth.

As commonly described in economic journalism, the structural shift might be one in which many high employing, high paying industries move from America to other countries, including China, of course. In that case, if there is to be a recovery, it is unlikely to be recovery of already lost jobs (though some businesses ARE moving some operations back to the USA). If there is to be economic recovery to a previous level of prosperity , it will have to be recovery to some new set of high employing, high paying industries. Many people hope those might be high technology industries. However, the problem arises that hitech industries might be high paying but not high employing. In fact, the high technology they produce might put low skilled workers out of employment.

However, Bob Gordon provides a more pessimistic and profound analysis, concerning the longrun growth in per capita real GDP produced by technological innovation. Increase in productivity – the value that workers produce per unit of time – is what raises per capita real output and consumption. Over the past three centuries the USA has benefitted from three relatively brief waves of technological innovation that have provided the basis for subsequent relatively long phases of economic growth – except in the third wave. The question is, what went wrong in the third wave and is America likely to benefit from any more major waves of technological innovation in the foreseeable future? Gordon says no. Many of the innovations from the second wave – such as urbanization – could happen only once.

The first technological revolution (1750 to 1830) replaced animal and human power with mechanical power: steam and railroads. The second technological revolution (1870 to 1900) introduced numerous innovations: electricity and the internal combustion engine, running water and indoor toilets, communications and entertainment, chemicals and petroleum. Many basics of America’s modern economy were created in the half century between 1870 and 1920. Later elaborations of similar technologies produced airplanes, air conditioning, and interstate highways. Thus the second technological revolution laid the basis for eighty years of rapid growth in per capita real GDP from 1890 to 1972. After that, from 1972 to 1996, such growth slowed.

The third technological revolution (1960 to the present) was in information technology: computers, the web, mobile phones. However, the spurt of growth in real per capita GDP that it produced was brief, lasting only from 1996 to 2004. Here Gordon’s pessimistic assessment becomes controversial. He has long expressed skepticism about the contribution of IT to actual productivity. From his point of view, the earlier technological revolutions enabled humans to do things they never could have done before. The IT revolution just gives humans new ways of doing things that they already know how to do. Some economists disagree.

Nevertheless, Gordon has a striking chart showing the rate of growth in per capita real GDP between 1300 and 2100. (To get such a long run, he links the early record from Britain to the later record from America.) There is virtually no growth before 1750, per capita real GDP languishing at a very low level until then. During the mid 1900s growth surges to a very high peak but then, according to Gordon’s estimates, is likely to plunge back down to the pre-1750 level!

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