Fiscal mess deeper than ‘cliff’

To paraphrase Samuel Johnson, nothing focuses the mind like a crisis. And, perhaps that is why the political class continually manufactures fiscal crises. The manufactured crises can be used to focus the collective political mind and help solve the underlying fiscal problem.

The fiscal cliff – the tax increases and indiscriminate budget cuts that, without action, will become official policy on Jan. 1, 2013 – is most appropriately viewed as the latest installment in this long list of manufactured fiscal crises.

The underlying fiscal problem is that the federal government continues to spend too much money today; is promising to spend even more money that it simply does not have tomorrow; and has created a tax system that is costly, complex and anti-competitive.

Over the past 50 years, the federal government has spent $113 for every $100 in tax revenues. Over time, these cumulative budget deficits have created our $16 trillion federal debt, which is now the size of our entire economy.

A $16 trillion debt, on a per capita basis, implies that every man, woman and child in the U.S. now owes over $52,000. And, the $16 trillion is the debt that we acknowledge.

The actual federal debt is much higher. Most of the Social Security, Medicare, and other federal benefits promised to retiring Americans are not funded. There is no savings account somewhere in Washington, D.C. that the Treasury will access to pay for the future benefits. Tomorrow’s benefits can only be financed by taxing the income of tomorrow’s workers.

The unfunded (and unaccounted) debt of the U.S. government is estimated to exceed $100 trillion.

And, this debt is in addition to the $16 trillion debt from our past spending binges that we are acknowledging. For those who keep track, unless entitlement changes are made, every man, woman and child will owe $373,000. A family of four would owe $1.5 million.

The federal tax system is just as problematic. The federal tax system is complex and filled with special interest carve outs that rewards political influence over market acumen. It is also costly for taxpayers to comply with the tax code. A study I co-authored with Arthur Laffer and John Childs estimated that for every $100 in taxes paid to the federal government, taxpayers must spend an additional $30 to comply with the tax system. In other words, taxpayers spend $130 to give the government $100. Additionally, the U.S. levies a corporate income tax rate that is higher and more burdensome than all of our major trading partners.

The combination of these trends has put the U.S. on an unsustainable fiscal path. Fiscal cliffs, debt ceilings, and other crises de jour will continue – and worsen – until the long-term fiscal soundness of the federal budget is restored.

The reforms that will put the U.S. on a sustainable fiscal path include: spending restraint that constrains the size and growth of the federal budget to an affordable level; entitlement reform that limits the uncontrolled growth in these programs; and, a pro-growth tax reform that raises the necessary revenue for the government while minimizing the tax distortions and costs on the economy.

Unfortunately, the fiscal cliff does not appear to be focusing the collective political mind enough. President Obama has stated that he will not allow the fiscal cliff to be resolved unless the tax rates for the top income earners are allowed to rise. As if the additional $82 billion a year in tax revenues from raising the top rate will materially change the country’s fiscal crisis. The indiscriminate budget cuts and tax increases that define the fi? to the economy.

However, longer-term imbalances are even a larger problem. The fiscal cliff created an opportunity to fix this longer-term imbalance. But is only an opportunity if the politicians don’t let this crisis go to waste.

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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