If Entitlement Programs Are Your Top Priority, the Fiscal Cliff Is Your Friend

By James Kwak

There is a lot of low-grade confusion in reporting on the fiscal cliff, primarily because most articles discuss two distinct problems: (a) the contractionary impact of automatic tax increases and spending cuts that go into effect on January 1 and (b) the large and growing national debt—often without clearly distinguishing between them. In fact, (a) and (b) go in opposite directions. Any deal that solves (a) will only make (b) worse; if you really only care about (b), you should be happy about (a). (Instead, Republicans who claim to care only about (b) are squawking about (a) because they want to preserve the Bush tax cuts.) Most reporters understand this and don’t make the obvious mistake of equating the fiscal cliff to the debt problem, but the two are juxtaposed so often they risk blurring into each other.

So, for example, the Washington Post published an article titled “Liberal groups mobilize for ‘fiscal cliff’ fight over Social Security, Medicare.” (As an aside, when did capitalization in titles become optional?) The facts in the article are fine, but you still could get the impression that the fiscal cliff poses a threat to Social Security and Medicare.

Just the opposite is true. If your top priority is the preservation of Social Security, Medicare, and Medicaid for the long term, then the fiscal cliff is the best thing that ever happened.

First, the expiration of the Bush-Obama tax cuts will, on its own, eliminate roughly half of the long-term gap between federal government revenues and expenses.* Higher tax revenues (raised through the individual income tax, which is the most progressive part of the tax code) will reduce the pressure to do something about entitlement spending—at least the pressure that is due to budgetary constraints, not the pressure that is due to ideological opposition to those programs.

Second, the automatic sequesters mandated by the Budget Control Act of 2011 barely touch the major entitlement programs. Social Security and Medicaid are specifically exempted; most Medicare spending cuts are limited to 2 percent. That means that the rest of the government gets smaller, again reducing budgetary pressure on these crucial programs.

Now, if you are the kind of person who cares about social insurance programs, you probably also care about unemployment, and you may legitimately worry that tax increases and spending cuts will hurt the economy and reduce jobs. You may be torn between two objectives: preserving social insurance programs for the long term and reducing unemployment in the short term. But you have to recognize that the fiscal cliff is unambiguously good for those social insurance programs. Otherwise you’re not making sense.

* For the estimates, see White House Burning, pp. 182–83.

30 thoughts on “If Entitlement Programs Are Your Top Priority, the Fiscal Cliff Is Your Friend”

  1. The answer here is not austerity but a Wall Street sales tax that levels the playing field between an industry that has robbed, pillaged, and raped the middle class, and a middle class already over-burdened with taxes.

    The president doesn’t need to enter into any kind of “Grand Bargain” because, as we all know, this means the middle class get rolled, again, and the kingpins slide on through un-scathed.

    There is sufficient momentum in the public consciousness to get this ball rolling and keeping it moving, so this is what needs to happen.

    The republicans have no clue about anything, and since their collective clock has been cleansed, rinsed, and disinfected, now is the time to strike the fires of TAXING WALL STREET, and let the bums of the universe and their stinking banks start paying their way forward.

  2. The Social Security trust fund, together with payroll taxes, is sufficient to cover program benefits for more than the next 20 years. Moreover, assuming no additional funding, currently scheduled payroll taxes can provide benefits equal to those now provided, even adjusted for inflation, for the indefinite future. Given all the real economic problems we truly must address now, there is no legitimate argument for even considering Social Security modifications until the economy is fully back on its feet and long-term costs and revenues can be more accurately projected.

    The Medicare trust fund was actually “going broke” when Pres. Obama took office, due in large to changes pushed through by the Bush administration. At that time, the trust fund was projected to be exhausted by 2016. However, the ACA (“Obamacare”), rather than taking the much vaunted $716 billion out of Medicare, actually added that amount to the Medicare trust fund; which is now projected to last until 2024. In one fell swoop, two thirds of the Medicare shortfall was eliminated. Eliminating the remaining one third could be even easier; for example, now that the ACA will protect older working Americans, we can in good conscience synchronize Medicare eligibility dates with those for Social Security. The relative ease of these Medicare fixes, and the fact that the small Social Security issues remaining are far beyond our legitimate planning horizon, why then all the hysteria about entitlements eating our children and grandchildren? In a word—TAXES.

    Everyone knows that Ronald Reagan reduced income taxes (more than one half for the wealthy); what is less commonly understood is that he extensively offset this by raising payroll taxes(more than double for most self-employed). Today, most American families pay more in payroll taxes than they do in income taxes. Between 1946 and 1981, income taxes averaged 12(+/-1)% of normalized GDP. Reagan reduced income taxes to near 9%. Clinton increased them back to 12%; and Bush/Obama reduced them again to 9 %( and below). However, on budget expenses (which exclude Medicare and Social Security) have remained 12(+/-1)% of normalized GDP throughout. The deficit in income taxes has been financed by borrowing, largely from the Social Security and Medicare trust funds. When Clinton raised income taxes back to 12%, this eliminated the on budget deficit. The CBO projected that this, plus the Social Security and Medicare surpluses, was enough to pay off the entire US debt before the Social Security/Medicare trust funds would have to be amortized for beneficiary payments, all without having to raise any taxes to pay for the amortization of those trust funds. Like Reagan before him, Bush took those excess payroll tax receipts and gave them “back” as income tax reductions, heavily weighted to the wealthy–who didn’t create those surpluses in the first place. By doing this, Bush guaranteed that income taxes would have to be raised in order to amortize the trust funds. Although the Republicans like to talk about those “47%” who in large part pay only payroll taxes as being supported and subsidized by those who pay income taxes, the truth is the opposite; ever since Reagan, income taxes have been subsidized by payroll taxes; and the failure to raise income taxes to pay back that subsidy, is to steal the money that middle-class workers have had taken out of their income to pay for their retirement.

    Hence, the only problem we have with entitlements is paying back the money that we borrowed from the Social Security and Medicare trust funds. This requires that we raise income taxes in the short term to 12% to cover normal on budget expenses. And, as soon as the economy recovers, we must raise taxes above 12% to pay back the trust funds. This is why the Republicans refuse to discuss raising income taxes; they would much prefer to steal workers retirement funds, and reduce the entitlements paid for by them. We do not have an entitlement problem, we have a Republican problem.

  3. WooHoo Bond Man and bmz….

    you can BET on it that the momentum is there – and growing :-)

    Just replace “king” with “banksters” in the original Declaration Of Independence and we’ve got an OFFICIAL AND LEGAL re-set of the situation.

    Don’t let the moment go. Knocked down by an “act of god” means it’s a good time to keep them down. Not like they did NOT do exactly that to 99%…kick ’em down and then kick ’em when they were down….

  5. We need to make sure that any reforms to Social Security be such that the trust fund is an intact, pre-paid investment. While current taxes can be used to help pay current benefits, any excess taxes need to be carefully walled off, so that no one gets their hands on those dollars (and their interest) other than the SS beneficiaries. That means no more borrowing from the Treasury to help pay for other expenses. If we continue along the same path, we will find ourselves in the same predicament today – a trust fund with promises to pay, but no pre-paid, intact funds to pay them – without the use of general revenues, as Roosevelt intended.
    Don Levit

  6. Higher tax rates do not produce proportionately more tax revenue. Worse, higher rates kill 3 times as much private sector income (production) as increased revenue. The increased government spending cannot offset this loss, even if that spending were entirely useful.

    Taxes, Simulus, and Growth
    12/01/10 – WSJ by Michael J. Boskin  [edited]
    === ===
    New economic research shows why lower tax rates spur growth.

    The last two major tax cuts boosted growth: Reagan’s in 1981-83 and G.W. Bush’s in 2003. They lowered marginal tax rates and were long lasting, both keys to success. Harvard’s Albert Alesina and Silvia Ardagna surveyed OECD fiscal policy changes over the past 40 years. They concluded that tax cuts have been far more likely to increase growth than has more spending.

    Former Obama adviser Christina Romer and David Romer estimate a tax-cut multiplier of 3, meaning $1 of lower taxes raises short-run output by $3. Mountford and Uhlig show that substantial tax cuts had a far larger impact on output and employment than spending increases, with a multiplier up to 5.0.

    Conversely, a tax increase is very damaging. Mr. Barro and Bain Capital’s Charles Redlick estimate large negative effects of increased marginal tax rates on GDP. The best stimulus now is to stop the impending tax hikes. Mr. Alesina and Ms. Ardagna also conclude that spending cuts are more likely to reduce deficits and debt-to-GDP ratios, and less likely to cause recessions, than are tax increases.
    === ===

    EasyOpinions.blogspot.com

  8. Why was growth higher from 1945-1980 than after the Reagan tax cuts? Why didn’t the economy stall after the Clinton tax increases? Why was growth lower under GW after his tax cuts than under Clinton? Mr. Barro may wish to reread the Romer’s as to what they were discussing about multipliers and perhaps add Pickety and Saez to expand his knowledge on the effects of higher rates on the higheest tax brackets.

  9. Trickle Down Theory…One Last Time…Hopefully!!!

    They are at it again. Cut the taxes on the richest of the rich and the corporations and they will spend their riches creating new jobs, and the resulting wealth will trickle down to the rest of us.

    A quick review is in order here. Jack Kemp, then a Congressman had lunch with Arthur Laffer, then an economist. The story is that Laffer drew a curve on a napkin to promote the theory that tax cuts for the rich produce economic growth and new jobs. That curve will forever be know as the Laffer Curve. Of course, the joke here is unintended.

    So here is your assignment. Take a look at corporate profits. They are high as they have ever been. Corporations are sitting on record amounts of cash and have been doing so for a number of years now. (Update: Business Week, Oct. 15, 2012, “Corporations are Sitting on $1.7 TRILLION in cash.”)

    The 1% now have more money than they have ever had and their share of the wealth of the country is staggering. (Update: that is now 40% of ALL the wealth in the country.)

    So where are all the new jobs that should have been trickling down to us since, oh say, the Bush tax cuts?????????????

    Even Mitt says that 23 million Americans are unemployed or under-employed, and nothing much has changed for five years now. Record numbers of people have been unemployed for over a year now.

    And yet there are still fools in Washington (and elsewhere) trying to sell us the Laffer Curve!! It is indeed a Laugh Curve, but the results ain’t funny. Tell them to stop trying to fool you. It ain’t pretty!!

  10. To Ted Kaminski,
    You pose many questions which presume the answers. Do you have links to support those implied statements? How about picking one solid point.

  13. James, I don’t agree with your concluding sentence that the fiscal cliff is unambiguously good for social insurance. If it were to happen, a recession would result, decreasing GDP. I do not know whether the spending cuts and tax hikes would offset this GDP decrease enough to actually reduce the deficit. In Europe, austerity has proved self-defeating in that regard. Therefore, it is possible that the cliff could actually increase the debt-GDP ratio. Then Republicans would once again continue to scream about the debt while simultaneously asking for tax cuts and the Obama would agree and go along with cutting entitlements.

    Actually nevermind, I don’t even have to rely on the above inferences upon inferences. Your point and my rebuttal are moot. Presently, the Republicans are screaming about the debt while simultaneously pushing for tax cuts, and Obama agrees (below $250K) and wants to unilaterally cut medicare and medicaid. That is what will happen.

    Odd that the President in his first term sought to expand healthcare to all Americans, and in his second, is trying to cut healthcare to the most vulnerable for the sake of a slight revenue increase that will happen anyway, if nothing is done.

  14. “Andrew_M_Garland | November 13, 2012 at 10:21 pm |
    To Ted Kaminski,
    You pose many questions which presume the answers. Do you have links to support those implied statements? How about picking one solid point.”
    Actually it’s been all down since 1971, when we accepted Friedman’s economics of free trade and the Market knows best. Before this we were the greatest creditor nation now we are the world’s greatest debtor nation.
    Reference http://www.amazon.com/13-Bankers-Takeover-Financial-Meltdown/dp/0307379051/ref=sr_1_1?s=books&ie=UTF8&qid=1352863796&sr=1-1&keywords=13+bankers+the+wall+street+takeover+and+the+next+financial+meltdown

  15. How utterly foolish is to pretend that the fiscal cliff would actually be beneficial to the protection and enhancements of entitlements. To assume that an increase in tax rates will bring automatically higher revenue on the long run without any consequences to the economic growth is not only bad economics but a complete distortion of the economic history of Europe in the last 50 years.

    It would be instructive for you to learn how the likely rise of capital gains by themselves will bring down economic growth, increase deficits and, as an aside, will bring heavy losses to all those that are following articles like this and assuming that their assets would not be heavily devalued when their return of investment is cut by 58%. They could do themselves a favor by reading “Whatever The Outcome of the Fiscal Cliff, Optimist Will Pay” at http://www.AmericasChroniscle.com

  16. Some people squawk about so called entitlement programs; Social Security, Medicare, and Medicaid as driving the United States over the fiscal cliff. All the while ignoring the $2B spent each week to support the war in Afghanistan and our continued presence in Iraq. The US went into Afghanistan to get Bin Laden and that effort has been achieved. Iraq was an unjustified war as most leaders now acknowledge. It’s time to get out of those theaters and shut off the flood of US dollars to those countries. Also, many folks will balk at reducing the US military budget because they say it will weaken our military. The military budget ballooned during the past (12) years due to the wars in Iraq and Afghanistan. Once we are through with that debacle the budget can be rolled back without weakening our military. And then there’s the US budget deficit, growing exponentially every minute of every day with no relief in sight. At nearly $17T the deficit will soon become self perpetual with little chance of reining it in without very serious impacts to our country. Political leaders and citizens alike must realize that getting our country back in balance will require sacrifice by all. However each time a proposal is floated some special interest group finds fault with it and the process stops. The term is known as kicking the can down the road. Instead of living in denial and kicking the can down the road it’s time to get serious with reducing our budget deficit and reining in government spending.

  17. ‘Why was growth higher from 1945-1980 than after the Reagan tax cuts?’

    A very low base, thanks to the Great Depression and WWII. Almost no international competition for American corporations for over a decade as Europe and Asia recovered from the war.

    After Reagan’s early tax cuts the country went on an unprecedented quarter century boom–only 2 short mild recessions to interrupt it–unrivaled in any other 25 year period in American history.

    ‘Why didn’t the economy stall after the Clinton tax increases?’

    Because they weren’t large enough to undercut the recovery that had been underway for over two years when they were passed into law. Also, Hillary Care was defeated.

    Then, in 1994, Republicans took over both houses of congress and Clinton’s worst instincts were checked. Also, Brad DeLong went back to Berkeley.

    ‘ Why was growth lower under GW after his tax cuts than under Clinton?’

    It wasn’t if you know how to compare AT SAME POINT IN THE BUSINESS CYCLE. Clinton had almost a three year head start over W. Clinton inherited an expansion from HW Bush, but W inherited a recession from Clinton, so the W expansion didn’t start until 2002.

    If you compare the two expansions from the troughs of the recessions they look remarkably similar. Of course, Clinton avoided the bursting of the housing bubble that started in the mid-1990s. A bubble which Clinton’s policies are largely responsible for. That also got passed onto W.

  18. ‘If your top priority is the preservation of Social Security, Medicare, and Medicaid for the long term, then the fiscal cliff is the best thing that ever happened.’

    You’d have be remarkably obtuse to the dynamics of an economy to believe the above.

  19. We have the answers; we merely lack the power and the will.
    Import tariffs on electronics and automobiles; transaction taxes for Wall Street trades; estate taxes raised to draconian over, say, 5 million dollars; Increase progressive income tax brackets back to Kennedy levels; remove the SS cap or at least raise it to 250k; Swedish breakup for the megabanks; End CFMA and reinstate a Glass-Steagall type of law to separate lending/repository functions from gambling; and a federal legal structure that prevents regulators from revolving door appointments and other conflict of interest/ethics rule enforcement.
    Cut Homeland Security and the defense budgets and increase funding for green energy, infrastructure repair and enhancement, and climate change mitigation. Swedish style vacation and maternity/sick leave would increase private sector economic activity and productivity-a no brainer. More education support targeted to public private partnerships anticipating job growth and opportunities. Mandatory federal service after HS graduation and mandatory year abroad as part of that so the hicks from the sticks and city folk can get broader experience and understanding of the world as well as fellow Americans-the key social benefit of the draft that limited extremism domestically, the source of our current road block.

  20. I have not been in the US for more than a decade so I really do not know, but… is that how you became the most powerful country on earth?

  21. The reason there is so much confusion between the nearby “fiscal cliff” and the long-term budget deficit and debt is because Republicans have been intentionally eliding the difference for months.

  23. I can buy into Bigsquatch’s list because it is mostly directed to improving our competitive position in the world.

    However, there is ONE HUGE mistake in that list. It involves the idiotic crap that both presidential candidates have been babbling about for over a year, and that is the jobs going overseas nonsense. Not one word of it is based on facts. Here is what the New York Times had to say a Sunday, or so, ago.

    “While there are no universally accepted numbers, the United Nations Statistics Division calculates that the dollar value of goods made in America is at an all-time high of $1.9 trillion, just about even with China. The catch is that the number of American workers needed to create all that value has dropped steadily.” I

    Any sensible business person always tries to keep costs low so his/her prices can be low. Remember all that stuff about prices and quantity demanded?

    Nobody ever mentioned that fact that the computer that I am writing this on cost about $600, but would have cost at least $3,000 if it were made in the U.S. The television set in the other room cost about $1,000, but it would have cost over $5,000 if it were made here. It should be crystal clear that virtually all Americans benefit from lower cost production overseas. But nobody ever mentions that.

    And that is why the rest of the list is so good, it is almost all aimed at improving the skills and abilities of our work force in the 21st Century.

    Next point: if we really add import duties that will raise the prices of what we import and we will all have to pay those higher prices, either by giving more money to the government to pay for those duties, or transfer our money to domestic manufactures who will be protected and can charge higher prices.

    Finally, we have hard evidence that tariffs are a truly stupid response to a lack of competitiveness in some industries. In 1930, Congress passed the Smoott Hawley Tariff Act to protect domestic industries. And what do you think happened? Yes, every other country retaliated by raising their taffifs!

    It got to the point where the average tariff on anything anywhere in the world was 81%!!! The World Economy was on the verge of collapse and only World War II saved it. And that cost a lot of lives!!

    Too bad Romney and Obama both flunked U.S. history. That can the only excuse for the utterly stupid proposals that put forward.

  24. It’s good to see more people noticing that the “fiscal cliff” might be a good thing and a step in the right direction.

    This whole thing reminds me of the Uncle Remus story about Brer Rabbit, Brer Fox and the briar patch. Brer Fox finally catches Brer Rabbit and tells him that he is in for it. Brer Rabbit begs for mercy asking only that he not be thrown into the briar patch. Brer Fox, not being a merciful sort, throws Brer Rabbit into the briar patch. Brer Rabbit, needless to say, was born and bred in the briar patch. He taunts Brer Fox and runs away.

    While this story is based on an old black folk tale, the whole Uncle Remus / minstrel show framing was rather racist so the story is not as well known now as in the past. There’s also the problem of saying Uncle Remus in front of a classroom full of ten year olds. On the other hand, a lot of us remember the story of how Brer Rabbit escaped from the evil clutches of Brer Fox. Ten dimensional chess this is not.

  25. First of all, this is not a “fiscal crisis”. Rather, it’s an “austerity crisis”. Want to end up like Europe, mandate austerity!

    Second of all, why does everyone ignore the fact that FICA taxes are capped at around $110-120k of earnings. Back before I retired. the cap was at something like $106k. Only once did I exceed that cap. Eliminate the cap!

  26. Today was European Day for Action and Solidarity against “austerity”. Participating countries included: Finland, Sweden, Latvia, Lithuania, Denmark, Germany, Austria, Belgium, UK, Poland, Czech Republic, Hungary, Slovenia, Switzerland, France, Luxemberg, Romania, Bulgaria, Macedonia and Malta.

    And China has a new leader.

    And older news, turns out that there maybe wasn’t an over-building of housing after all since Sandy refugees are being sent to live at the Monmouth government base in NJ. In the same area, the look-at-how-holy-we-are-banksters-doing-god’s-work have decreed a 90 day moratorium on hauling people out of the house and throwing their stuff out on the street for the vultures via fraudclosures. Unemployment jumped so many points that they didn’t even get specific. So pretty much the last remnants of USA Middle Class in NJ in this economy have lost it all. Nothing like capitlism for turning every “act of god” into accumulating more than the 2.08 TRILLION 480 people already have! And these noveau homeless certainly paid out in taxes MORE than what any house still standing will be said to be worth by the manipulated markets….

    So how to avoid the REAL ISSUES of “austerity” for others to pay down the “debt”?

    Invade Gaza. The Petraeus thing didn’t work…

  28. No, No, No James. Too much analysis. NO REDUCTIONS TO SOCIAL SECURITY, MEDICARE, AND MEDICAID. It is a political decision, not an economic one.

  29. You misunderstood the Washington Post article. It was about liberals fearing that a budget deal negotiated before the “fiscal cliff” would include cuts to social programs, not that the fiscal cliff triggers would cut those programs.

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