A Few Reasonable Men

By David Dittman • November 13, 2012 • Canadian Edge Weekly

From the crucible of federal electoral politics to the cauldron of “fiscal cliff” negotiations, the US has transitioned, finally, out of what seemed an interminable though nevertheless fraught exercise into a compressed drama–“sequestered” spending cuts and expiration of tax breaks written into the Budget Control Act of 2011 will, without new Congressional action, take effect on Jan. 1, 2013–with domestic and international ramifications.

It’s now D-Day plus seven, President Obama has made his first remarks outlining his view that taxes on top incomes must rise, and Congressional Republicans have sounded by turns confrontational on the issue of higher rates but conciliatory as far as finding ways to boost revenue through loophole closures.

Senate Minority Leader Mitch McConnell (R-KY) and Speaker of the House John Boehner (R-OH) must cope with a growing number of their party who seem to be backing away from the hard-and-fast anti-tax pledge written by Americans for Tax Reform and its leader, Grover Norquist, and signed by decreasing numbers of Republican elected officials.

The president, meanwhile, will have to deal with Democratic pushback against what appears to be his willingness to entertain incremental rollbacks to entitlement programs such as Social Security. This willingness was likely telegraphed in a post-election day opinion piece by Mr. Obama’s former director of the Office of Management Peter Orszag.

According to his bio at the New York Times’ Economix blog, Bruce Bartlett “held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul.” He is neither Democrat nor socialist.

Source: Bloomberg

In a Nov. 13 post Mr. Bartlett suggests a path to fruitful negotiations for higher tax rates that involves allowing the so-called Bush tax cut to expire, which they were written–“stupidly,” according to Mr. Bartlett–by Republicans to do. These rates never had the full stimulative effect they might have because they weren’t permanent and taxpayers were therefore unable to make long-term decisions based on them.

Because Mr. Obama is in a stronger negotiating position politically and the economy is on much better footing than it was in 2010, he can be more aggressive with Mr. Boehner and Mr. McConnell than he was the first time the temporary Bush tax cuts were up for renewal.

Mr. Bartlett also notes, by the way, that federal government revenues “are just 15.8 percent of gross domestic product, compared with a postwar average of 18.5 percent, which even Mr. Norquist accepts as a long-term goal. The sooner we get there, the sooner we can get the national finances on track toward sustainability.”

Mr. Bartlett opens his commentary with the assertion, “Despite Republican propaganda to the contrary, the long-term fiscal problem of the United States is principally that revenues are too low.” His case is all about taxes and rates rather than spending and entitlements. But this part of the equation can’t be ignored.

In his first remarks on the subject following his victory over Republican standard bearer Mitt Romney, Mr. Obama referred to past efforts to cut spending and indicated his willingness to entertain more:  

Last year, I worked with Democrats and Republicans to cut a trillion dollars’ worth of spending that we just couldn’t afford. I intend to work with both parties to do more, and that includes making reforms that will bring down the cost of health care, so we can strengthen programs like Medicaid and Medicare for the long haul, but, as I’ve said before, we can’t just cut our way to prosperity.

He later noted his “detailed” budget that provides for investments things such as education and clean energy but that also reduces the deficit by USD4 trillion over 10 years.

Mr. Obama concluded, “I’m not wedded to every detail of my plan. I’m open to compromise. I’m open to new ideas. I’m committed to solving our fiscal challenges, but I refuse to accept any approach that isn’t balanced.”

“Balance” means cuts will be accompanied by higher rates for the wealthy: “If we’re serious about reducing the deficit, we have to combine spending cuts with revenue. And that means asking the wealthiest Americans to pay a little more in taxes.”

Canada had its own experience with its own spiraling debt-and-deficit problem in the 1990s. Before Canadian politicians mustered the courage to deal with out-of-control budgets John Fund, writing in The Wall Street Journal, labeled the country “an honorary member of the third world.

Source: Bloomberg

In March 1995 Liberal Finance Minister Paul Martin tabled a Canadian federal budget that imposed drastic spending cuts following relatively small tax increases that had come earlier in Prime Minister Jean Chretien’s regime, which started in 1993. In four years Canada had gone from deficit to surplus and was on its way to building the foundation that helped it survive relatively well the Global Financial Crisis/Great Recession of 2007-09.

The experience of the Great White North’s austerity is now widely cited by right-leaning opinion-makers as the workable template for the US as we engage our own seemingly intractable budget mess. But there are important distinctions between the Canada of the early to mid-1990s and the US today.

Canada’s austerity program helped reduce interest rates. But rates are already at historically low levels in the US, leaving no room for improvement.

Spending cuts also led to a lower Canadian dollar, as the chart below depicting the flight of the loonie from 1990 through 1999 illustrates. A weaker currency made Canadian exports more competitive in global markets. The US relies less on exports, so a weaker dollar–if this were to occur–would have little impact.

At any rate, Canada enjoyed strengthening demand from a rapidly reviving US and from what was then a still-nascent economic power, China. This external demand for resources made up for the negative impact of deficit reduction on the domestic economy. It’s hard to identify markets hungry for increased US exports as Europe still teeters and Asia attempts to negotiate a Chinese slowdown.

A recent study by the International Monetary Fund reveals that Canada is indeed exceptional. The IMF considered 172 fiscal policy changes in relatively wealthy countries and found that on average reducing the budget deficit by 1 percent of gross domestic product (GDP) reduced output by two-thirds of a percent and boosted the unemployment rate by one-third of a percent. The US is already suffering a shortfall in aggregate demand. Cutting it further will likely make matters worse.

Source: Bloomberg

At the time of the 1995 Canadian federal budget a poll by the Angus Reid Group found that two out of three respondents approved of it, and the Liberal government’s support actually increased five points, from 58 percent to 63 percent.

Canadians were certainly happy not to be faced with still higher taxes. And the Liberal Party, long criticized for its pragmatic approach at the expense of principles, benefitted from the absence of a true social-democratic movement in Canada then.

The Reform Party, which then included a prominent upstart by the name of Stephen Harper among its members and has since merged into the Conservative Party of Canada, stood alone among opposition parties in calling for even deeper cuts, labeling the Martin budget “cowardly.”

This type of aggressive advocacy of austerity made the Liberals look reasonable by comparison, even as they presented what Maclean’s described as “the toughest budget of any federal government in recent history,” even to stand as “kinder, gentler cost-cutters.”

It’s not necessary that only one among President Obama, Leader McConnell and Speaker Boehner look most reasonable over the coming weeks. Hopefully all three will emerge from the heat of this battle with a set of legislative achievements that help avoid the fiscal cliff, put the US on a long-term path to a sustainable federal budget and sustain a nascent domestic economic recovery.

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