The Four Myths of the Fiscal Cliff

The media, pundits, and leaders from both political parties continue to warn of the impending fiscal cliff. Amidst all this chatter, four myths are being promoted as established fact. All are incorrect. Public policy based on such mythology threatens this nation’s economic well-being.

MYTH 1: The Essence of the Fiscal Cliff

According to accepted political wisdom, the fiscal cliff refers to diminished economic growth resulting from increased tax rates on the middle class combined with federal discretionary spending cuts. Acceptance of this definition ignores the actual fiscal cliff. The REAL fiscal cliff is the economic ruin that long term structural deficits and excess spending built into our federal budget through baseline budgeting. If federal spending actually strengthened the economy, we would be experiencing an unrivaled boom. Instead, we are in the midst of a post WWII record low employment level growth. The real fiscal cliff is caused–not avoided–by high federal spending.

MYTH 2: The spending cuts are too deep

Over the past 20 years, federal spending has grown a cumulative 71% in excess of inflation. In 1992, federal spending was $2.079 trillion in 2012 dollars. In 2012, federal spending totaled $3.563 trillion. The aim of the sequestration is across the board spending cuts with the goal of reducing the deficit by $1 trillion over ten years. In the first year of sequestration, $109.4 billion in cuts would occur from the 2010 budget baseline. This totals just 3.1% of the total 2012 budget. In fact, because the baseline grows each and every year, most of the cuts are not really cuts at all! The baseline cap–which grows every year–is simply reduced from previous estimates. Of course, cuts to military and non-discretionary spending exceed 7% of the baseline for 2013. The military cuts are of particular concern. However, to suggest that finding 3.1% savings in the overall federal budget is somehow extreme simply denies reality.

These modest cuts will leave spending at levels still far higher than the Clinton era and even the George W. Bush era. And spending increases each and every year after 2013 under the sequestration! In fact, in 2018, non-defense discretionary spending returns to an all-time high under these “cuts.”

MYTH 3: We have a “revenue” problem

The revenue problem refers to the notion that revenues are too low. Typically, special attention is drawn to the tax rates paid by the “wealthy.” However, taxes are not too low. In actuality, taxes are too high. Once again, take a look at the last 20 years. In 1992, federal tax revenue totaled $1.642 trillion in 2012 dollars. In 2012, revenue skyrocketed to $2.435 trillion in 2012 dollars. While federal spending has eclipsed revenue by more than $1 trillion each of the last four years, too little revenue has not been the culprit!

During the past 20 years, the population has increased from 256 million to 314 million, a 22% increase. If federal spending increased only at the inflation rate PLUS this 22% increase in population, the current budgetary situation would be far different. How different? Total spending in 2012 would be $2.543 trillion with a resulted deficit of just $119 billion dollars. Federal spending limited to just inflation plus population growth over the last 20 years would result in 90% deficit reduction.

Yet, the politicians who willfully expanded federal spending far beyond inflation and far beyond population growth now claim “low revenues” have brought us to the brink of fiscal disaster. Such a claim is untrue–and avoids the reality that deep spending cuts – not tax increases– are now needed.

MYTH 4: Deep spending cuts will harm economic growth

In actuality, behemoth government spending is curtailing economic growth in the present. The sluggish pace of economic growth, languid job growth, and the record low labor force participation rate are all due in large part to high government spending and borrowing. Every dollar spent by the federal government is one either siphoned away from the private sector in the form of taxation, borrowed, or printed by Federal Reserve through its federal bond buying program. Taxation reduces the amount of capital available to stimulate development of supply of goods and services, borrowing diverts capital from private sector business development, and the Federal Reserve’s efforts to keep bond buying “affordable” discourages the accumulation of capital by artificially depressing long term interest rates. These harmful actions are occurring now–and are impacting economic growth in the present. Economic growth will improve once this spending trajectory is reversed.

With more capital left in the private sector, supply capacity will expand. Businesses, manufactures, and the private sector will have more funds to grow. Capital in the private sector creates more capital as businesses prosper. Greater supply of goods and service translates directly to greater per capita income.

Until our political leaders recognize that the fiscal cliff is one caused by too much federal spending rather than by spending cuts, we will continue to endure subpar economic growth and burden future generations with enormous debt.