Monday November 12, 2012

Averting a catastrophic fall over the fiscal cliff looming six weeks off may well be the ultimate test of a working American democracy. The elections are over. The winners are, basically, the same people who were in charge a year ago.

There is a Democratic Senate that has failed to even debate, let alone pass, a budget three years in a row. There is a Republican House that has tried conscientiously to deal with unbridled deficit spending, but adamantly refuses to raise income tax rates on the rich ($250,000 income and up) or again increase the national debt limit without major restraints on more spending.

And there is the newly re-elected Democratic President, whose budget proposals were unanimously rejected by both House and Senate, who hasn't been able to discipline the leaders of the chamber controlled by his own party, who abruptly discarded the recommendations of his own budget commission, and who on November 9 announced again that any budget deal be "balanced" by raising income tax rates on taxpayers who now pay about 45 percent of all income taxes.

These people now, somehow, will have to take enormous and politically unpopular steps to rescue our country from a fiscal cataclysm.

Earlier this year the Committee for a Responsible Federal Budget, composed of a bipartisan host of former budget directors and members of Congress, set out the magnitude of the approaching precipice.


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The income tax rate cuts of 2001 and 2003 will expire. Capital gains will be taxed at 20 percent instead of 15 percent, and dividends will be taxed at as much as 39.6 percent instead of 15 percent.

The Alternative Minimum Tax, created in 1969 to catch 155 high income households that had escaped the income tax by claiming large deductions, will again hammer 30 million mostly middle income taxpayers.

Doctors serving Medicare patients will see a sudden 27 percent reduction in their reimbursements, likely resulting in many of them refusing to accept more Medicare patients.

With a fourth consecutive year of trillion-dollar-plus deficits, the federal government has now run the gross national debt over $16 trillion, 102 percent of the Gross Domestic Product. The federal debt held by the public is now 70 percent of GDP, a level not experienced since 1950. The national debt limit of $16.4 trillion will be reached by New Year's Day.

In an analysis released a day after the elections, the Congressional Budget Office pointed out that if all the presently mandated sequestering of spending and raising of tax rates is allowed to happen, unemployment is likely to rise from the present 7.9 percent to 9.1 percent, and the country will fall back into recession.

While this has been going on, the Federal Reserve has maintained an ultra-low interest rate policy in the apparently vain hope of driving down unemployment. If the Fed should be forced to raise interest rates to combat inflation caused by the trillions of new dollars it has put into circulation, the interest cost of Treasury obligations - and the deficit - will expand rapidly.

Erskine Bowles, the former Clinton chief of staff who co-chaired Obama's ignored deficit reduction commission, recently said that "Going over the fiscal cliff would mean allowing a massive and immediate cut to nearly every major government agency and activity, including those vital to our national security or economic growth. It would mean a large and immediate tax increase on nearly all Americans, not just the highest earners. It would mean a double-dip recession at a time when the economy is still very weak and many Americans are struggling to find work."

From another perspective, the aforementioned Committee concluded that "allowing the country to hit the fiscal cliff at year's end would be a dangerous mistake, but adding $7.5 trillion to our debt by extending the expiring policies and repealing the sequester, without putting the budget on a more sustainable path, would be a travesty."

There is a solution to this unprecedented fiscal challenge. It includes reining in the insupportable excesses of Big Government: tightening Medicare, Medicaid, disability, and welfare, reducing defense and non-defense discretionary spending, deregulating the American economy, spurring low-cost energy production, forswearing crony capitalist bailouts of favored industries and labor unions, and - to make these essential steps just barely acceptable to liberals - installing a pro-growth tax code that has the effect of extracting more tax dollars from the rich and successful.

The very big question is whether the present cast of characters can actually put the country on this path. Let's hope so.

John McClaughry is vice president of the Ethan Allen Institute (www.ethanallen.org).