Fiscal cliff and America's debt

[Greatness]

I've been following the fiscal cliff 'crisis' for the past few weeks and as Jan 1st 2013 draws closer the less likely it seems that they'll come to an agreement. However, after doing a bit more reading and research it seems that whatever negotiation or deal they come up with their debt levels will only increase. Currently, the US are in $16~ trillion in debt almost at their debt ceiling of $16.4 trillion I think it is - they are currently trying to get that ceiling further increased!
Anyway, it seems whatever happens the economy will probably go back into recession if it isn't already - even if they strike a deal. I can't recall the specifics but the interest that they have to repay in a year is approximately the same amount as what they receive from tax revenue. Even if they can manage to increase tax rates and decrease spending recession is likely due to the consequences of such actions.
It seems unlikely that America will be able to pay off these debts... The options/probabilities at this stage are inflate the currency or default . Although they probably won't default unless the situation gets extraordinarily bad. But if they do, it will be chaos...

What are your thoughts on this situation?
Interesting times ahead.

[slothpomba]

Well, it looks like they're going to run out of money soon...

But in a letter to congressional leaders, the US Treasury Secretary, Timothy Geithner, admitted he would take ''extraordinary measures'' to postpone a US default on its loan obligations which would otherwise fall due on New Year's Eve.

The Treasury will use accounting measures to create about $US200 billion clearance under the debt limit - a sum that would normally last the government about two months. - http://www.theage.com.au/business/world-business/little-sense-of-urgency-despite-nearness-of-fiscal-cliff-disaster-20121227-2bxx0.html

I think they've had the debt problem you mention for awhile now. I'm no economist but i'm sure they have measures in place for it. Keep in mind they dont need to repay all their debt at once, they can borrow more to service their existing debt, sell more bonds or just print more money. Hitting the ceiling is the more pressing concern than paying off the massive debt.

If you follow Keynesian economics during a recession or just after one, the last thing you want to do is have the government pump *less* money into the economy, especially a large nation like the USA where they can control their own currency and conceivable sell more bonds or print more (unlike the eurozone where individual countries cant print their own money). More government money means more jobs and more money floating around in general. If you have more people working, they have more to spend in shops and things and it keeps these industries going on too, its a flow on effect (Keynesian Multiplier).

They've created this arbitrary need and goal to cut spending by x date. I think cutting spending now would be a big mistake. If anything, they need to spend more, especially on the poorest (because they're most likely to spend almost all the money they get, they need to after-all). Cutting welfare, food-stamps and things like that are all part of going over the fiscal cliff and it'd be a very bad idea.

The republicans are looking like clowns right now. Their republican speaker tried to put forward a bill to the republican members that would give everyone below 1 million dollars a tax cut:

That all fell apart when Boehner abruptly pulled out of the negotiations. He opted instead to push for a House vote on his “plan B” to extend tax cuts for all earning less than an astronomical $1 million a year, only to abandon the plan when he couldn’t round up enough Republican votes to pass it. - http://www.guardian.co.uk/world/2012/dec/22/john-boehner-fiscal-cliff-undoing

A large segment of the republican party would rather the economy goes over the cliff (and most likely back into recession) and everyone suffers rather than raise tax rates on millionaires who make up maybe 1 or 2% of the country and yet have ~50% of the country voting for their party, i wonder if the 49% who aren't millionaires will ask themselves hard questions about voting republican.

[TrueTears]

the u.s really can't afford to print much more money, sure it may suffice in the short run but in the long run, inflation will depreciate the US dollar even more -> very hurtful on the real economy.

[JellyDonut]

They don't really need to come to an agreement. Most likely, they'll find out a way to loophole themselves out of it. American lawyers are really good at doing that.

Considering their existing financial conditions, borrowing more and/or printing money aren't ideal options

[LazyZombie]

The US definitely won't default. That would be a disaster.

There's no doubt that the american government is going to print more money. They already are, and the Australian dollar is probably going to remain more valuable than the American dollar for while yet. And the RBA is trying its best via interest rate cuts etc to try and stop the Australian dollar from increasing further. In 2013 many countries like Europe, China and Japan, are going to print lots of money too, so the value of their currencies don't increase, and so their exchange rates can be lowered. And (especially in the case of China) so the US doesn't end up having to pay less interest due to depreciation on all the money its borrowed. Alan Koehler calls it the "currency wars".

Sure, printing money can't be good for the economy, but so are tax increases, spending cuts, (fiscal cliffs), and especially defaulting.

The US economy is in a pickle. Let the tax increases and spending cuts go ahead - oh no! Fiscal cliff crises! Recession! Extend tax increases and spending cuts? Further debt, and probably so much that they'll hit the debt ceiling. Credit rating downgrade -> decrease in investment and lending -> dundunduun, recession looming. How will the US tackle these problems in 2013?

I think the Congress pretty much needs to come to an agreement as to how to decrease the gap between expenditure and tax revenue each year, and decrease the debt slowly. And they can avoid the fiscal cliff. Win win. The debate is over whether the best way to do that is through spending cuts or through tax hikes for the wealthy. I'm just wondering why can't they do a bit of both? Gradually? Either way, they're going to be forced to make a decision.

Ultimately, though, I feel as though I don't really understand the fiscal cliff problem (I still get confused when reading about it) and the economy in general, enough to have a truly informed opinion of it. Get in an actual debate, and I'd probably start getting confused over terms and the like. I wonder how much VCE economics will help

[Planck's constant]

The fiscal problems of the US are unique, because they have a very large military budget as a percentage of Government spending.

[Professor Polonsky]

Statutory Debt Limit

Let's quickly dispel a myth. The US debt position is rather comfortable. Moody's and S&P took away their AAA rating for political reasons, not economic ones. Following the last statutory debt limit crisis, they both expressed concerns (which indeed turned out to be true) that another such crisis may occur.

What is the statutory debt limit? In the US, the maximum dollar amount of obligations the Government holds (i.e. debt) is set in law. That is done to provide Congress with oversight over Federal borrowings, as part of the American Separation of Powers doctrine. When the total amount of public debt reaches (or nears) the statutory limit, the Treasury takes 'extraordinary measures' to ensure it is able to continue paying off its obligations. As the article states, that usually is enough for a few months - probably more than is publicly stated, but they stray on the safe side. I believe this was first done in the 90's, during Clinton's Presidency. Following that, the US would have to default on its debt as it would not be able to continue paying off its obligations, as it needs to borrow more money beyond the debt limit to pay off interest on its previous borrowings. That won't ever happen unless Republicans go absolutely batshit insane.

(By the way, the system of 'borrow money to pay the interest on previous borrowings' is completely normal, and does not suggest an uncomfortable debt position. All countries in the world do that to maximise their ability to spend money and minimise interest paid.)

There is a Constitutional argument that the 14th Amendment voids the debt limit. It states that "The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned." As those borrowings are required by law (appropriation legislation), the argument goes that the 14th Amendment requires them to be paid-off, regardless of the debt limit. President Clinton supports this theory, but it appears that the Obama Administration does not.

So that's that about the debt ceiling.

Expiring Programs

There are all sorts of taxes which will go up if a deal is not reached. The expiration of the Federal income tax cut enacted in 2001 and 2003 ('Bush tax cuts') is what has been receiving the most attention in the media. It appears likely that on this issue they will settle at extending them for all taxpayers except for households earning more than $400000 a year.

The payroll tax holiday which has been signed into law by Obama and subsequently extended until the end of 2012 has been receiving very little interest in comparison, albeit being quite significant. The payroll tax is levied on employees and is how they buy into social security and medicare. For a few years its rate was cut from 6.2% to 4.2%, and it will go back up at the end of this year. Regardless of other political happenings, extending the tax holiday is out of the question (unfortunately), which is why it is not usually considered part of the fiscal cliff.

Other taxes which are scheduled to go up are Capital Gains Tax and the Estate (inheritance) Tax. These are major points of contention between Democrats and Republicans, as they mostly affect higher-income taxpayers.

Federal Unemployment Benefits are also scheduled to end, however it seems increasingly likely that they will be extended.

Another barely-understood aspect of the fiscal cliff is the Alternative Minimum Tax (AMT) affecting more and more middle-class taxpayers. The AMT is calculated separately from the regular income tax, and the taxpayer must pay the higher of the two. When it was designed in 1969, it was only supposed to affect the richest 155 taxpayers - but the American tax code is shitty like that.

The 'doc fix' is yet another issue. In 1997, a policy was enacted to reduce payments to Medicare providers by tying them to a lower inflation-adjustment calculation than the one which was used. Each year afterwards (with a couple of exceptions), Congress has delayed the implementation of this policy, so that doctor payments will not go down. If another 'doc fix' is not enacted, payments to Medicare providers will go down 27% starting 2013.

Furthermore, all kinds of tax credits and spending contained in the Recovery Act ('the stimulus bill') are set to expire over the next few months. This is entirely expected, and won't have such a large impact as they have been slowly wound down.

Overall, the decrease in income should all tax cuts expire is seen here:



The reason why higher-income tax-cuts will be especially hit also has to do with new taxes contained in PPACA (the healthcare law).

Sequestration

Austerity, basically.

If you guys remember, in July 2011 we had a similar panic about the debt limit being reached. As part of the deal between Obama and House Republicans, a bipartisan Congressional committee was formed to find at least $1.2 trillion in savings over 10 years. Obviously, being a bipartisan entity in the US, it failed miserably. Instead, spending cuts specified in the deal will now occur automatically. They are referred to as 'sequestration' or 'the sequester'.

The sequestration cuts are split roughly 50-50 between defence and non-defence spending. Government agencies will be hit, with many lay-offs possible. Pentagon spending will be cut by 9.2% while non-defence agencies will see a cut of 8.4%. However, entitlement programs will not be hit under sequestration. http://www.politico.com/story/2012/12/sequestration-where-will-the-cuts-hit-85385.html

tl;dr: look here!

[slothpomba]

They don't really need to come to an agreement. Most likely, they'll find out a way to loophole themselves out of it. American lawyers are really good at doing that.

Considering their existing financial conditions, borrowing more and/or printing money aren't ideal options

The deficit isn't nearly as bad as it looks according to this article by Paul Krugman (he won the noble prize in economics but he does bend a bit to the left wing).

In-fact, as Keynes argued, we should be spending more than ever in an economic recession like this. The idea is you increase government spending during a recession ( i mentioned in my other post why this was good for the economy as a whole, you give the dole to unemployed people, say $100 a week for simplicity, they might spend $80 dollars of that a week, bettering them, then the shopkeepers and busineses use that $80 and might buy $60 in stock from suppliers or hire more employees, it continues down in a chain), if necessary, even to the point of debt and you pay down the debt when times are good.

What the Dr. Evil types think, and want you to think, is that the big current deficit is a sign that our fiscal position is completely unsustainable. Sometimes they argue that it means that a debt crisis is just around the corner, although they’ve been predicting that for years and it keeps not happening. (U.S. borrowing costs are near historic lows.) But more often they use the deficit to argue that we can’t afford to maintain programs like Social Security, Medicare and Medicaid. So it’s important to understand that this is completely wrong.

Which brings us back to ONE TRILLION DOLLARS.

We do indeed have a big budget deficit, and other things equal it would be better if the deficit were a lot smaller. But other things aren’t equal; the deficit is a side-effect of an economic depression, and the first order of business should be to end that depression — which means, among other things, leaving the deficit alone for now.

And you should recognize all the hyped-up talk about the deficit for what it is: yet another disingenuous attempt to scare and bully the body politic into abandoning programs that shield both poor and middle-class Americans from harm.

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It appears likely that on this issue they will settle at extending them for all taxpayers except for households earning more than $400000 a year.

Grover Norquist and the Tea Party won't be happy about this though. The recent failure of the republican members to pass a bill lowering taxes on those earning below a million dollars failed, embarrassing the speaker of the house.

So, i'm a little skeptical on this.

Federal Unemployment Benefits are also scheduled to end, however it seems increasingly likely that they will be extended.

I think it would be a real, real horrible idea if they did.

This is a cool thing to try - https://www.nytimes.com/interactive/2010/11/13/weekinreview/deficits-graphic.html and here's another better one (https://isurvey-us.yougov.com/refer/budgetpuzzle) you can choose your own cuts and tax raises and see how'd you go.

Slate article talking about what people chose.

[Professor Polonsky]

An interesting point is that the deficit naturally rises and falls a lot due to decreases/increases in revenues, and it is due to decrease a fair bit over the next few years as (partially thanks to economic recovery) revenues increase. This will occur regardless of any changes in policy.

[JellyDonut]

The thing about Keynesian economics is that a fiscal and monetary policy is not half-assed. The mechanics simply put, as I see it, is that Keynes sought out to negate fluctuations within the short run business cycle. When there is a boom, you raise interest rates, increase taxes, decrease spending. In a bear market, you do the opposite. The problem with the Americans, is that Greenspan departed from this when, prior to the GFC, lead an expansionist monetary policy, in an era when it arguably wasn't warranted. The problem with raising more money through either debt or inflation tax is that the funds rate is already hovering just above 0% and the fed has already gone through 3 QE measures.

I always found Krugman to be slightly disingenuous in his claims. He's right in saying that pursuing a balanced budget is silly but a blind rush to end the depression at the expense of the deficit is equally as silly. The Clinton administration could afford larger deficits precisely because it went through the internet boom and that it wasn't bogged down by pre-existing public debt, or at levels comparable to now at least.

[slothpomba]

The problem with the Americans, is that Greenspan departed from this when, prior to the GFC, lead an expansionist monetary policy, in an era when it arguably wasn't warranted.

A little tangential but he saw there was problems and knew there should be regulation on a lot of things prior to the GFC but he didn't do it because he was ideologically opposed to it.

There was a real good docco on it - Inside Job. He did a lot of thing stupid things because of his neoliberal ideology.

Let alone the bullshit of supply-side "economics" or the idea of the trickle down...

The problem with raising more money through either debt or inflation tax is that the funds rate is already hovering just above 0% and the fed has already gone through 3 QE measures.

Can you explain this a little more? Obviously from my sig i'm no econ major, i'm limited by what i managed to teach myself. I understand with interest rates pretty much at 0%, you can't apply standard monetary economics. As far as i know, the idea is by lowering interest rates, people will borrow more money (to invest, start up businesses, buy cars, etc) because its cheaper to do so (lower interest afterall) and pump all this extra money into the economy (more jobs, more growth, etc)

I'm not exactly sure what QE is though. You mention theres a problem with raising money through debt, couldn't the government just take on debt? The limit they have right now is pretty artificial.

I always found Krugman to be slightly disingenuous in his claims. He's right in saying that pursuing a balanced budget is silly but a blind rush to end the depression at the expense of the deficit is equally as silly.

Obviously, you want some kind of decently healthy balance between the two. In economic conditions like this though, i think it is a good idea to have the balance tipped towards spending. Cutting things (especially like social security, pensions, food stamps) seems counterproductive, even cutting federal jobs.

[JellyDonut]

During the subprime mortgage crisis, the market found that it was sitting on a bunch of  Mortgage-Backed Securities (MBS) that paid no money. In addition, a lot of the banks were facing liquidity issues since their overnight market was seized up. In other words, there exists a market where banks are able to lend to one another at an extremely short period (typically overnight, hence the name) and the rates are determined by their confidence in one another. Banks needed liquidity and so the fed provided it by "buying" the MBS from firms. The fed can do this because they don't have liquidity issues and they aren't really a business in the first place.

(I wrote this part first but I later realised that the above was sufficient)

The key thing you want when conceiving monetary policy is a stable and positive inflation rate. The implications of this isn't really something that can be completely explained in a single post so I'll try to keep it intuitively succinct. Consider the counter deflationary case: if the (nominal) value of your wages decreases, that means you have less to spend on goods, and since businesses receive less revenue and can therefore afford to pay their workers less. The same intuition as the Keynesian multiplier you mentioned before. Conversely, if inflation rate is too high, the value of your money is gradually chipped away. What's having a million dollars if everyone else is having a trillion.

The benefits from lowering the interest rates on an economy diminishes based on its prior interest rate and how much the fed chooses to drop it.   For obvious reasons, once you hit 0%, you can't go any lower (a negative rate implies that you're getting paid to borrow money (it has happen before)). Now imagine the deflationary spiral of the first post combined with a 0% interest rate. You get into a liquidity trap where you just have to watch everything fall apart.

The problem with taking on debt is the compounding interest it entails

[Professor Polonsky]

This is a cool thing to try - https://www.nytimes.com/interactive/2010/11/13/weekinreview/deficits-graphic.html and here's another better one (https://isurvey-us.yougov.com/refer/budgetpuzzle) you can choose your own cuts and tax raises and see how'd you go.

New version of that

[Professor Polonsky]

Negotiations between Reid and McConnell (Democratic and Republican Senate leaders) broke down due to McConnell's insistence on reducing social security benefits. Reid promptly walked away from negotiations as that's a big no-no. McConnell reached out to Biden in order to continue negotiations, and they've been at it since. Senate Republicans agreed to drop their demand for the drop in Social Security benefits.

The reason Boehner is not participating in negotiations is because he'd rather not be seen in his own caucus as the one who caved in to Democrats, as he could face a new leadership challenge come January 3 (when the 113th Congress is sworn in).

Should Biden-McConnell negotiations fail, Senate Democrats plan to bring forward a stopgap bill which will extend the Bush income tax rates for those making below $250000 and unemployment benefits. It is unclear as of yet whether Republicans will block the bill - even if the Democrats master 60 votes, an objection by any single Senator could delay proceedings so that they would not be completed before the new year.

EDIT: Biden-McConnell reached a deal on tax issues, no agreement on the sequester as of yet. Democrats want to delay its implementation by a year.

[slothpomba]

‘Fiscal cliff’ deal reached

President Obama and Senate leaders struck a bipartisan agreement late Monday to let income taxes rise sharply for the first time in two decades, fulfilling Obama’s promise to raise taxes on the rich and avoiding the worst effects of the “fiscal cliff.”

The agreement, brokered by Vice President Biden and Senate Minority Leader Mitch McConnell (R-Ky.), primarily targets taxpayers who earn more than $450,000 per year, raising their rates for wages and investment profits. At the same time, the deal would protect more than 100 million households earning less than $250,000 a year from income tax increases scheduled to take effect Jan. 1.

The deal came together barely three hours before the midnight deadline, after negotiators cleared two final hurdles involving the estate tax and automatic spending cuts set to affect the Pentagon and other federal agencies this week.

Republicans gave in on the spending cuts, known as sequestration, by agreeing to a two-month delay in budget reductions that would be paid for in part with new tax revenue, a condition they had resisted. And the White House made a major concession on the estate tax, agreeing to terms that would permit estates worth as much as $15 million to escape taxation by the end of the decade, Democrats said.

http://www.washingtonpost.com/business/fiscal-cliff/biden-mcconnell-continue-cliff-talks-as-clock-winds-down/2012/12/31/66c044e2-534d-11e2-8b9e-dd8773594efc_story.html?hpid=z1

---------------

Short summary from Slate:

Taxes

•    For households earning more than $450,000, the top income tax rate will rise from 35 percent to 39.6 percent
•    For households earning less than $250,000, income tax rates will not rise
•    For households earning between those two figures, some exemptions and deductions will expire
•    Investment taxes and estate taxes will rise, though with big exemptions
•    Stimulus tax credits for college tuition and the working poor will be extended for five years, while benefits for the long-term unemployed will be extended for one year
•    The alternative minimum tax will not go into effect for some 30 million taxpayers, but the payroll tax cut will expire, hitting most taxpayers

Revenues

• The deal will raise about $600 billion over the next decade compared to a pre-fiscal cliff baseline, less than the $1.6 billion trillion Obama first sought
• Compared to a post-fiscal cliff baseline, however, the deal is a huge tax cut that will slash revenue by some $3.7 trillion

Spending cuts

• Sequestered cuts to defense and other budgets will be delayed two months under an agreement that would balance much shallower cuts with some revenues