Since the re-election of President Barack Obama, I've been fielding phone calls from friends and commentators around the world who are asking about the U.S. fiscal cliff. It turns out to be extraordinarily hard to explain.
The first problem is the notion of the cliff itself. It, of course, exists because the members of Congress agreed that if they couldn't agree on policies and procedures to reduce the U.S. federal budget deficit and the long-term trajectory of U.S. national debt by the end of this year, they would automatically allow a doomsday scenario to unfold. This scenario would allow President George W. Bush's tax cuts to automatically lapse and be replaced by the marginal tax rates that obtained under Bill Clinton while also automatically cutting about $600 billion of defense and other discretionary spending. It has been anticipated that the impact of this would be to a shift in U.S. GDP growth in 2013 from about plus 2.5 percent to about minus 2.5 percent growth. In other words, a rather nasty recession.
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The first question from Japan was how Congress could agree on something as draconian as this as an automatic solution but could not come to a discretionary agreement on milder and more balanced measures. In other words, why would Congress decide to allow the house to burn down automatically at the turn of the year but not decide to remove the matches and gasoline before then? Are congresspersons mostly pyromaniacs? Isn't it their job to work out compromise budgets precisely so that the house won't burn down? Why would they deliberately choose a doomsday automatic scenario knowing there was a greater than minuscule chance that it would actually be triggered? I tried to explain that ideologues would rather be dead and right than wrong and alive, but I'm not sure my Japanese friend understood.
Another question came from Australia. "How much are we talking about," my friend asked? " I mean, is it anything that couldn't be covered by an increase of a few percentage points on high income earners?"
I explained that President Obama's idea is to increase taxes by 3 to 4 percentage points on the top 2 percent of income earners but that this proposal was being stubbornly and energetically resisted by the Republican Party leaders in Congress.
"What is the top tax rate right now," my friend asked. When I told him it was about 43 percent including state taxes and Social Security, he was flabbergasted. "But we already pay much more than that in Australia," he said, and added that Australia's top tax rate of 46.5 percent is about the same as most other leading countries while the U.S. rate is among the lowest, being fourth from the bottom out of 34 countries.
"Why," she asked, "is it so hard to ask rich Americans to pay what other rich people pay in other advanced countries?"
Another good question. I offered the explanation that many U.S. leaders are convinced that raising taxes would reduce growth and act as a drag on job creation. But my friend pointed out that Australia is booming and creating many more jobs than America despite having much higher tax rates.
She continued that Germany also has much higher tax rates and is also running the world's largest trade surplus. She suggested that America should consider the possibility that its lagging growth rate and trade deficit might stem from paying too little in taxes rather than too much. Recent economic research, she emphasized, has shown that rising income inequality like that in the United States can itself be a drag on growth.
Next was an old colleague in France who asked about the expenditure side of things. Could things like defense, Social Security, and health care spending be substantially slashed? I explained that total annual U.S. defense spending is over $1 trillion when the costs of the CIA, State Department, veterans health care, and other defense related activities are all included. My friend pointed out that this sum is more than equal to the defense expenditures of the rest of the world combined. "You could cut that in half and still be spending about the same as the next 15 countries," he said.
Then he turned to health care. He noted that at 16 percent to 17 percent of GDP, U.S. spending on health care is about double that of France and most other developed countries such as Japan, Germany, Britain, and Canada. These countries all have universal coverage for their citizens and these citizens all have significantly longer life spans than U.S. citizens and fewer infant mortalities. Why couldn't America just copy and imitate some of these national policies and plans for health care delivery? What could I say? He's right on both counts.
I don't think I made any of my overseas friends understand the cliff, but I did come to realize that from abroad it makes America look feckless and incapable of dealing with its own problems let alone providing hegemonic leadership for the world.
Clyde Prestowitz is the founder and president of the Economic Strategy Institute (ESI).