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Fiscal Cliff Economics

By   /   November 27, 2012  /   Comments

Today, we’re going to take a quick look at basic microeconomics to help understand why our elected leaders in Washington D.C. see no easy fixes to the “fiscal cliff” issue that will be dominating political news for the rest of the year.  For the three of you still reading after that first sentence, I thank you in advance.

First, let’s understand how we track economic performance in this country.  Whether we’re doing good or bad is largely determined by our growth (or decline) in the Gross Domestic Product.  A GDP growth rate of 3-4 percent is considered robust.  A GDP growth rate under 2% is considered sluggish.  If the GDP growth rate is negative, economic activity is declining and our economy is in recession.  The point is, small changes in our rate of growth determine whether we’re doing very good or very bad.

Now let’s review how this mythical number is calculated.  The customary Econ 101 method is by calculating the amount of spending in four categories:  Consumer Spending, Investments, Government Spending, and Net Exports.

Consumer spending is by far the most significant, accounting for roughly 71% of our $15 Trillion economy in 2011.  Government spending is a not insignificant 20% of the economy.  This includes not only federal spending but state and local government spending as well.  Investment is roughly 13% of the GDP.  This is not only capital investment, but also includes things like inventories businesses are holding for later sale.  It thus somewhat represents future consumer spending and while relatively small, its watched closely because changes in this number can often show which direction  the economy may be headed in future quarters.

If you add those numbers up, you’ll notice they represent 104% of our economy.  That’s because our next exports are negative, representing -4% of our economy.  In short, we import more than we export, and that’s how we account for a large portion of our consumer spending on items made for us overseas.

One of the assumptions regarding basic economic models is that the period above is closed, and that all money generated is spent in the same period.  We – and especially those in Washington – know this isn’t the case.  Thus, basic economics teaches you that if you want to increase government spending, you have to increase taxes (which would then reduce the money available for consumer spending and/or business investment).  Washington figured out a long time ago that they didn’t need basic models when they instead have something called deficits.

Those in Washington know very well that they are more likely to keep their jobs if consumers are happy and the economy is growing.  The two are, after all, closely linked.  At some point over the past few decades, Washington has discovered that they could completely de-couple the amount of money government spends from the amount of money they take from consumers and businesses in the form of taxes.  The gap is commonly known as the budget deficit, and it now represents roughly 40% of the federal budget.

Democrats are generally proposing to tax “the rich” to plug this hole, knowing there isn’t enough money in their proposed tax increase to substantially close the gap.  But by only wanting to tax a relatively small percentage of people, most will feel unaffected and thus remain happy (and spending) consumers.

Republicans claim to want to cut spending, but despite the rhetoric since gaining a House majority in 2010, haven’t managed to find actual places to cut in significant percentages from the existing baseline.

And at the end of the day, a lot of what we see and hear out of Washington from both parties is just that.  Rhetoric.  Because both parties know we have grown quite used to running our economy on borrowed money.  Thus far, our creditors haven’t asked for an increase in interest rates, which would “crowd out” other investment as the natural counterbalance to consumer and government spending.

Politicians of all political stripes know that tough cuts or large tax increases would easily sway the current GDP numbers to a negative position for at least a few quarters.  It’s basic math in the model above.  The problem is, consumer sentiment would likely turn negative during the news reports of these “bad economic times” and a real recession could take hold as a result.

House members are elected every two years, as are 1/3 of senators.  Presidential campaigns are already forming for 2016.  No one really wants to take the risk that “fixing” a problem may cause another one.

And why would they?  Borrowing money is easy.  And talk is cheap.

Charlie Harper is the Atlanta based Editor of PeachPundit.com, a conservative-leaning political website. He is also a columnist for Dublin Georgia based Courier Herald Publishing.

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