June 2012

The Economic Uncertainty Continues

by John R. Hendrickson

The economic uncertainty that has been plaguing the economy since the “Great Recession” is still continuing. Although the United States is supposedly in an economic recovery, unemployment remains high. In addition, economic storm clouds are threatening a European economic collapse, which may cross the Atlantic. Both businesses and individuals are waiting anxiously for the upcoming 2012 election to determine the future direction of public policy. At the present a great philosophical divide exists between Republicans and Democrats over a variety of issues. In order to revive economic growth, increase employment, and to remove the uncertainty, policymakers must follow a course that focuses on spending and tax reduction, while eliminating unnecessary regulations.

At the heart of the economic uncertainty is the approaching “fiscal cliff” which the United States is heading towards. The “fiscal cliff” represents the current fiscal crisis with our national debt of $16 trillion and our federal government running annual trillion dollar deficits. In addition, massive tax increases await the economy in January 2013 unless Congress prevents what is called taxmageddon. “Taxmageddon is a $500 billion tidal wave of tax hikes — not over 10 years but in a single year and continuing thereafter. It is an average tax hike of nearly $3,800 per taxpayer.”[1] As J.D. Foster, a Senior Fellow at The Heritage Foundation, wrote:

Unlike a tidal wave, however, Taxmageddon is not an act of nature but arises out of past acts of Congress and the President. The 2001/2003 tax cuts, originally set to expire at the end of 2010, were then extended for two years until January 1, 2013. The same holds for Alternative Minimum Tax relief, death tax reforms, and a passel of provisions known as ‘the extenders.’ Early in 2012, Congress extended through this December a lower payroll tax hike. All of these extensions expire at the same time: December 31, 2012. At the same time, one of Obamacare’s worst tax provisions — a 3.8 percent income tax hike operating through the Medicare payroll tax mechanism — goes into effect. Its implementation should be delayed until such time as Obamacare can be repealed.[2]

This massive tax increase on the horizon, in addition to regulatory policy and the future result of the Patient Protection and Affordable Care Act (Obamacare) is causing the economy to become more uncertain. The weak economic growth in a period of supposed recovery from the “Great Recession,” high unemployment, and record numbers of Americans receiving some form of government assistance, are continued evidence of market uncertainty in the economy. Even though the official unemployment rate is 8.1 percent, which is still considerably high, the actual rate would be at least 11 percent when those individuals who are either working part-time or discouraged from looking for employment are taken into consideration. This means that the best way policymakers can help the economy would be reversing the current policy trend.

Larry Kudlow, a noted economist and former official in President Ronald Reagan’s administration recently wrote:

Tax-cut certainty is so vital right now because the anemic economic recovery may be moving towards deflation. That’s the message of a gold price that has collapsed by near 20 percent, falling from around $1,900 an ounce to the mid-$1,500s. With a risk-averse economy at home, and with the Greek and European financial crises abroad, the demand for dollars seems to exceed the dollar supply printed by the Fed [Federal Reserve]. This could be solved by more quantitative easing. But a better approach for a system already oversupplied with unused liquidity would be the extension of tax-rate growth incentives, not more pump-priming.[3]

“The uncertainty over the Bush tax cuts already has caused a number of business leaders to threaten a hiring freeze and a dampening of investment until they can figure out the after-tax cost of capital and rate return on investment,” noted Kudlow.[4]

In addition to the looming taxmaggedon that is coming down the road the nation also faces a serious fiscal crisis that threatens to destroy the nation. The federal government is currently spending about $3.8 trillion and Congress has failed to pass a budget in several years. Federal spending is 25 percent of Gross Domestic Product (GDP). President Barack Obama and Democrats have been pushing for more revenues, that is, tax increases in order to avoid the “fiscal cliff,” but the problem is spending rather than revenue. As an example:

When President [Obama] entered office, the national debt was $10.6 trillion and today it is over $15.6 trillion. President Obama has increased the national debt by $5 trillion, more than any other President. He has done this with four straight years of trillion-dollar deficits. The fifth year, 2013, will see an estimated deficit of $977 billion under the Obama budget. The President’s budget will make high government spending permanent; spending never goes under 22 percent of GDP in his 10-year budget. His budget also does not seriously address entitlement reforms necessary to strengthen Social Security and Medicare.[5]

Recently the United States Senate overwhelmingly voted to reject the President’s budget proposal, while House Republicans have passed Representative Paul Ryan’s (R-WI) “Path to Prosperity,” proposal, and Senators Mike Lee (R-UT), Rand Paul (R-KY), and Pat Toomey (R-PA) have introduced proposals to address this fiscal crisis. Others, such as Senator Tom Coburn (R-OK) as well as the Simpson-Bowles Commission have also offered solutions to address the spending problem.

In addressing this fiscal emergency, Senator Pat Toomey recently stated:

We have a full-blown crisis that awaits us. It could arrive at any moment, virtually, if we don’t change the course we’re on. The deficit that we have in 2012, $1.3 trillion, is the fourth consecutive year with the deficit over a trillion dollars. We are now routinely running deficits that are 7 percent, 8 percent, 9 percent of GDP, and of course, every year that you run a deficit, the excess of spending over tax revenue has to be funded by more borrowing…Today our total, our actual debt held by the public is 73 percent of our total economic output. And that’s just the publicly-held debt. That does not include the liabilities within the government, which, if you add that, it’s up to 100 percent of total economic output.[6]

Senator Rand Paul stated that the federal government is “currently borrowing $50,000 a second. We borrow $4 billion a day and we’re borrowing over $1 trillion every year.”[7] Sen. Paul also argued that this fiscal crisis is a significant “threat to our national security.”[8] The debt crisis also has economic consequences. “Many economists have said that this burden of debt is actually causing us to lose a million jobs a year. It crowds out private investment because we’ve got to take care of financing this enormous debt,” stated Paul.[9]

Solving the fiscal crisis will not just mean cutting federal spending, but also reforming the entitlement programs of Social Security, Medicare, and Medicaid. These entitlement programs consume a large portion of the federal budget and unless reformed threaten to overtake the budget requiring massive amounts of revenues to pay for the programs. Michael Tanner, a Senior Fellow at the Cato Institute, noted that “Social Security faces unfunded liabilities of more than $15.8 trillion,” while Medicare faces a “budget shortfall of between $50 and $100 trillion, depending on which accounting measure is used.”[10] Entitlement spending along with the massive increase in federal spending is at the heart of this fiscal crisis.

“Our country’s choices are now restricted. Either we reduce spending to shift resources toward more productive uses or we increase taxes to finance the welfare state,” wrote Allan H. Meltzer, who is currently serving as a distinguished visiting fellow at the Hoover Institution.[11] We are already seeing the high-water mark of the welfare state in Europe as the financial crisis across the Atlantic threatens to throw the continent into a severe economic crisis. The storm clouds in Europe should serve as a warning.

“Welfare state spending helps the recipients, but it reduces national productivity, economic growth, and living standards,” argued Meltzer.[12] It is clear that not only more Americans are depending on some form of government assistance, as symbolized by the high unemployment, but as Cato’s Michael Tanner states, “the poverty rate has risen to 15.1 percent of Americans, the highest level in nearly a decade…”[13] Policymakers must also rethink public policy in relation to poverty because “the United States spends nearly $1 trillion every year fighting poverty.”[14]

It is clear that economic uncertainty will continue as long as the policy outcomes do not change. In addition, the economic crisis that is currently overwhelming Europe still could have major ramifications on the United States. Europe appears to be moving in a socialist direction as the results of recent elections demonstrate, but the United States must not follow in that direction.

Creating economic stability and ending the uncertainty will require not only stopping the approaching tax increases as symbolized by taxmaggedon, but also achieving significant tax reform. As an example Senator Paul has proposed a 17 percent flat tax and if achieved it would result in “a boom in this country like you’ve never seen…”[15] Cutting spending along with tax reform would unleash an incentive for private sector growth. President Ronald Reagan during the 1980s proved that following a conservative economic agenda of low tax rates and spending reductions would create economic growth. Reagan’s policies resulted in both a stronger economy and dollar, which led to economic growth.

President Reagan understood the importance of following constitutional principles in formulating economic policy, but perhaps the best example would be to follow the policies of President Warren G. Harding and Calvin Coolidge during the 1920s. President Harding inherited a severe economic crisis, the depression of 1920-1921, which also had high unemployment of 12 percent. President Harding responded by initiating a program which included both spending and tax reductions. Although the 1920s is far different from today (Harding and Coolidge did not have to deal with the complexities of the modern welfare state), nevertheless their economic agenda of spending cuts, tax rate reductions, and paying down the national debt was not easy to achieve.

The Harding and Coolidge spending cuts and tax reduction resulted in the depression of 1920-1921 being very short lived. The policies of reducing government spending, lowering tax rates, and paying down the national debt created a period of prosperity. Amity Shlaes, a journalist and historian of the 1920s and Great Depression era, recently wrote that as a result of the Harding-Coolidge spending and tax reductions:

Voters and markets took the budget cut as a down payment and trusted that the country was headed in the right direction. As the government redeemed that faith with the tax cuts, commerce stirred. The economy grew without inflation.[16]

The tax rate reductions that were championed by Harding and Coolidge not only led to significant economic growth, but more revenue for the government. Secretary of the Treasury Andrew Mellon, who championed the low tax policies of the 1920s, was able to get “Congress to lower the top tax rate from 73 percent to 24 percent.”[17] The noted economist Thomas Sowell argues that “the government actually received more tax revenues at the lower rate than it had at the higher rate.”[18]

The Harding and Coolidge policies added certainty to the economy, which in turn created the “Coolidge Prosperity” of the “Roaring Twenties.” As Amity Shlaes wrote:

Today’s debate has a disingenuous aspect. Trust now matters. The real way to establish trust isn’t to trash austerity. It is to find a way to reduce the budget, not for the sake of budgeting alone but to prove that the leaders really want the government to be smaller. The tax cuts must come along, and fast, but commitment to smaller government matters most.[19]

History has demonstrated that to restore trust and certainty in the economy we must follow policies that are consistent with constitutional limited-government. Harding, Coolidge, and Reagan proved this and following their philosophy and principles will not only lead to economic growth, but also save us from the approaching fiscal Armageddon.

John R. Hendrickson is a Research Analyst at Public Interest Institute. 

The views expressed herein are those of the author and not necessarily those of Public Interest Institute or Tax Education Foundation. They are brought to you in the interest of a better-informed citizenry.

[1] J.D. Foster, “Preventing taxmageddon is Congress’s summer job,” Issue Brief #3608, May 17, 2012, The Heritage Foundation, Washington, D.C., <http://www.heritage.org/research/reports/2012/05/tax-increase-preventing-taxmageddon-is-congress-s-summer-job> accessed on May 18, 2012.

[2] Ibid.

[3] Larry Kudlow, “Extend the Bush Tax Cuts Now,” National Review Online, May 17, 2012, <http://www.nationalreview.com/articles/300306/extend-bush-tax-cuts-now-larry-kudlow> accessed on May 17, 2012.

[4] Ibid.

[5] Senate Republican Policy Committee, “FY 2013 Budgets: Senate Democrats complicit in Obama’s record debt,” May 15, 2012, Senate Republican Policy Committee, Washington, D.C.,

< http://rpc.senate.gov/public//index.cfm?a=Files.Serve&File_id=a640aa34-2130-4b4a-b94d-9d3fe052d600> accessed on May 25, 2012.

[6] Pat Toomey, “Senator Pat Toomey speaks on the Senate floor about his budget resolution,” May 16, 2012, Office of Senator Pat Toomey, Washington, D.C., <http://www.toomey.senate.gov/?p=press_release&id=592> accessed on May 25, 2012.

[7] Rand Paul, “Senate votes on Sen. Paul’s FY2013 budget: A platform to revitalize America,” May 16, 2012, Office of Senator Rand Paul, Washington, D.C., <http://paul.senate.gov/?p=press_release&id=524> accessed on May 25, 2012.

[8] Ibid.

[9] Ibid.

[10] Michael D. Tanner, “The coming entitlement tsunami,” Cato Institute, April 7, 2012, Washington, D.C., <http://www.cato.org/publications/commentary/coming-entitlement-tsunami> accessed on May 17, 2012.

[11] Allan Meltzer, “Why capitalism?” Defining Ideas, May 23, 2012, Hoover Institution, Stanford, California,

< http://www.hoover.org/publications/defining-ideas/article/118006> accessed on May 24, 2012.

[12] Ibid.

[13] Michael Tanner, “The American welfare state: How we spend nearly $1 trillion a year fighting poverty — and fail,” Policy Analysis, No. 694, Cato Institute, Washington, D.C., p. 1.

[14] Ibid.

[15] Paul.

[16] Amity Shlaes, “Supply-siders’ case for austerity carries no shame,” Bloomberg, May 16, 2012,

< http://www.bloomberg.com/news/2012-05-16/supply-siders-case-for-austerity-carries-no-shame.html> accessed on May 25, 2012.

[17] Thomas Sowell, “Defending tax cuts for the ‘rich,’” National Review Online, May 23, 2012,

< http://www.nationalreview.com/articles/300752/defending-tax-cuts-rich-thomas-sowell#> accessed on May 25, 2012.

[18] Ibid.

[19] Shlaes.