The Bipartisan March to Fiscal Madness
By DAVID A. STOCKMAN
Greenwich, Conn.
IT is obvious that the nation’s desperate fiscal condition requires higher taxes on the middle class, not just the richest 2 percent. Likewise, entitlement reform requires means-testing the giant Social Security and Medicare programs, not merely squeezing the far smaller safety net in areas like Medicaid and food stamps.
Unfortunately, in proposing tax increases only for the very rich, President Obama has denied the first of these fiscal truths, while Representative Paul D. Ryan, the chairman of the House Budget Committee, has contradicted the second by putting the entire burden of entitlement reform on the poor. The resulting squabble is not only deepening the fiscal stalemate, but also bringing us dangerously close to class war.
This lamentable prospect is deeply grounded in the policy-driven transformation of the economy during recent decades that has shifted income and wealth to the top of the economic ladder. While not the stated objective of policy, this reverse Robin Hood outcome cannot be gainsaid: the share of wealth held by the top 1 percent of households has risen to 35 percent from 21 percent since 1979, while their share of income has more than doubled to around 20 percent.
The culprit here was the combination of ultralow rates of interest at the Federal Reserve and ultralow rates of taxation on capital gains. The former destroyed the nation’s capital markets, fueling huge growth in household and business debt, serial asset bubbles and endless leveraged speculation in equities, commodities, currencies and other assets.
At the same time, the nearly untaxed windfall gains accrued to pure financial speculators, not the backyard inventors envisioned by the Republican-inspired capital-gains tax revolution of 1978. And they happened in an environment of essentially zero inflation, the opposite of the double-digit inflation that justified a lower tax rate on capital gains back then — but which is now simply an obsolete tax subsidy to the rich.
In attacking the Bush tax cuts for the top 2 percent of taxpayers, the president is only incidentally addressing the deficit. The larger purpose is to assure the vast bulk of Americans left behind that they will be spared higher taxes — even though entitlements make a tax increase unavoidable. Mr. Obama is thus playing the class-war card more aggressively than any Democrat since Franklin D. Roosevelt — surpassing Harry S. Truman or John F. Kennedy when they attacked big business or Lyndon B. Johnson or Jimmy Carter when they posed as champions of the little guy.
On the other side, Representative Ryan fails to recognize that we are not in an era of old-time enterprise capitalism in which the gospel of low tax rates and incentives to create wealth might have had relevance. A quasi-bankrupt nation saddled with rampant casino capitalism on Wall Street and a disemboweled, offshored economy on Main Street requires practical and equitable ways to pay its bills.
Ingratiating himself with the neo-cons, Mr. Ryan has put the $700 billion defense and security budget off limits; and caving to pusillanimous Republican politicians, he also exempts $17 trillion of Social Security and Medicare spending over the next decade. What is left, then, is $7 trillion in baseline spending for Medicaid and the social safety net — to which Mr. Ryan applies a meat cleaver, reducing outlays by $1.5 trillion, or 20 percent.
Trapped between the religion of low taxes and the reality of huge deficits, the Ryan plan appears to be an attack on the poor in order to coddle the rich. To the Democrats’ invitation to class war, the Republicans have seemingly sent an R.S.V.P.
Washington’s feckless drift into class war is based on the illusion that we have endless time to put our fiscal house in order. This has instilled a terrible budgetary habit whereby politicians continuously duck concrete but politically painful near-term savings in favor of gimmicks like freezes, caps and block grants that push purely paper cuts into the distant, foggy future. Mr. Ryan’s plan gets to a balanced budget in the fiscal afterlife (i.e., the 2030s); the White House’s tactic of accumulating small-fry deficit cuts over the enormous span of 12 years amounts to the same dodge.
Such fiscal jabberwocky ignores the fact that we have experienced a recession every five years or so for the last six decades; that the budget is now exposed to even more frequent and amplified cyclical turbulence amid the aftershocks of the financial crisis; and that the United States does not have a divine right to issue any amount of interim debt that suits the ideological convenience of the two parties.
Nevertheless, the Democrats are immobilized because Keynesians insist on kicking the budgetary can down the road until cyclical “demand” has in their estimation fully recovered, while Republicans sit on their hands because supply-siders insist on letting the deficit fester until tax cuts work their alleged revenue magic.
A generation ago, such spurious ideological conceits would never have taken root, because deficits had adverse consequences like rising interest rates or an outflow of monetary reserves.
But for decades now, the central banks of the world have been giving policymakers a false signal that sovereign debt is cheap and limitless. Functioning like monetary roach motels, central banks have become a place where Treasury bonds go in but never come out — thereby causing bond prices to be far higher and interest yields much lower than would obtain in a market that wasn’t rigged.
Indeed, the Fed and currency-pegging central banks in East Asia and the Persian Gulf have absorbed nearly all of Uncle Sam’s multitrillion-dollar spree of debt issuance. Moreover, about $4.6 trillion, or more than half of all debt held by the public, is now sequestered in central banks — paid for with printing-press money.
Even central banks cannot defy the canons of sound finance indefinitely, however. Japan will buy less Treasury paper as it turns inward to recover from the wrath of nature. Likewise, China will drastically curtail its currency pegging and related Treasury bond purchases in order to suppress the rip-roaring imported inflation and speculative bubbles now engulfing its domestic economy. And unless the Fed wants to ruin the value of the dollar, it will need to keep its promise to get out of the bond-buying business, too, when its second round of quantitative easing ends in June.
With the central banks no longer ready to buy, the Treasury market will once again be driven by real investors — many of them likely to demand higher interest rates owing to the heightened fiscal risks recently highlighted by Standard & Poor’s. Ominously, the biggest and baddest of these real investors, the quarter-trillion-dollar Pimco Total Return Fund, has already thrown down the gauntlet by selling Uncle Sam’s paper short.
INTEREST rates have been falling for 30 years, but Pimco’s short call could well mark a generational reversal. If so, rates will continue to rise, and the fiscal time frame will be abruptly foreshortened from the distant foggy future to the Treasury’s borrowing needs in the here and now. Then the abject deficiencies of the dueling budget plans will be self-evident.
By 2014, for example, the Ryan plan does not save a dime from the $2.2 trillion baseline for Social Security, Medicare and national security spending. Then it extends all the Bush tax cuts at a cost of $350 billion while instructing the states to reduce spending for the poor by $100 billion and the Congress to slice domestic discretionary spending by 25 percent. That toxic brew is likely to find few takers — even at a Mad Hatter’s tea party.
The latest iteration of the Obama plan is little better. By 2014, it would generate $70 billion from taxing the rich and perhaps $30 billion from the president’s belated call to re-examine our over-financed military but virtually nothing from freezes on domestic programs or from Medicare reimbursement reforms.
So the Ryan plan worsens our trillion-dollar structural deficit and the Obama plan amounts to small potatoes, at best. Worse, we are about to descend into class war because the Obama plan picks on the rich when it should be pushing tax increases for all, while the Ryan plan attacks the poor when it should be addressing middle-class entitlements and defense.
In the real world, however, the global bond market is already rumbling — and around the corner, a fiscal conflagration surely lies.
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