By: Peter Schiff Friday, November 9, 2012

Now that President Obama has been re-elected, the media is finally free to focus on something besides the clueless undecided voters in Ohio, Florida, and Colorado. The brightest and shiniest object that has attracted its attention is the "fiscal cliff" that we are expected to drive over at the end of the year unless Congress and the President can agree to turn the wheel or apply the brakes.

Fresh from his victory, the President took time today to let the nation know how he proposes to avoid the cliff: to raise taxes on those Americans who make more than $250,000 per year. He made clear than no one making less than that will be asked to pay any more. The two percent of taxpayers that the President is targeting earn 24.1% of all income and pay 43.6% (as of 2008) of all personal federal income taxes. Sounds like a fair share to me. But the four or five percent tax increases on those earners that are being proposed would only yield around $30 to $40 billion per year in added revenue, a drop in the federal bucket. Even if they were to double the amount that they pay our deficit would only be cut by about one third (even if those increases did not trigger an economic slowdown).

So what exactly is this looming menace, and why is it so dangerous? Stripped of its rhetorically charged language the fiscal cliff is simply a legal trigger that will trim the deficit in 2013 by automatically implementing spending cuts and tax increases. In other words, the government will spend less, and more of what it does spend will be paid for with taxes rather than debt. Isn't this exactly what both parties, and the public, more or less want? The fiscal cliff means that the federal budget deficit will be immediately cut in half, shrinking to approximately $641 billion in 2013 from the approximately $1.1 trillion in 2012. What is so terrible about that? I would argue that there is a greater danger in avoiding the cliff than driving over it.

If you recall, the cliff was created by a deal last year when Congress couldn't find ways to trim the deficit in exchange for raising the debt ceiling. When they failed to reach an agreement, Congress knew they had to raise the debt ceiling anyway. The resulting Budget Control Act of 2011, signed in August of that year, offered the pretense that they were dealing with our long-term fiscal crisis and not simply raising the debt ceiling with no strings attached. This was done not only to appease some House Republicans, who had threatened to vote against a debt ceiling increase, but to satisfy the bond rating agencies that had threatened (I would choose a different word or provide a source to back this up)a down-grade if Congress failed to act.

Now the focus turns to how Congress will dismantle the structure it created just 16 months ago. There can be little doubt that they will as economists are assuring politicians that driving over the fiscal cliff will immediately bring on a recession. The expiration of the Bush era tax cuts for all taxpayers will cost Americans an estimated $423 billion in 2013 alone. Hundreds of billions of across the board spending cuts, including the military, have been delineated. No politician would allow that to happen.

It is amazing that members of Congress can keep a straight face as they claim to want to address our long-term deficit problem while simultaneously working to avoid any substantive action. No doubt an agreement will be reached that will replace the looming fiscal cliff with another one farther down the road (which they can easily dismantle before we actually reach the precipice). Will the rating agencies buy this bill of goods a second time? If we lack the political courage to go over this fiscal cliff, why should anyone think we will be able to stomach going over the next one? Especially since each time we delay going over the cliff, we simply increase its future size, making it that much harder to actually go over it.

Many currently believe last year's S&P downgrade resulted from the same congressional dysfunction that resulted in the fiscal cliff agreement. The truth is that the downgrade would probably have been much greater, and more rating agencies would have likely joined S&P in taking action, had it not been for the fiscal cliff agreement. If further downgrades fail to be issued when the lame duck Congress inevitably comes up with another can kicking deal, then the agencies themselves could lose any remaining credibility. In my opinion, the only explanation for inaction by the rating agencies would be for fear of regulatory retaliation by a vindictive U.S government.

I do not think it is a coincidence that while the banks are suffering a regulatory backlash as a result of their perceived culpability for the mortgage crisis, the credit rating agencies have been relatively untouched. But the credit agencies played a key role in catalyzing the mortgage crisis by giving questionable ratings to the mortgage backed securities. My guess is the government simply does not want to open up that can of worms as similar mistakes are being made with respect to the agencies' ratings of government debt.

The truth is that regardless of what you call it, going over the fiscal cliff is not the problem, it is part of the solution. Our leaders should construct a cliff that is actually large enough to restore fiscal balance before a real disaster occurs. That disaster will take the form of a dollar and/or sovereign debt crisis that will make this fiscal cliff look like an ant hill.





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