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The Circle Bastiat

'Fiscal cliff': Cut the spending – and the melodrama

The 'fiscal cliff' is the crisis that didn't need to be, if the Bush tax cuts had been made permanent and Keynesian influence hadn't spread.

By John P. CochranGuest blogger / January 1, 2013

The U.S. Capitol in Washington is seen at dawn in mid-December, amid the escalating drama of the 'fiscal cliff' negotiations. Had the Bush tax cuts been made permanent, the nation could have avoided the current impasse.

J. Scott Applewhite/AP/File

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Last Wednesday (Dec 26, 2012), I posted the following comment on The Amazingly Popular Bush Tax Cuts by Randall Holcombe:

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No original expiration date, no current ‘crisis’ and no or little impact on policy and regime uncertainty attributed to this part of tax code which has hampered economic planning since the shift in Congress to Dems in 2006.

 Real Housewives of the Beltway: How the script for the fiscal cliff melodrama was written” in the Wall Street Journal (Sat. December 29, 2012) provides a more comprehensive discussion of how this on-going “melodrama was written.” The first item they mention is the one I highlighted above:

The first mistake goes back to the original compromises to pass the Bush tax cuts of 2001 and 2003. Those lower tax rates are expiring now because they weren’t made permanent then.

But for the Journal the primary culprit underpinning these continuing bad policy choices is the ‘vampire’ like Keynesian influence on “mostly Democrats but increasingly many Republican and conservative intellectuals─who think that growth derives from government spending … .” Though, as argued by Block and Barnett (“Involuntary Unemployment,” Dialogue, Vol. 1, 2008, pp. 10-22), “one would have thought that Keynesianism would have been stopped dead in its tracks by the phenomenon of stagflation.” Too bad the stake was never completely drive through the heart of the vampire. Thus the vampire lives and as a result of this underlying fallacious view of how the economy operates, The Journal argues:

The third and biggest blunder is the Keynesian mantra of “timely, targeted and temporary” tax cuts and spending. We thought this had been buried by the Reagan years. But it made a comeback in 2008 with Nancy Pelosi and Harvard economist Larry Summers.

The economic theory is that Congress can, in its ever-present wisdom, calculate precisely the right amount and timing of temporary tax cuts and spending increases to stimulate the economy. But the tax cut must be temporary so as not to add to the “long-term” deficit. And the tax cut must be targeted, lest it benefit someone who makes more money than Ms. Pelosi and Mr. Summers like.

The result has been continuing bad fiscal policy, expansion of government (See Robert Higgs’s excellent discussion here), and an ever accommodative Fed with no permanent benefits (and few if any temporary benefits) but with significant costs both current and future.

Recovery and renewed economic growth depend on decreasing, not increasing government involvement in the economy. Per Rothbard (America’s Great Depression, p. 22)”

There is one thing the government can do positively, however: it can drastically lower its relative role in the economy, slashing its own expenditures and taxes, particularly taxes that interfere with saving and investment. Reducing its tax-spending level will automatically shift the societal saving-investment–consumption ratio in favor of saving and investment, thus greatly lowering the time required for returning to a prosperous economy. Reducing taxes that bear most heavily on savings and investment will further lower social time preferences. Furthermore, depression is a time of economic strain. Any reduction of taxes, or of any regulations interfering with the free market, will stimulate healthy economic activity; any increase in taxes or other intervention will depress the economy further.

In this environment, a truly Rothbardian policy would be a win-win policy for both the short and the long run.

Chances of such a policy – slim to none with 99.99999 … %  odds on none.

Given the actual problem is the spending, the size of the government relative to the economy, then the sad thing is that going over ‘cliff’ may actually cause less long run harm than any likely compromise.

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