Warren Buffett says the US economy is strong enough to withstand a fall over the coming fiscal cliff when taxes and spending cuts are scheduled to take $600 billion a year out of the economy. With his billions I am sure his mortgage is paid and his car will be filled with gas, but for millions of Americans both without jobs and terrified they will lose the jobs they have, Mr. Buffett’s “What me worry” narrative is a callous insult.

While even the drive-by media mavens seem to understand that tax increases that are too great or spending cuts that are too steep will push the US economy back into another recession, most analysts seem blissfully unaware as to how jobs are created and the economy grows. Very simply, the choice comes down to two approaches, one which works and one which doesn’t. First, should we pursue a strategy that pushes a government spending led recovery? Or second, should we create the business conditions where private investment, coupled with prudent and restrained public spending, creates the necessary jobs to get the US back to full employment?

The Administration will not support any budget and tax agreement unless significant amounts of revenue from tax changes are generated. Their going-in position is to raise $1.6 trillion over ten years though it is unclear whether the $50 billion annual tax increase related to funding the Affordable Care Act is included.

This strategy includes tax rate changes on the top two rates, and elimination of certain itemized deductions, as well as changes to the tax rates for dividends and capital gains. The administration would not rule out revenue generated from tax changes other than rate changes but claimed you could not get enough revenue from such changes in any case. They apparently are stuck on trying to wring greater amounts of revenue from a fixed economic pie.

Notice however that estimates of greater revenue from tax changes or tax reform that would generate greater economic growth would not be accepted by the administration, as they claimed such estimates would be the result of “dynamic scoring”. In 1986, for example, the tax reform was “on paper” revenue neutral, but an historical analysis reveals that revenue grew and extra 6% annually as a result of the pr-growth bias in the adopted reforms.

Bu administration policy is that any revenue increases projected as a result from greater economic growth and greater employment than is now estimated as a result of tax changes will not be accepted by CBO or OMB in their economic baselines.

Why is this? This is a built in feature of the 1974 Budget Act that prohibits such scoring to be used by the Congressional Budget Office. This helps preserve a built in bias re: budget numbers towards greater spending and higher rates of necessary taxation. This bias is so absurd but is illustrated by an exchange between former Senator Packwood, then Chairman of the Finance Committee, and a high official in the US Treasury Department. Packwood asked what revenue the US government would collect if tax rates were raised to 100%. Perplexed, the Treasury official asked his colleagues, sitting just behind the witness table. He then told the Senator that well, about 100% of all income earned would be sent to the Treasury!

Would raising tax rates only on the “rich” really make much of a difference in the future budget deficits? In rough numbers, raising the top two tax rates back to the Clinton era levels will generate somewhere between $45 billion and $82 billion a year according to a wide range of estimates. What is not understood by many pushing for higher rates is that the revenue gained is not “free”. There must be an assessment of the extent to which taking such private capital from the private economy will reduce consumption, savings and investment in the private economy, all of which generates some degree of revenue for the US government. Most analysts who have examined this believe the net funds raised from raising the top two rates would be closer to $50 billion a year or $500 billion over the next decade, or less than a third of the revenue target demanded by the administration and a paltry 5% of the $1 trillion annual deficit.

This is mainly a political problem for the Democrats. They are unwilling to even contemplate any kind of entitlement reform or non-defense spending cuts unless “the rich are also punished”. In their thinking, social, health and poverty program expenditures are not to be changed under normal circumstances. In their view, these are the proper functions of government, and with ever expanding eligibility through administration rule making for poverty programs plus a built-in expanded roles for the government in labor, energy and the health care market, government spending is now projected to, in their view, properly reach $5.5 trillion in ten years, with total expenditures over the next decade projected to reach $44 trillion.

Therefore, any reduction in spending is “punishing” the poor or the Middle Class, and if any “sacrifice is needed”, a “balanced approach” requires taxing those “who can afford it”, and this is “fair”. Thus the constant argument that the Bush tax rate reductions adopted in 2003 are “unnecessary” and “unfair”.

But knowing that the wide swath of middle income earners will not accept seeing their tax rates go up, the Democrats decided early on they would characterize the entire tax reform adopted in 2003 as “tax cuts for the rich”. But to raise an appreciable amount of money, taxes had to go up on those other than billionaires and millionaires, including those earning over $200,000 a year. Thus the demonization of those people described repeatedly as “billionaires and millionaires”, even though most were not.

Raising tax rates on the so-called “rich” thus gives the Democratic Party “cover” to “justify” or explain to their radical left constituencies that some changes to entitlements and discretionary spending also have to be part of the mix, even if only cosmetic. But remember, the “cuts” in the projected future deficit spending which the administration constantly heralds have already been agreed to in large part: the spending reductions are reductions only from future expenditures and they were agreed to in the debt ceiling agreement of 2011.

But the tax increases of $1.6 trillion-now being advocated by the administration– were not part of any agreed upon package that now includes $2.5 trillion in future spending “restraint” that now may be achieved in full through sequestration primarily of discretionary spending. But because all tax rate cuts expire at the end of CY2012, taxes on everyone will go up dramatically. Now to forestall that, the administration wants to keep income taxes as they are for everyone, except for those evil millionaires and billionaires, even if their individual income only exceeds $125,000 annually.


But the administration make no pretense, however, that the massive spending projected for the future as 10,000 baby boomers retire every day will be changed. The US is running as fast as it can approaching a larger and more dangerous fiscal cliff, and that is the future unfunded liabilities of our entitlement culture which includes Medicaid, Medicare, Social Security, Federal pensions of all kinds, insurance and other loan programs, (the US taxpayer is now the payer of last result of $1 trillion in student loans which is a back door massive subsidy of the liberal Marxists in academia, many of whom in the real world could not get jobs).

The accepted Washington catechism is that the $80 trillion estimates (I have seen estimates as high as $120 trillion over the next 50-70 years) for future unfunded US government liabilities-while true-are not fit discussion material for debt discussions. As former Carter and Clinton official Bob Beckel complained to Sean Hannity, “Why do we have to balance the budget or pay the debt back?” Similarly, Congressman Charles Rangel, the former chairman of the tax writing House Ways and Means Committee also told Hannity that there was no worry because the full faith and credit of the US government would allow us to borrow whatever future money we needed to pay for these entitlements.

This is why the “Tea Party” is so despised. It is not that their social issue positions are out of step with the mainstream of American culture. It is not that they will impose some Christian Talibanization on America’s suburban bedroom communities, (the worry of Paul Begala). The Tea Party fundamentally is asking a very simple question: are you America willing to put your fiscal house in order?

The President gave his answer on David Letterman when he professed not to know the exact level of the nation’s debt but assured the American people that it was a “long term problem, not a short term problem”. That is code for we do not have to deal with it until after the next election. This is very true as Bob Woodward’s book “The Price of Politics” explains in great detail. The Treasury Secretary said that our fiscal situation was “beyond unsustainable” but that the President of the United States was “ambivalent” about what the US should do about it.

The administration during 2011 negotiations with the Congress was adamant that any deal not getting it through the 2012 election was not going to be accepted. Thus the OMB director Jack Lew proposed sequestration. It was adopted by the President and given to Congress as a “take it or leave it” proposition, with the alternative of default the only other “plan” on the table. This despite the fact that Pelosi, Boehner, McConnell and Reid had in fact agreed to a one year extension of the debt ceiling with corresponding spending offsets but which was rejected by the administration. This is all described by the drive-by media as “being balanced”.

Missing from all of these discussions in large part is the big elephant in the room no one wants to acknowledge. While a restraint in government spending can markedly reduce the Federal annual deficit, the US government will not be able to pay its bills without marked increases in revenue. That revenue cannot be “taxed” from an existing economic pie or an economic base which is growing at 1.7-2% a year. Population growth in the US continues at 3 million a year or near 1% and a large number of new people each year comes into the workforce due to graduating from school and being admitted as immigrants.

The elephant in the room is the business environment that determines investment levels and which in turn determines employment. Some analysts, especially those on the left, believe technology and its resulting productivity has eliminated traditional sources of employment growth and that the US , like Europe, must come to accept a 10-12% unemployment rate as normal and social government expenditures of 25% of GDP. This compares to full employment of 4% or less and peacetime US government expenditures which have historically averaged 18-19% of GDP.

What determines a sound business environment? The head of Goldman Saks addressed this in large part in a recent piece in the Wall Street Journal. Larry Kudlow writes about this repeatedly. There are six key ingredients: Tax policy, energy costs, the value of the US dollar, health care expenditures and rules, debt levels and regulatory policy. In the past decade, the US helped produce a combined energy and housing bubble through totally nonsensical housing policies led by the Clinton administration and a multiple decades’ long inattention to energy markets and energy policy including massive restrictions in the availability of Federal land for energy development and EPA restrictions on energy technology and production.

Tax policy has become a political football, with the administration blaming every assorted ill in America’s economy on those evil tax cuts for the rich, although extending them in December 2010 was somehow necessary to help a slowly growing economy, (which was then in fact growing faster than the US economy is now!). Our corporate tax remains the highest in the industrialized world, even when adjusted for allowable deductions and expenditures, and we are the only OECD country that double taxes foreign corporate earnings.

Health care costs are both the major cost of government and the driver of our debt, as well as a significant cost in employing new people. But for some reason, we decided to adopt a huge and new health care entitlement program costing $2.7 trillion over a decade. On top of which we inexplicably adopted new taxes on health care equipment manufacturers of $220 billion over that same decade as one bill payer which apparently is leading to less employment in the very industries that are projected to pay the bills for Obama Care. Sounds to me like the misguided luxury tax on yachts and airplanes adopted in 1990 which led to wholesale bankruptcies and employment loss in the boat industry.

Regulatory policy is becoming increasing burdensome, amount to hundreds of billions in additional business expenditures, with EPA and the US government apparently on a mission of revenge, retribution and redistribution. How else can one explain terrorizing Amish farmers over whole milk sales, confronting a 6 year old over the contents of her lunch box, stopping the construction of a home over false wetland concerns that ends up being stopped only after reaching the US Supreme Court, and efforts to stop fracking technology and offshore drilling which courts have found to be deliberately falsified with regulatory books having been cooked. And government dictated health care has not yet been implemented!

And of course to come full circle, the US governments spending habits now at $3.7 trillion will approach $5.5 trillion in a decade with no prospect for any reasonable reforms and changes being adopted to put our house in order.

It is not that we do not know how to raise revenue and put our people to work. With the same tax structure as we have today, the US government saw revenue grow from $1.7 trillion to $2.5 trillion from 2003-7. This period also saw corresponding GDP growth of 40%. Jobs grew by 8 million as well. (The economy has not yet got back to that $2.5 trillion revenue producing level some 3+ years into the US economic recovery which simply is evidence of how poor the current recovery remains.)

In 1983, 1997 and 2004, we saw 11.5 million people added to the US employment rolls, years immediately following major tax rate reforms that saw tax rates cut dramatically. In the case of 1983 all rates came down; in 1997 we cut capital gains taxes and increased the child tax credit; and in 2003, income tax rates and capital gains rates declined significantly. Employment not only went up by over 3 million a year on average, revenue to the Federal government also increased.

And each of these years saw a major, even huge increase in net private investment into the US economy-30% under Reagan for example in 1983 alone. The total net increase in investment for the three years was close to $600 billion.

By comparison, the four year increase in private investment in 1979, 80, 81, 82 was a paltry $100 billion, compared to the surge in investment in 1983-84 which reached an additional $350 billion. This is the primary reason the US economy in 1983 produced more than 4 million jobs.

Isn’t that what we should be concentrating on? How do we do that again should be the debate, shouldn’t it? And what US policy has to change to enable that to be done again? But to examine those questions, we would have to admit that much of the economic policies of the 24 years from 1983-2007 “worked”.

We would also have to stop demonizing those couples making a little over $100,000 each, stop penalizing success, and realize we cannot have the US government pay for everything, including heath care, food, phones, homes and energy. Wouldn’t it be a better use of our energy to actually figure out what makes people risk their own capital to start a new business, which produces some 80% of all the new jobs in a recovery, and duplicate the job growth in 1983-89, (20 million), 1991-2000 (24 million) and 2003-7 (8 million)?

And what about the drive-by media? They would have to go back and admit their complaint that the Reagan economy was “just creating hamburger flippers”, was based on the same angry, uninformed, ideological clap trap which we hear today.

Will we have that debate? Well, don’t hold your breath. At least not until you go flying over the economic cliff we apparently are intent upon approaching as fast as possible. But Warren Buffett assures us there is nothing to worry about. This is called the “Alfred E. Neumann What Me Worry Economic Strategy”. When hurtling over an economic cliff, smile and hold your breath.

Peter Huessy is President of GeoStrategic Analysis of Potomac, Maryland , a defense and national security consulting firm.

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