Beyond The “Fiscal Cliff” Artificial Melodrama, There Is The Serious Business Of Real Fiscal Reform And The Need To Improve US Long Term Economic Competitiveness – This Will Require Leadership And Political Courage

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By Paolo von Schirach

November 30, 2012

WASHINGTON – No way to know how the unfolding “Fiscal Cliff” drama about the need to have a short term fix for US federal spending and revenue will end up. May be a last minute compromise (before December 31) will be hatched. Or perhaps not.

“Fiscal Cliff” is a distraction

Still, while all this is significant, the man-made element of urgency attached to this crisis may allow a misperception as to what America’s long term fiscal and economic predicament really is.

Right now we are all focused on the negotiations between the Obama White House and the House Republicans. Will they come to a compromise about immediate spending cuts and revenue increases? And, if so, who will benefit politically?

This is good Beltway melodrama, providing good fodder for the 24/7 cable TV programs that treat political news as entertainment. But, as all entertainment, it is ultimately a distraction. Even if Washington eventually managed to avoid the dreaded “Fiscal Cliff”, we can rest assured that that any deal will not take care of the slow deterioration of our national finances. And it certainly would not fix America’s systemic competitiveness crisis resulting in a less productive economy that generates a lower tax revenue.

The real issues: social policies

Let’s look at America’s predicament. Social policies first. Just like other advanced industrial democracies, over time America built up its social safety net with the policy goal of improving the living conditions of the elderly. Larger and more generous social programs in the aggregate mean more revenue devoted to more expensive social programs benefiting mostly retirees. Over time, just as in other Western countries, Washington discovered that these costly programs, designed in different times for a completely different society, no longer pay for themselves. And this is mostly due to new and negative demographic trends.

The social programs were designed to be be self-sustaining. Active people would pay into the system and the funds collected from them would be used to pay benefits to retirees. Good idea. Except that now, due to much lower US fertility rates, we have relatively fewer active people paying into the system, while we have more seniors living longer who receive inflated benefits.

Unaffordable safety net

Add to this negative demographic trend the peculiar American feature of out of control health care costs, and you have the making of a crisis, a slow moving crisis, but a crisis nonetheless. To put it simply, the systems making up the “safety net” are now financially unsustainable, unless we want to increase taxation in order to make up the difference between national revenue and what will have to be paid out to current and future retirees. If you consider that already today about 60% of total federal revenue goes to cover the cost of social programs, you get an idea of the horrendous dimensions of this problem.

Washington does not invest any more

An often overlooked but terribly important corollary of increased social spending is reduced federal investments in education, basic science, technology, medical research, infrastructure, space exploration, you name it. In a constrained fiscal environment characterized by permanent high deficits, as social spending goes up the percentage of federal outlays going to what is generally called “non defense discretionary spending” keeps going down, (to about 15% today), as it is crowded out by more politically sensitive social programs.

Impossible to calculate the long term damage caused by a government that, contrary to past performance, is now unable to contribute to the national innovation machine, since it has become essentially a giant transfer payments agency. But systemic government under investment is bound to have negative consequences.

The real issues: competitiveness

Looking at US long term competitiveness, we should consider public education reform, our rate of technological innovation and targeted immigration policies. It is no secret that America’s public education has been in a slow moving crisis for decades. Whatever the efforts, we are still far from a meaningful trend reversal. Put it simply, today’s under educated young Americans will be tomorrow’s under qualified workers. America’s superior economy was built on the basis of a good public education system. Impossible to stay competitive in a global knowledge economy with ignorant workers.

Furthermore, America needs to encourage innovation. One way to do this is to make it easier for average people to start a business. Lower corporate taxes in the context of a broad based tax reform that would lower rates while eliminating preferential treatment, (the so called “tax expenditures”), would help business formation, at the same time promoting innovation.

By the same token, encouraging talented immigrant (many already here because of their studies) to set up shop in the US would help economic activities, business formation, employment and innovation.

It can be done

Can Washington reform social spending, overhaul the tax system and at the same time create a more pro-business policy environment? Of course it can. All of this is complicated, but not impossible.

However, results are predicated on large amounts of political courage and true leadership. We can only hope that, once we have gotten beyond this artificial “Fiscal Cliff” melodrama, serious people will get to the serious business of fixing public spending and restoring the fundamentals of healthy economic growth. The more Washington waits, the more difficult it gets.

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