Monday, December 31, 2012

On the Eve of the Fiscal Cliff

It is New Year's Eve and still no resolution to the fiscal cliff.  I had thought there would be a resolution but it seems unlikely now.  As I have written before, I don't think it will be a cliff since things will change slowly and Congress can still act in January to change things. The extent to which one views the changes tomorrow as a cliff depends on how Keynesian one is. Since I am not a Keynesian, I don't see it as dramatic as many others do. John Cochrane has a post on his blog that puts the cliff in perspective. He calls it a molehill.  As he notes, the key question involves incentives and we have to look much more broadly at things than just the tax rates in the tax code.

The fiscal cliff can lead to positive things if President Obama and Congress use the next couple of months to work out a long-term solution to the budget deficits that includes true tax reform, i.e., a tax structure that raises revenue in line with needed spending, that minimizes disincentives for work and investment, and eliminates most of the portions of the budget and tax codes that engage in industrial planning.

Greg Mankiw's article in the New York Times yesterday pointed out some basic facts that both political parties tend to ignore.  Any long-term solution to budget deficits requires that the middle class pay substantial taxes.  Alternatively, cuts in entitlements have to be large and our entitlement programs basically are for the middle classes. 

New Year's Eve is supposed to be a time of optimism--hopes for the new year. Fortunately, as people we can have a good year even if the macroeconomy is not great.  Life consists in more than wealth and consumption goods. I prefer to rely on God's grace than on my 401k plans or on social security.

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