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The Bowles-Simpson Commission sequestration of expenditures and the expiration of the Bush tax cuts present President Obama not only with the greatest challenge, but also the greatest opportunity of his Presidency. The threatened economic melt-down could also be an historic opportunity to reverse the 30 year long trend in increasing income in-equality in the USA. Follow me below the fold if you want to understand how the President can turn this crisis to America's advantage and achieve one of the greatest progressive transformations of the political and economic landscape since the New Deal and Great Society of FDR and LBJ:

The US Congress must approve any increase in the US debt ceiling on a regular basis because, even when the debt is not rising as a % of GDP or adjusted for inflation, it is still rising in nominal terms. Debt as a % of GDP is the standard way of measuring the sustainability of debt, and so increasing the debt ceiling is no big deal in economic terms as long as the economy is also growing just as fast over the medium or long term.

Increases in the debt ceiling used to be routine, but in recent years Republicans have used them as an opportunity to force the Obama Government to make swinging cuts in Government expenditure and thus achieve the conservative aim of limited Government. Indeed, this is a major change from their attitude when a Republican President is in power.

"Reagan," Vice President Dick Cheney famously declared in 2002, "proved deficits don't matter." Unless, that is, a Democrat is in the White House. After all, while Ronald Reagan tripled the national debt and George W. Bush doubled it again, each Republican was rewarded with a second term in office. But as the Gallup polling data show, concern over the federal deficit hasn't been this high since Democratic budget balancer Bill Clinton was in office. All of which suggest the Republicans' born-again disdain for deficits ranks among the greatest - and most successful - political double-standards in recent memory.

Last year negotiations on a debt ceiling increase became so fraught that a default on US debt was threatened and the US credit rating was reduced for the first time in US history. Agreement was eventually reached to raise the ceiling pending further negotiations on expenditure reductions, and the Bowles-Simpson Commission was set up to come up with proposals to do so. The Bowles-Simpson Commission proposed a "sequestration of expenditures" - swingeing cuts in defense and other expenditure to come into effect in January 2013 if no agreement is reached.

In addition, the Bush tax cuts are due to expire in January 2013 unless they are further extended by congress. President Obama proposed extending them for all families earning less than $250,000 p.a. but Republicans insist they should be extended for all tax payers regardless of income. The combined effect of the tax cuts coming to an end (thus raising income tax levels) and the Bowles-Simpson Commission sequestration of expenditures coming into effect at the same time would be so deflationary, than many economists predict that the US economy would lurch back into recession.

There is thus a huge game of bluff and counter bluff being played out between the President and the Republican dominated congress at the moment, as to whether the Bush tax cuts should be extended to all (as the Republicans want, and as to whether the debt ceiling will be raised again to avert the Bowles-Simpson cuts in expenditures many of which - particularly those in defense - Republicans do not particularly want either.

Many progressives are urging the President to call the Republican's bluff and let the Bush tax cuts lapse and the defense expenditure reductions kick in - in other  words, to let the economy fall off the "Fiscal Cliff" -  in the belief that Republicans would then quickly cave in and agree to a raising of the debt ceiling in return for no reductions in military expenditure and at least some extension of the Bush tax cuts beyond what the President proposed and campaigned on.

However Republicans have shown a willingness to allow the US economy to deflate by opposing the Stimulus Plan, the Auto-bailout, the previous attempt to raise the debt ceiling, and the President's Jobs Bill - aimed at increasing employment. Indeed it was a key part of their plan to prevent the President's re-election by painting him as unable to manage the economy. Whether they will change their tune now that he is re-elected for the next four years, is open to debate. It is possible that their financial backers in Wall Street and industry more generally will tell them that the price of any further political opposition to the President on this issue is simply to high in terms of corporate profits forgone.

But what if Congressional Republicans simply dig in and refuse any further raising of the debt ceiling and approval for any Budget the President proposes which doesn't include even more swingeing expenditure reductions in social and health care entitlements? The early indications are that they are digging in for a long war against the President, and Democrats more generally, in an effort to retain as much political power as possible. What if no agreement is reached, and the President is faced with a situation where the tax cuts lapse and the Bowles-Simpson Commission proposed a sequestration of expenditures kick in resulting in the US economy sliding into recession?

I would like to propose a strategy the President might use to avert recession and circumvent the debt ceiling, or at least force the Republicans' hand to come up with a proposal more acceptable to Democrats. Suppose the President were to do the following early in 2013 once the Bush tax cuts have lapsed, and the  Bowles-Simpson Commission cutbacks have kicked in:

  1. Announce immediate and huge reductions in future US military procurement.  Military procurement cycles tend to be long, so there will be little immediate effect on military capabilities, and any deflationary effect will be very gradual - but the political effect of announcing the future cutbacks will be immediate. Republicans, and their financial backers in the Military Industrial complex will be absolutely furious.
  2. Announce a significant reduction in US forces and bases worldwide including an accelerated withdrawal from Afghanistan. Democrats would not be unduly alarmed, for the most part, progressives would be pleased, and Republicans would be aghast. The effect on the US economy however would be minimal as the expenditure reductions are in external markets, and bringing more troops home might actually increase domestic consumption.
  3. Announce a US Government zero interest "loan" program for middle class families who are effected by the cessation of the Bush tax cuts at least equivalent to the additional taxes they might have to pay - but also available to the poorest families who are not liable to pay income tax at all - to help reduce the impact of other non-military expenditure reductions forced by the Bowles-Simpson Commission sequester. The fact that it is a loan program means that the debts are technically in the names of those families, and do not increase the US Government's debt.

The effect of these loans would be to enable these families to maintain (or in the case of the poorest families to increase) their disposable "income" and thus their levels of consumer expenditure. The overall economic effect would be to negate the deflationary impact of the tax increases and maintain and increase the consumer expenditure component of GDP. In addition, because lower income groups tend to spend a greater proportion of their income domestically, the multiplier effect of such domestic expenditures would be much greater than if that same "loan" had been given to top earners who would spend a greater proportion of that loan on imported goods or indeed spend it directly abroad. The net effect of these loans would then actually be to grow the economy more and counteract the deflationary effect of the ending of the Bush tax cuts and the reductions in Military expenditure.

Of course Democrats would promise that these loans would be forgiven and made permanent as soon as Democrats managed to achieve control of Congress. If Republicans opposed these proposals, they would effectively be campaigning for tax increases. The effect of the loan program would be far more progressive than any tax reduction, because even low income families who do not qualify for income tax would qualify for the loans. In addition the Republican threat to "tank" the economy would be negated, and many of their favorite military spending programs would be cut. Some of those military expenditure reductions would have been enabled in due course by the ending of the Afghanistan war in any case, so President Obama can present them as "responsible", even if they ended up happening sooner than planned.

President Obama would only agree to terminate the loan program in return for republican agreement on a long term debt reduction plan which meets his targets for employment creation and health and welfare benefits. Any tax reductions would have to be progressive and help even the poorest families. The public option (which could arguably be introduced by Executive Order) would be back on the table, and the Republican threat to destroy the economic recovery averted.

What's not to like?

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Comment Preferences

  •  Wealthy should make a '1 time' extra payment (1+ / 0-)
    Recommended by:
    Frank Schnittger

    To pay down the federal debt.

    Reducing the federal debt will, by itself, reduce the annual deficits.


    Now, why does it make sense for the wealthy to pay down the debt?   Because it will lower their taxes in the future, by lowering the interest paid on the national debt (this takes up close to 30% of the U.S. budget).

    If you, or I had to pay 30% of our annual income to fund our own debts, we would be very reluctant to do so - instead apply more money to the principle (as good Suze Orman tells us all to do).


    Why the wealthy?  Because only the wealthy have the wherewithal to make an extra tax payment.

    This idea has been discussed widely in Great Britain, and has had much appeal there.

    If the wealthy know that their money is not going to social programs or research, but is simply going to pay down the national debt, they might see how sensible an idea it is.

    If it can't be done in one year, then have the extra tax be called a tax surcharge that will be in place only as long as it takes the wealthy to eliminate the national debt.

    It could work, especially if there is a public campaign to focus on the national debt (featured prominently in Republican billboards).  Go after the debt, and the deficit will shrink rapidly due to cuts in interest payments.

    And the not so wealthy could be given encouragement to help pay down the national debt, as well.  Everyone should be encouraged to participate.

    Can you imagine anyone who wouldn't want to do something to help eliminate the national debt, without draconian budget cuts?

    The only reason we have national debt and deficit is because the people with nearly all of the expendable income are not paying enough in taxes.

    There could also be options, such as either move funds into taxable accounts from Cayman Islands or pay a mandatory amount (fee) that would be applied to the national debt.

    Someone like Romney could be required to pay $1 million toward the national debt every year that he continues to keep his funds overseas, for example.

    •  Public Debt=Private Crdit (2+ / 0-)
      Recommended by:
      PennBrian, hubcap

      For every $ public debt there is a private creditor (or foreign state) which holds that debt and who is receiving interest on it. The great untold secret is that the rich actually love a big public debt because:
      1. They get paid interest on it without having to work for it, and
      2.  They can use the "debt overhang" to put pressure on the Government to reduce social expenditures and transfers to the poor.

      The Government doesn't even have to tax the wealthy to stop that scam. It could simply print the money and pay of the debt itself (that is why the analogy between state and family finances so beloved of the right wing is actually misleading and false, Families can't print money).

      Everybody will scream "but that will cause massive inflation and hurt everyone" - well yes and no. Because the US economy is no where near capacity, the effect on inflation will be minimal.  And secondly, whatever inflation it does cause does not effect the rich and poor equally - the effect of inflation is mostly to reduce the value of the retained wealth owned by the rich - which is why they hate inflation so much.

      What you have to understand is that basically "the national debt" is an accounting scam caused by a government NOT printing enough money to cover the cost of its programs, and agreeing, entirely unnecessarily, to pay more money to the already wealthy, for the privilege of borrowing back its own money. Tax, in this context, is merely what a Government uses to "retire" money out of circulation to prevent inflation caused by excessive money supply - over and above that required to enable efficient functioning of an economy. A Government does not have to raise tax to fund its services - it prints money to so - and uses tax to control excessive inflation that would otherwise result from a never ending increase in the money supply.  You should read up on Modern Monetary Theory.

      •  Frank - the President would never (1+ / 0-)
        Recommended by:
        Frank Schnittger

        unilaterally reduce future procurements, or overseas bases and armed forces personnel, without consultation with Congress and the DoD first.

        "let's talk about that"

        by VClib on Tue Nov 13, 2012 at 04:27:55 AM PST

        [ Parent ]

        •  It's not unilateral if it is a requirement (0+ / 0-)

          of the Bowles-Simpson deal which has been approved by Congress. Presumably its up to the armed forces to come up with a plan to cope with the cuts required by the Bowles-Simpson sequestration.

          •  Frank - that's a completely different (1+ / 0-)
            Recommended by:
            Frank Schnittger

            It's one thing to tell the DoD that they need to cut $50 billion/yr for the next ten years out of the budget for the and have them come up with a plan. That's not how I understood what you wrote. I read that you thought the President should make unilateral decisions. The same is true for the $50 billion of domestic spending cuts, starting this fiscal year. That also needs to be done in conjunction with the Cabinet and Congress. We certainly won't get the Defense cuts without a dollar for dollar cut in domestic spending.

            "let's talk about that"

            by VClib on Tue Nov 13, 2012 at 11:26:59 AM PST

            [ Parent ]

    •  nycv - accounts held in the Caymans (0+ / 0-)

      are taxed the same as accounts held in NYC. US taxpayers are subject to the same IRS code regardless of where their financial assets are domiciled. So while various countries are viewed as "tax havens" assets held there are treated the same for the purposes of US federal income tax. For citizens of those countries and some other nations the tax havens have an actual benefit. That's not the case for Americans.  

      "let's talk about that"

      by VClib on Tue Nov 13, 2012 at 04:02:50 AM PST

      [ Parent ]

      •  They aren't held in personal accounts (1+ / 0-)
        Recommended by:
        Frank Schnittger

        Large amounts are accumualted in accounts held by corporatations that are located off shore.  Funds located in the Caymens also avoid US regulation and oversight.  The US taxpayer would hold shares in the fund, and would owe tax on any distributions, but the funds themselves could make investments all over the world, not pay distributions, and be subject to little tax or regulation.  

        Often these funds are controlled by US citizens.  The location in the Caymens is simply to avoid taxation and regulation.

        •  acer - I was responding to nycv's comment (0+ / 0-)

          where they wrote that Romney, and other individual tax payers, should pay an extra $1 million in federal income tax every year they had an account in the Cayman Islands.

          However, I don't really understand your comment. Large amounts, some say several trillion, are held offshore by corporations because to repatriate them would require the corporations to pay full US corporate income tax. It makes no sense for corporations to bring the money back to the US at 65 cents on the dollar when they can invest those funds anywhere else in the world at 100 cents on the dollar. That's just how the current tax laws are written. The US is the only G20 country that even tries to collect corporate income tax on a world wide basis. That's corporations, now let's discuss funds.

          Every large real estate fund, oil & gas fund, movie production fund, venture capital fund, private equity fund and hedge fund that is raising money using a partnership ownership model follows exactly the same practice. They will establish two sister funds, one for US taxpayers which will be registered as a US limited partnership and another offshore in a tax haven like the Cayman Islands for non-US taxpayers. The funds invest in complete tandem and can often invest anywhere in the world, although some partnerships are restricted to investing in the US. The reason for the dual funds is that non-US investors want no part of dealing with the IRS. It gets very complicated requiring those non-US entities to jump through a lot of hoops to show they owe no US income tax. When there are sister funds the fund manager will not let US taxpayers invest in the offshore sister fund. The goal is not to have US investors escape taxes, but to allow entities that have no US tax liability to invest with less hassle. These investment partnerships historically had little regulation because the investors were limited to individuals with very high net worth or institutions. In many cases the minimum investments were $5 or $10 million. That has changed and these partnerships are now under much closer regulation. However, if a fund manager in England, Hong Kong, or Germany, as an example, has one fund, typically domiciled in a tax haven, any US investor, who qualifies, can invest, but that investment has to be disclosed to the IRS.

          "let's talk about that"

          by VClib on Tue Nov 13, 2012 at 11:51:05 AM PST

          [ Parent ]

          •  Just pointing out there are benefits... (0+ / 0-)

            even for Americans.  Tax deferral is a benefit.  And sometimes income is even artificially shifted to offshore corporations from US subsidiaries, just to avoid current taxes. Also, in some cases there is tax avoidance, not legal, but made easier in the past by the lack of regulation and reporting.  I'd like to know whether Romney paid his taxes on that Swiss bank account for example, or whether he was one of those who took advantage of amnesty in 2009.

            But with regard to Romney's Caymans accounts, they were through Bain, and legal, but yes, they also helped him pay a very low rate, though this had more to do with the carried interest loophole, than where they were located.  

            But look at the big picture here.  We have businesses which make virtually no capital investments.  And yet they pay no corporate or business tax, because they are "pass throughs", partnerships or S-Corps or similar.  But then, they still "pass through" these earnings as capital gains, which are for no good reason taxed at a lower rate.  On top of which, the managers of these funds then are even able to treat their own profits--essentially management fees, since they weren't investing their own funds--also as "capital gains".  

            Even for businesses which do involve capital investment, the capital gains tax break there only comes when you sell, so the effect of the tax code is to encourage disinvestment, not investment.  And then, rather than reinvest in the US, they are further incentivized to move the funds offshore.

            So we are giving people tax breaks to sell jobs creating investments in the US, giving them further incentives to move investments overseas, and then not taxing these overseas entities at all, even though they are owned and controlled by US residents and conduct little actual activity in the Cayman Islands.  

    •  nycv - you can't have payments to reduce the debt (1+ / 0-)
      Recommended by:
      Frank Schnittger

      when you are running annual deficits. Any additional increase in federal government revenue, from whatever source, would simply lower the annual deficit for that fiscal year, but the total debt would still increase. If we returned to a position where we were running the federal budget at an annual breakeven, or surplus, then taxpayers could make payments to reduce the debt.

      "let's talk about that"

      by VClib on Tue Nov 13, 2012 at 04:07:59 AM PST

      [ Parent ]

  •  Congress wouldn't agree to any of that (2+ / 0-)
    Recommended by:
    ask, Frank Schnittger

    Most of your suggetions aren't bad, but aside from withdrawing from Afghanistan, they are all things which would have to be approved by congress.  

    I tend to think the President should just let the "fiscal cliff" happen.  I think it's better than any deal he is going to get from the current congress, anyway.  

    1. 36% of the "fiscal cliff" comes from the expiration of the Bush tax cuts, which have been harming the economy anyway.

    2. 20% comes from the expiration of Obama's payroll tax cut and extension of unempolyment benefits.  These are things which have helped working families, but were always intended to be temporary.

    3. Only 11% of it comes from the automatic spending cuts, and half of those come from defense, which really needs to be cut anyway.  

    4.  Altogether, the spending cuts in 2013 amount to just over 4 tenths of a percent of GDP.  The spending cuts alone won't be that harmful to growth.  And the tax increases will be less harmful than many analysts seem to think (and might even help).

    5.  Allowing it to occur prevents the Republicans from again holding the economy hostage over a debt ceiling increase early in 2013.

    This level of deficit reduction in one year would have been disasterous 2 or 3 years ago, when many Republicans wanted to make cuts on a similar scale, but the same policy would be the best thing for the economy in another 2 years when we are growing strongly.  

    Right now, while the recovery has improves, it's still not a great idea to do these things this quickly, but it wouldn't be any great disaster, and it's still likely better than trying to deal with this congress.  

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