THE BLOG
11/13/2012 06:09 pm ET Updated Jan 13, 2013

The Dilemma of Fiscal Cliff -- The Solution Is to Scrap It

The current economic policy priority should be to reduce the rate of unemployment down to 4 percent and subsequently seeking policies to reduce deficit and debt after the economy is robust. The current dilemma of fiscal cliff offering two possibilities neither of which are practically acceptable nor offering desirable alternatives. When the bipartisan Committee met last summer and concocted mandatory tax increase and spending cuts, the dilemma of fiscal cliff was created by default. The Committee's goals were to solve two problems concurrently, i.e., to reduce unemployment and reduce deficit/debt, by the end of 2012. But these two objectives worked against each other when the economy is already in a recession (8+ percent unemployment). Ostensibly, their prescription could not solve either problem, and if implemented it could lead to an economic depression. Why? Because the economy is already in a recession sustaining approximately 8+ percent reported unemployment while the real unemployment rate is in double digit as the discouraged unemployed numbers have withdrawn from the labor force and are no longer counted by the Department of Labor. Macroeconomic theory dictates that during recession, government should lower taxes and increase government expenditure to increase aggregate demand and get the economy to shift from a contraction to an expansion phase. It follows that at this time, taxes should not be increased rather they should be decreased.

The Committee's prescription last summer must have been based on the assumption that the economy would be in an expansionary phase by the end of December of this year, 2012, and the Committee's recommendation of increasing taxes on the rich and decreasing government expenditures would be triggered in January of 2013. But the recession did not taper off since last summer and therefore its prescription to raise taxes on the rich and reduce government expenditure would be ruinous upon the economy as it will cause the rate of unemployment to rise. Abstracting from the emotional predilection of the ideologues on the issues, the above prescription would be counterproductive with respect to deficit and debt because if the economy turn into a depression, government revenues would shrink causing a rise in deficit/debt. Raising taxes and lowering government expenditures could reduce deficit/debt if the economy were in an expansionary phase of a business cycle not in a recessionary or contraction phase of the business cycle as we are at the present time.

What is the Solution?

Clearly the Committee's determination of raising taxes and cutting expenditures was inherently inconsistent and should be scrapped for the time being until the economy rebounds into an expansionary phase of the business cycle. Moreover, in terms of priority if a choice is being made to either reduce unemployment or reduce deficit/debt, unemployment must be tackled first. The economic and social cost of unemployment is heavy, immediate and in the short run. When the economy is robust and reaches full employment, government revenues will rise and the deficit could turn into a surplus; as it did during the last year of the Clinton administration. This is much better rout than the fiscal cliff. During World War II, national debt rose close to the level of GDP. Subsequently it declined during the robust years of post-World War II era. Deficit and debts are caused by recessions and wars. The U.S. economy sustained a major recession since 2007 and two wars (Iraq and Afghanistan) the general public can live with deficit/debts as they are recorded into ledgers and books but not with high unemployment. They want food on the table, clothing, shelter, health care, recreation and other necessities of life.

Moreover, in the current debate it should be pointed out that any argument to raising government revenues, the discussion is superfluous between the alternatives of raising tax rates on the rich and closing loopholes to generate more revenues, in fact closing the loopholes would generate more governmental revenues than raising the rates by a few percentage points.

In the final analysis, it must be emphasized that during recession raising taxes and reducing government expenditures is clearly a violation of sound macroeconomic policy and should not be tried. At this time there is a dire need to reduce unemployment by lowering taxes and increasing government expenditures.

Subscribe to the Politics email.
How will Trump’s administration impact you?