Monday, December 17, 2012

More Cliff Notes

Here's Part 2 on "cliff notes" (after Part 1)...

Last week, I wrote about the infamous, impending and ominous “Fiscal Cliff”. A combination of cuts in the planned growth of federal government spending and large increases in federal taxes is scheduled to take place on January 1. It doesn’t take a PhD in Economics to know this would cause problems for our limping labor market and our slowly growing macroeconomy.

There are three issues at hand. First, the underlying problems are our massive federal budget deficits and rapidly growing budget debt. Second, the potential solutions are also problematic. Actual reductions in government spending (however unlikely) and big increases in tax rates (and likely, an increase in tax revenues) would make it even more difficult for the economy to grow.

Third, all of this contributes to what economists call “regime uncertainty”. Nobody knows what Congress and President Obama will do—from the extent to which they’ll address the problem to the particular solutions they’ll embrace. And nobody knows if we’re near the cliff that limits the size of the debt. The debt may soon be perceived by investors as unmanageable. If so, they will refuse to loan money to the government—or will require a higher interest rate. This means higher debt payments, more trouble for our economy, and tighter austerity measures in the future. Finally, no one understands how ObamaCare will be implemented—or how that will impact business decisions.

Any investment becomes more difficult when risk and uncertainty increase. Consumers are less likely to buy cars and homes. Businesses are less likely to hire workers and expand their scale of operations. Investors will require a higher rate-of-return to offset the higher risk—in order to make their capital available. And all of the above will reduce economic growth.

Worse yet, there are other cliffs in our near future. In the realm of the budget, we’re scheduled to hit the debt ceiling again in February and the federal budget’s “continuing resolution” spending ends in March. If recent history is any guide, both decisions will feature plenty of political drama. 

Health care has cliffs too. Doctors are planning for a big increase in their marginal income tax rates. And on January 1, Medicare reimbursements to physicians are scheduled for a 27.4% cut. Congress typically intervenes to prevent cuts like this, but this time may be different. Tighter budgets and a desire to restrict Medicare costs may lead Congress to allow the cuts to stand.

Finally, in January 2014, we can look forward to the imposition of cliffs within ObamaCare’s mandates. For example, since the law and its costs have a larger impact on firms with more than 100 employees, firms will try to stay underneath that threshold. Smaller firms will avoid growth and larger firms will look for opportunities to spin their activity into smaller, less-regulated entities.

Some cliffs are tough to avoid, given the nature of the subsidies in ObamaCare. For example, the government already provides a massive indirect subsidy (more than $100 billion) to purchase insurance through your workplace, since it is a non-taxed form of compensation. (This subsidy causes most of the troubles in our markets for health insurance and health care, but that’s another article!) Now, ObamaCare provides direct subsidies to the working poor and those in the middle income classes. For the working poor, these subsidies are much larger. The good news for them is that they have access to a larger subsidy; the bad news is that this cliff provides firms with a strong incentive to offload those employees to ObamaCare.

Some cliffs could be avoided if the subsidies are set up properly. Unfortunately, under ObamaCare, marriage is penalized for middle-income, dual-earner households. As with any means-tested welfare program, there are also substantial penalties for work, since benefits are reduced as one earns more money. Beyond that, there are a few large cliffs at certain income levels—where benefits are dramatically reduced if you earn one dollar “too much”. At 400% of the poverty level (about $90,000 in income), subsidies are suddenly reduced from about $5,000 to zero. And at 133% of the poverty line, earning an extra dollar would result in contributing 3% rather than 2% of your income to insurance premiums.

Politicians are fond of “cliffs” these days. You can understand why, right? Because the general public doesn’t pay much attention to political economy, politicians have a strong incentive to ignore subtle costs and to procrastinate by pushing costs into the future. If they’re going to postpone tough decisions and add a lot of uncertainty to the economy, perhaps we should send them over an electoral cliff at our next opportunity.


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