By Timothy F. Kearney, Ph.D., Misericordia University
Washington is in the midst of cantankerous discussions about how to avoid the so-called "fiscal cliff," a combination of major tax hikes for all taxpayers and modest across-the-board spending cuts – except for veterans' benefits, Social Security, and Medicare and Medicaid – throughout the federal government that will automatically go into effect Jan. 1 if no action is taken by our nation's elected leaders.
The federal deficit would be reduced from $1.089 trillion in fiscal year 2012 to $641 billion in fiscal year 2013, according to the Congressional Budget Office, if these automatic tax hikes and budget cuts are realized. Crossing the fiscal cliff, though, could also send our nation's economy back into recession and could send the unemployment to 9 percent. Given the repercussions, it's no surprise, that negotiations in Washington are focused on how to avoid this fiscal cliff.
Much of the discussions revolve around returning the rich – individuals earning more than $200,000 and married couples making above $250,000 – to the income tax rates of the late 1990s under President Clinton. It's a good framework to consider: The economy was strong, the budget was in surplus, and job growth was robust. As such, there is a broad understanding that President Clinton's recipe of tax cuts on capital gains in the 1997 Taxpayer Protection Act, sharp cuts in public spending, and sensible deregulation delivered that record economic boom. The income tax hikes of 1993 did deliver a slower economy and a Republican-led Congress by 1994, so even President Clinton famously admitted he raised taxes too much in 1993. Still, the Clinton years are a worthwhile example of a time when bipartisan agreement reached a balanced approach to deliver a budget surplus and economic growth.
In fiscal cliff negotiations, President Obama and House Speaker Boehner have agreed to exempt 98-percent of taxpayers from the higher tax rates under former President Clinton. Rather than raising $275 billion and reducing the nation's deficit to $850 billion be re-instituting all Clinton-era tax rates, Obama's proposal would only generate an additional $84 billion in new revenue and barely put a dent in the $1.089 trillion deficit.
A hallmark of the Clinton years was a major reduction in federal spending. On his watch, spending as a share of the economy reached the lowest levels since the 1960s. Since that time, however, both President George W. Bush and President Obama went on unprecedented spending sprees. Federal expenditures as a share of the economy are at levels not seen since World War II. Returning spending to Clinton-era levels would reduce expenditures by about $800 billion.
By studying the fiscal policies and the prosperous economic era of the late 1990s, we find that our economy can grow and flourish with higher tax rates and significant federal spending cuts. A first cut implies that the U.S. would need nearly $3 of spending cuts for each $1 to bring the budget towards balance.
Given the weak state of the current economy, our fiscal policy should be adjusted slowly but surely in the direction of somewhat higher tax rates along with much less federal spending. We agreed with President Obama in 2010 when he warned the economy was too weak to let the Bush-era tax rates expire. While the economy is somewhat weaker today, it is clear that we can use the fiscal policies of the Clinton years as a guide for bringing our economy back to more prosperous times.
Timothy F. Kearney, Ph.D., is an assistant professor and chair of the Department of Business at Misericordia University in Dallas, Pa.