The phrase ‘fiscal cliff’ now permeates the American media. In essence, the cliff is a series of legislated fiscal triggers that will be activated on 1 January, which include the ending of President Bush’s tax cuts, the re-introduction of the payroll tax, the ‘sequestration’ of the American military budget, and the renegotiation of the debt ceiling (Democrats want Congress to issue an expiry-free ‘get-out-of-jail-free’ card). You may be forgiven if your eyes glaze over when considering the déjà vu nature of the debate to cull and rationalise State tax and spending commitments – note the one-sided nature of these talks thus far. What cannot be forgiven, however, is endemic political legerdemain.
Discussions of government funding are usually greased with the euphemism of ‘compromise’; in this case, by a Democratic White House and Congress who urge their Republican colleagues to solve the impending fiscal cliff by compromising on their pledge not to raise taxes, principally on those earning $200,000 or more, and so to make substantial steps towards bridging the gap between revenues and expenditures. (Cuts to government spending are requisite to abide by the conventions of partisan etiquette but, as has been noted by President Reagan and others, when Republicans agree to tax increases to be accompanied by spending cuts, taxes are raised but cuts never materialise).
Compromise was classified as a virtue in the political lexicon at least since the days of Aristotle, who wrote of the practice in the Nicomachean Ethics: ‘sometimes we must incline towards the excess, sometimes the deficiency, because in this way we shall most easily hit the mean, namely, what is good (1109b).’ In aiming for the good of the American State, Democrats praise an excess of taxation while castigating deficiencies in government programmes; Republicans hold the opposite position. Can either party be said to represent the true good?
Economic analysis would give Republicans the upper hand; for while it is argued that increased tax rates result in increased tax revenues, Laffer curve analysis proves otherwise: the correlation is not static as assumed, but dynamic, as taxpayers adjust to enhance subjective well-being. Based on the axiom that at both zero and 100 percent tax rates the government will collect no tax revenue, the curve shows that there is a level of taxation that will result in optimal private-sector growth (e.g. financing the essentials of law and order that promote economic activity). Past this point of tax increases, growth with continue, only more slowly, until the optimal taxation point is reached; beyond this point, although tax rates increase, tax revenues will fall. As Arthur Laffer emphasised at a recent lecture at IEA, ‘not only will we reduce tax revenues from the rich if we raise tax rates on the rich, but we will hurt the economy.’
This is reminiscent of another Aristotelian insight: that sometimes, when the options are between right and wrong, no compromise is possible. ‘Not every action or feeling admits of a mean … In their case, then, one can never hit the mark, but always misses. Nor is there a good or bad way to go about such things … doing one of them, without qualification, is to miss the mark (1107a).’ So, whereas there are better and worse levels of taxation up to the optimum taxation level (i.e. diminishing rates of economic growth), past this level there is no mean rate: it results in both less economic growth and less tax revenue, and is wrong.
To cut spending or raise taxes? To hold to economic principle or acquiesce to political expediency? These are vital questions laid before US politicians, a class not known for courage when serving as the standard-bearer for unpopular policy. And so each day America’s fiscal cliff looms ever closer upon the horizon.