It's clear Wayne Swan doesn't understand the US economic debate.
YOU wouldn't know it from the media coverage, but Wayne Swan's foray into US politics showed a profound misreading of Washington's economic debate on the eve of the presidential election.
According to the Treasurer: "The biggest threat to the world's biggest economy are the cranks and crazies that have taken over a part of the Republican Party."
How so? Because their opposition to high spending could prevent Congress from resolving its budget problems, known as the "fiscal cliff". That would mean a major withdrawal of government spending, which in Swan's telling could drive the US economy into recession.
Just what a debt-burdened US needed: a lecture from an Australian Labor politician not to cut spending.
To understand the US economic debate properly, one needs to recognise two different fiscal cliffs. The first cliff is the rise in tax rates because Bush-era reductions are set to expire at the end of the year. The second cliff is the $1 trillion-plus in cuts in defence and domestic discretionary spending during the next decade as part of last year's compromise to reduce the debt.
Like most Keynesians, Swan misdiagnoses the real threat to the US economy: it's the taxes, not spending, as The Wall Street Journal consistently editorialises. Take some history: in the past three decades, Washington has made two major efforts to cut federal spending. The results: long booms.
In the 1980s, a combination of tax and spending cuts led to a decade of economic expansion. After the Republican Congress and Democrat Bill Clinton implemented budget reforms in the mid-1990s, spending began to fall as a share of gross domestic product until the early 2000s. The economy and stocks boomed.
In the Bush and Obama eras, however, federal spending has increased from 18.2 per cent of GDP to 24 per cent. In early 2009, White House advisers predicted the $830 billion stimulus package would deliver less than 6 per cent unemployment by now. Obama himself declared his presidency would be "a one-term proposition" if he did not turn around the economy.
It's been more than three years since the recession technically ended. Yet the economy is limping at less than 2 per cent growth and 8.1 per cent unemployment. Meanwhile, real incomes have declined nearly 6 per cent, the US deficit has doubled and the debt has increased by more than $5 trillion.
Contrary to Swan, what could push the US off the fiscal cliff is the scheduled tax increases by year's end. That may explain why 19 congressional Democrats have supported House Republicans to extend the current rates for another year. (Memo to the Treasurer: are these Democrats "crazies and cranks" too?)
But neither the President nor the Democrat-controlled Senate is co-operating. That means liberals are essentially backing a gigantic tax increase in the New Year, which would put the brakes on the most sluggish recovery since the Depression.
There are, of course, other risks and uncertainties involved. As Federal Reserve board member Richard Fisher conceded last week: "Nobody really knows what will work to get the economy back on course."
But if a recession occurs next year, it's a fair bet the Democrats' refusal to pass the Bush-era tax cuts, taken together with taxes on capital gains, dividends and estates on January 1, will cop a lot of blame.
All of this is crucial to understanding how Swan misunderstands the legislative debate in the US. It also helps clarify the stakes of the 2012 election. Above all else, the Obama-Romney contest represents a philosophical debate about the size and scope of the federal government.
This debate has been raging since Barry Goldwater's failed bid against LBJ's Great Society in the mid-1960s. It accelerated in the '80s with the Reagan agenda of tax cuts and deregulation. Then the mid-1990s brought us the Republican takeover of Congress, which pushed Clinton into declaring "the era of Big Government is over" (welfare reform, balanced budgets, the North American Free Trade Agreement).
But the past decade has hurt the cause of smaller government and the US has gone down the road to higher levels of spending and regulation.
That is why Mitt Romney's running mate, Paul Ryan, the Tea Party and a new breed of Republican governors represent a refreshing change. They repudiate Obama's let-government-solve-it liberalism, and Bush's don't-rock-the-boat Republicans.
That means reforming entitlement programs (Medicare, Medicaid, Social Security) that are on an unsustainable trajectory as well as proposing tax reforms that reduce rates in exchange for closing tax loopholes. It also means finding a way to cut indecently high spending and insanely high debt while reviving a lacklustre economy.
A choice, not an echo. Get ready to hear Romney make that pitch in the first presidential debate.
Frequently Asked Questions about this Article…
What is the "fiscal cliff" and why should everyday investors care about it?
The article describes two parts of the fiscal cliff: scheduled year‑end rises in tax rates as Bush‑era tax cuts expire, and more than $1 trillion in planned defence and domestic discretionary spending cuts over the next decade. For investors, a fiscal cliff matters because sudden tax increases or big spending cuts can slow economic growth, raise recession risk and increase market volatility—all of which can affect corporate profits, stock prices and consumer spending.
How could the scheduled tax increases at year‑end affect markets and personal investments?
According to the article, tax increases on income and on capital gains, dividends and estates could put the brakes on a fragile recovery. For markets and personal investments this may mean lower after‑tax returns, reduced consumer demand, pressure on corporate earnings and increased market uncertainty—especially if the tax changes are large and happen suddenly.
Is the current US risk driven more by spending cuts or by tax rises?
The piece argues the bigger short‑term risk is the planned tax rises, not the discretionary spending cuts. While long‑term spending and entitlement reform are important, the article suggests scheduled tax increases at the turn of the year are more likely to slow growth and possibly push the economy toward recession.
How have US federal spending and debt changed recently, and what does that mean for investors?
The article notes federal spending rose from about 18.2% of GDP to roughly 24% during the Bush and Obama years, the deficit has roughly doubled, and the debt increased by more than $5 trillion. For investors, those trends shape the fiscal policy debate—pressure to reduce deficits can lead to tax increases or spending cuts, both of which can influence economic growth and market returns.
Why did some congressional Democrats support extending current tax rates, and what does that mean for investors?
The article reports that 19 congressional Democrats backed House Republicans to extend current tax rates for another year to avoid the immediate impact of the scheduled tax increases. For investors, an extension would postpone tax‑related shocks and reduce short‑term downside risk to growth and markets, though it may leave underlying fiscal issues unresolved.
How could outcomes from the 2012 US election affect investor decisions?
The article frames the 2012 election as a debate over the size and scope of federal government. A win for candidates favouring smaller government—like Mitt Romney and running mate Paul Ryan and elements of the Tea Party—would likely emphasize entitlement reform, spending cuts and tax reform. Those policy directions could influence long‑term fiscal sustainability, market regulation and investor expectations about growth and returns.
What are the main fiscal risks and uncertainties investors should watch right now?
Key risks highlighted include the scheduled tax increases at year‑end, the planned discretionary spending cuts over the next decade, uncertainty around entitlement reforms (Medicare, Medicaid, Social Security), and broader unknowns about what policy mix will restore growth. The article quotes a Federal Reserve member saying nobody really knows what will work to get the economy back on course—so investors should monitor policy decisions closely.
What policy changes are Romney, Paul Ryan and the Tea Party proposing that could impact long‑term investing?
The article notes they advocate entitlement reform (changes to Medicare, Medicaid and Social Security), tax reforms that lower rates while closing loopholes, and cutting high spending and debt. For long‑term investors, such changes could affect fiscal sustainability, future tax burdens, healthcare costs, and regulatory settings—factors that influence economic growth and asset returns over time.
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