It’s been said that economists lack common sense, what with their assumptions that people always act rationally and all. There’s a joke that perfectly captures this idea, and it goes something like this: An economics professor and a student are walking down the street. The student says “Hey, look, there’s a $100 bill on the sidewalk!” The economics professor replies “That’s impossible — if it were really a $100 bill, someone would have picked it up by now.”
That’s the rational way of thinking. And, it’s that kind of thinking that dominates at places where economists gather, like the National Tax Association’s 105th Annual Conference on Taxation, which is taking place Nov. 15-17 in Providence, Rhode Island.
The opening session of the three-day conference was titled “Cliffs, Walls, Explosions and Wrecks — Finding a Good Fiscal Detour.” Incoming NTA president Diane Lim Rogers of the Concord Coalition explained that the fiscal cliff is the combination of federal spending cuts and tax increases that are scheduled to shrink the federal deficit to $641 billion from $1.1 trillion in the current fiscal year, a decline of $487 billion in one year. Tax increases account for $478 billion, or 98 percent, of the deficit reduction.
The assembled tax policy experts were supposed to explain how politicians in Washington can craft a detour from the fiscal cliff and do the rational thing — prevent the U.S. economy from falling back into recession and driving the unemployment rate up to 9.1 percent next year, as predicted by the non-partisan Congressional Budget Office. While many economists would like to see the federal budget deficit cut, no rational one wants to do so at the expense of causing a recession.
So, what to do? Alan Auerbach of the University of California at Berkeley pointed out that the fiscal cliff really captures two problems, an economic one and a political one.
As Auerbach says, “we have to distinguish between the economic problem created by the short-run and long-run fiscal imbalances, and the political problem created by the fiscal cliff.” In other words, we shouldn’t spend too much time worrying about a trillion-dollar deficit when we face the long-run fiscal problem created by the fact that federal spending on just three programs — Social Security, Medicare, and Medicaid — will take up about 60 percent of the federal budget (excluding interest payments) within a decade. That doesn’t leave a lot of room for spending on other things, like education, defense, and international affairs. What we really need, according to Auerbach, is major tax reform.
But, that’s not happening any time soon. When asked, none of the economists polled in the room saw tax reform taking place next year. Of course not — it’s not rational to believe that Congress and the administration could reform the tax code in less than a year. As Len Burman of Syracuse University pointed out, the last major tax reform took years to negotiate.
As for the fiscal cliff, Auerbach says “that’s a political problem.” We’ll go off it only if the politicians can’t figure out how to make a last-minute detour. Auerbach doesn’t recommend this option, however. “Shooting ourselves in the head and declaring victory isn’t a good idea,” he said. “Going into a recession without doing anything about the structural deficits isn’t worth it.”
Gene Steuerle of the Urban Institute talked about what he called “The Modern Disease.”
“It’s not the deficit that matters so much, but that politicians on both sides of the aisle have made extraordinary promises on spending that stretch infinitely into the future,” according to Steuerle. He noted that right now, each American household pays about $21,000 in federal income taxes and receives about $30,000 in spending from the federal government. “Economic growth won’t solve the problem. Even though revenue increases as the economy grows, spending is growing even faster than the economy is.”
Cutting spending on entitlements, thus, is the rational thing to do. No politician who wants to be re-elected, however, is going to propose sharp spending cuts in the name of deficit reduction — at least not until another politician goes first.
Rogers closed the discussion by asking the 300 or so economists whether they thought that Congress would deal with the fiscal cliff by the end of the year. Roughly 60 percent said yes, which, of course, would be the rational outcome from an economic point of view.
Some non-economists don’t take such a rational view.
I asked Bill the bartender at Blue Fin what he thought about the fiscal cliff. He confessed to not knowing what it was. When I explained that it was the combination of tax increases and spending cuts that would throw the U.S. economy into a recession and maybe cause him to lose his job, he said, “Do you have any other good news to tell me?” I then said not to worry, because his representatives in Washington would solve the problem, to which he replied, “That’s why we have the problem!”
Betty, another non-economist, thinks we’ll go over the cliff. Why? “Because then nobody’s to blame. They can all say that it wasn’t their fault.”
That may be the most rational thing said all morning.
Joann Weiner teaches about economics, finance, and taxes at George Washington University. She has previously written for Bloomberg, Politics Daily, Tax Analysts and the Treasury Department. You can follow her on Twitter @DCEcon.