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How Obama, Boehner Will Deal with the Fiscal Cliff

Politics / Taxes Nov 10, 2012 - 12:28 PM GMT

By: Gary_North

Politics

Best Financial Markets Analysis ArticleI begin with North's law for dealing with political Keynesians: "When you've got them by the boondoggles, their hearts and minds will follow."

On January 1, 2013, federal taxes will go up. There is no way around this. One way or the other, federal taxes will go up.

There are some questions associated with this forecast. First, which taxes will be going up? Second, who will wind up paying most of these taxes? Third, what effect will this tax increase have on the American economy?


Obama is beginning to sound as though he is ready to compromise in some way with John Boehner over some kind of substitute tax program. Boehner is making similar noises with respect to his willingness to compromise in some way to work out a deal with Obama. The problem is simple to state: (1) Boehner has said that he will not accept any tax revision that places additional taxes on the wealthy, and (2) Obama is philosophically opposed to anything that is going to raise taxes on the poor.

THE VICIOUS VAT

The tax that would really generate a great deal of revenue is the value-added tax. The VAT has been used for a generation in Western Europe to extract enormous wealth out of the taxpaying population, which is everyone.

The VAT has this advantage from the point of view of the government: there is no escape. The tax is imposed on all profitable transactions along the chain of sales. Any business that makes a profit is going to have to pay the VAT. There is no way to hide from the tax collector. He collects mostly from businesses, and businesses have detailed records of what they spend. The digits are easily available. So, there is no place to hide.

The other advantage of the VAT is that it is paid by everybody who makes a retail purchase. It is not exactly a sales tax, but it is close to it. If you buy a product, you pay your share of the tax that was imposed on the retailer. If you do not buy, the retailer is hurt, because he has paid the wholesaler. The wholesaler has to get his money back, because he already paid the tax when he purchased the item from the producer. The producer paid the tax when he bought raw materials in the open market.

From bottom to top, everybody pays on any profitable transaction. This means that it is a comprehensive tax, in a way that no other tax is. It is comprehensive in the sense that everybody who makes a retail purchase pays it, and also in the sense that no business can escape it. This is why it generates so much revenue.

The problem with the VAT for Obama is that it is a flat tax. The poor cannot escape from it. If they buy something, they pay this tax. Even worse from the point of view of Obama, everybody pays the same percentage. Rich and poor, middle class and lower middle class, everybody who makes a retail purchase is paying the same percentage of his income.

This is why the Democratic Party never comes out in favor of the VAT. The VAT is ideologically irreconcilable with the wealth distribution policy of the Democratic Party. The Democrats want the rich to pay a higher percentage of their income to the government than the poor man pays. With the VAT, everybody pays the same.

The big problem with the VAT is that Republicans would probably favor it over any other kind of new tax. Precisely because it is a flat tax, which means that, from the point of view of modern political rhetoric, it is a regressive tax, Republicans would be more willing to vote for this than for an increased percentage of extraction from the rich. Reverse this argument, and you have the Democratic Party's view of the VAT.

Because we are dealing with a lame-duck Congress, and because the President has been reelected, this would be the ideal time for the government to impose a VAT, assuming that the Democrats have the votes in the Senate to get it passed, and also assuming that Obama is willing to compromise. In my opinion, Obama is always ready to compromise. So, the crucial issue here is the Democratic majority in the Senate. Will these people vote for what is essentially a comprehensive sales tax on all transactions? My assumption is that the Senate will not do this, but my assumption is also that the House of Representatives would go along with this before it would go along with a tax on the rich.

STATUS QUO 2000

I think the best we can hope for is that there will be no agreement coming out of Washington this year. The Bush tax cuts will go out of existence on January 1. We will revert back to where we were in the final days of President Clinton. The advantage with this is that we know at least some of the effects of this tax increase. We have paid into this system in the past. There is nothing radical about it.

The other advantage of doing nothing is that there will be automatic spending cuts. The main loser in this round of spending cuts will be the Pentagon. Republicans generally do not want to cut the budget of the Pentagon, while Democrats are far more willing to do this than Republicans are. So, from the point of view of the Democrats, the automatic sequestering that will begin on January 1 would seem to be an advantage. Compared to a comprehensive sales tax on all added value across the boards, which will be paid for by all members of society at the same percentage rate, doing nothing would seem to be the ideological safest road to tax reform that the Senate's Democrats are likely to pursue.

There is no question that we are facing what Bernanke has called a fiscal cliff. There is no question that the combination of increased taxes and reduced federal spending will produce a lot of unintended unpleasant consequences. No one really knows what the effect of these spending cuts will be, but it is clear that this is the right path for the government. Cutting spending is crucial for the continued economic growth of the American economy.

I have no illusion about any tax policy somehow solving the problem of the unfunded liabilities of Social Security, Medicare, and Medicaid. There is no solution to that problem other than default. Somebody is going to have his income reduced when the deficit in the General Fund gets so large that interest rates will start going up. Social Security, Medicare, and Medicaid are all running red ink. This red ink has to be made up by payments into the trust funds by the Treasury. This requires that Congress find a way to raise revenue, or at least to sell Treasury debt to naïve investors who think this can go on forever.

Keynesians are upset by the fact that government spending will be reduced. Austrians are delighted by the fact. Keynesians are in no way concerned if rising taxes are imposed mainly on the rich. Republicans in Congress don't like the sound of that. They will resist it if possible. They have the votes to resist in the House. The Republicans can stop any attempt by Obama to increase taxes on anybody. Obama knows this.

Boehner does not have to compromise at all. If he stands his ground, and tells party members not to vote for any proposed increase of taxes on the rich, he can defeat Obama. He has the upper hand.

OBAMA ON THE FISCAL CLIFF

If Boehner is concerned about the fiscal cliff, then he is concerned about something the government has already accepted. That compromise was made in 2011. That fight does not have to be fought again.

The Republicans will face the prospect of a recession in 2013, but it will be a bipartisan recession. The Democrats voted for this solution, and Obama accepted it. The Republicans can point to the Democrats and blame them if there is criticism of the Republicans for not doing anything to change the tax code. It will be very difficult for Democrats to blame the Republicans for intransigence, when the changes in the tax code that will automatically begin on January 1 were already voted on by Democrats.

The Democrats want to maintain the existing level of federal spending. They want to do this by extracting more wealth from the rich. There's nothing new here. It is business as usual for Democrats. The Republicans' resistance to the suggestion is also business as usual.

Nothing that the Congress can do is going to solve the problem of the unfunded liabilities of Medicare, Social Security, and Medicaid. It is all kabuki theater. The on-budget deficit of $1 trillion is a bad joke. The real deficit is at least 11 times larger. There is no way to solve the problem of the unfunded liabilities of the federal government, other than by some form of default. Somebody's goose is going to get cooked. Politically, it is not clear whose goose will be cooked, but somebody's surely will be.

So, from this time on, Republicans will blame every downturn in the economy on Obama. There will be no way, from this point on, for Obama to point the finger at Bush. If the Bush tax cuts automatically go out of existence on January 1, we will revert back to the Clinton tax program.

At that point, Obama becomes a gigantic donkey, and the Republicans' political task will be to pin the tail of recession on Obama. He will not be able to spend the next four years complaining that it is all Bush's fault. Once the Bush tax cuts go out of existence, the resulting recession will be all Obama's fault. He knows it, the Republicans in Washington know it, and the Democrats in the Senate know it.

This is why Obama is not in a good bargaining position. For the next two years, and possibly four years, he will not be in a good bargaining position. The Republicans hold the hammer. All they have to do is nothing, and whatever happens, at least if it's bad, they will get to blame on Obama and the Democrats. When the Bush tax cuts lapse, we move back into Clinton territory.

If Boehner plays his cards right, he will be in the catbird seat. "Don't blame us." The Democrats have control of the Senate. The Democrats have control of the White House. The tax policies were invented by Clinton. The Republicans fought the tax increases that Clinton imposed on them. So, there is no way for the Democrats to get out of the line of fire. They are going to have to grin and bear it.

This, and this alone, is why Obama may be willing to accept a VAT. I hope he is not. The VAT is a devastating tax on business, and it will lead to increased unemployment. Coupled with the effects on businesses that Obamacare will impose on them, this will be the double whammy. Rising taxes and rising medical health insurance costs will combine to push the economy into recession.

I am not at all worried about the cuts in federal spending. The more austerity, the better, I say. The larger the cuts, the less Keynesianism. Keynesianism believes that federal spending is what holds up the economy. Keynesians come in many varieties, from conservative to radical, but they share this in common: they think federal spending increases productivity, and therefore increases employment. Austrian school economists reject this theory of economic cause-and-effect.

From a political standpoint, the Republican Party is in an ideal position to reap the benefits of inaction. All they have to do to become political victors is nothing. If they sit tight, kick the can down the road again, refuse to raise taxes, and allow spending cuts to fall where they may, they will get to see Barack Obama twisting slowly, slowly in the wind. I think it couldn't happen to a more deserving guy.

My fear is this: Republican Keynesians, believing that federal spending cuts are bad for the economy, by accepting all the nonsense that austerity for the government means austerity for the economy, are going to stand on the sidelines and scream at the House of Representatives to make some kind of tax deal. The best possible tax deal politically for Republicans is no deal. The best possible tax deal politically for the economy is no deal.

What we need is a massive austerity for the government. But we are not going to get that in 2013.

Given the fact that we are not going to get massive austerity for the federal government, which is another way of saying a massive tax rebate to the American people, we should come out in favor of the status quo. The status quo will mean a large target on the backside of President Obama. The Democrats are in control of the White House and the Senate. There is no way that they are going to be able to get away with blaming the Republicans for doing nothing, because the agreed-upon spending cuts and tax hikes were a bipartisan operation in 2011.

If Romney had been elected, then he would be the sacrificial lamb. He would be out there begging the Democrats to work some kind of deal. He would be the one trying to keep the tax hikes and the spending cuts from going into effect. He would be the political target. The best he could do would be to blame everything on the mess he inherited from Obama. Obama has played the Bush card for four years, but there is no way that he will be able to play it for the next four years.

As soon as real tax pain is imposed on the American voters, as soon as unemployment begins to move up, as soon as the recession begins to wipe out pension funds, everybody's eyes will turn, as always, to the savior state in Washington, DC. Voters will be demanding that the government do something, when the crisis that is upon them is the result of what the government has already done.

What is Obama's fallback position? He cannot blame Bush for the next four years. He cannot blame Bill Clinton for the tax system that Clinton rammed down the throats of the Republican Party in the middle of the 1990s. He cannot blame Bernanke, because no President has ever blamed the Chairman of the Federal Reserve. Presidents are allowed to blame other politicians for the evils of the age, but they are not allowed to blame the Federal Reserve System.

Obama has to have somebody to blame, but he has run out of plausible candidates.

Read the rest of the article

Gary North [send him mail ] is the author of Mises on Money . Visit http://www.garynorth.com . He is also the author of a free 20-volume series, An Economic Commentary on the Bible .

http://www.lewrockwell.com

© 2012 Copyright Gary North / LewRockwell.com - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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