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The Real Cliff

The staggering debt from decades of continuous government borrowing is about to come due

Dec 24, 2012, Vol. 18, No. 15 • By CHRISTOPHER DEMUTH
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It is important to understand that the fiscal cliff is a charade. There are, to be sure, many conscientious debt reformers working to avert our proclaimed year-end epic fall​—​along with many cynics who are using the occasion to advance pet projects that will make the debt problem worse. But all concerned are working within a fiscal system that has become seriously pathological. The cliff is the latest expression of that pathology.

Ravenswood Red Ledger Ink

Just last year, the president and Congress agreed by statute to (a) increase the federal government’s public debt by more than $2 trillion (up to $16.4 trillion) and (b) begin reducing annual federal spending by less than one-tenth that amount starting in 2013. A variety of temporary tax reductions, aimed at spurring recovery from the Great Recession, were also scheduled to expire in 2013. Now that the new debt has been borrowed and spent, the prospect of actually reducing our annual $1 trillion deficits by a significant amount is regarded by all sensible people as a catastrophe that must be avoided at all costs.

And what is to be done to stop the spending cuts and tax increases? This month’s partisan positioning over raising taxes on the wealthy masks a consensus, embraced by the leadership of both parties, on two essential principles of cliff-avoidance. First, the vast majority of Americans who are middle class must be spared any clear-and-present impositions: Their direct income taxes must not be increased, and their Social Security and Medicare benefits must not be reduced any time soon​—​meaning that any reductions will be as contingent, and possibly ephemeral, as last year’s debt-reduction accord. Second, the federal debt must be immediately increased by yet another $2-3 trillion, with further increases of equal magnitude certain to follow.

These principles embody America’s de facto fiscal policy since the early 1960s: continuous government borrowing to pay for current consumption. That policy was, in the first instance, an unintended consequence of Keynesianism, which proposed that government shore up aggregate demand by spending more than it taxed during economic downturns.

Previously, government borrowing had been mainly for investments to secure or improve the future​—​expenditures appropriately shared with future generations. These included not only physical infrastructure such as roads and water systems but also wars (almost always debt-financed) and national expansion (Jefferson purchased the Louisiana territory mainly with Treasury bonds, which Napoleon promptly sold at a discount).

Keynes introduced the idea that government could legitimately borrow not only for production but also for consumption. Just as a creditworthy individual may take out a mortgage to purchase a home with future earnings, so government could borrow a share of tomorrow’s wealth to meet urgent current needs. There had always been cases, such as natural disasters, in which governments had spent liberally, and if necessary by borrowing, to sustain incomes in the face of widespread emergency losses. Writing in the 1930s, Keynes in effect generalized the proposition to encompass economic emergencies of the magnitude of the Great Depression. His postwar apostles made refinements​—​such as “countercyclical stabilization” and “the full-employment balanced budget”​—​to moderate more routine fluctuations in the business cycle.

These were important intellectual advances. Although subject to many objections and qualifications, they were admirable efforts to respond to hardship and harness the modern economy more tightly to individual well-being. But, like many such advances, they emerged from a particular milieu and then reshaped that milieu in surprising ways. The Keynesian nostrums were conceived in an era when the balanced budget was the universally accepted norm: They assumed that debts incurred during depressions and downturns would be balanced by surpluses during booms and upturns. And the prospect of balance over the course of business cycles seemed unproblematic during the Depression, when the economy had been roaring in the recent past, and during the three postwar decades (through 1974) of bracing growth marred by only moderate recessions.

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