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al-Iqtisadia, Saudi Arabia

The US Budget Crisis, Simplified



By Dr. Muhammad Aal ‘Abbas

Translated By David Bishop

16 February 2013

Edited by Vic­to­ria Denholm


Saudi Arabia - al-Iqtisadia - Original Article (Arabic)

What is the truth behind the conflict over U.S. economic policy, and how can it be explained in "economic" terms to the non-expert reader in “economic” brevity? It is simply the old conflict over taxes between the Democratic Party and the Republican Party. This is the battle that took on a new dimension prior to the era of former Republican President Ronald Reagan, where a long argument broke out over what at that time was called the Laffer curve.

The economic theory behind this curve is elegant and simple, but its political effects have been far reaching in the United States where Republicans have frequently won – despite undertaking many risky foreign adventures– just because they have adopted the philosophy of this theory. In short, the curve depicts the relationship between the government’s net revenue from taxes and the average taxes. The curve says that the amount of revenue from taxes will be zero if the average rate is zero percent and that it will also be zero if the average is one hundred percent. That is, a tax rate of zero percent means that people will pay nothing to the government, and the yield from taxes is thus nil, which is logical. But when the tax rate reaches one hundred percent, people simply will stop working because work has no meaning when the government takes all the profits. Thus, the tax rate that can accrue revenue to the government is definitely between zero and one hundred percent, but how much exactly?

The genius of the Laffer curve is that it says that the revenue of a tax rises with the average tax rate until a certain level, after which any increase in taxes will lead to a decrease in revenues as the average tax rises. [This continues] until we reach zero revenue with a one hundred percent tax rate. It thus follows that lowering average tax rates will encourage people to work and be productive, thus increasing their profits, and in the end will increase government tax revenue.

This policy certainly makes Americans happy. Thus Republicans adopted policies of lowering average tax rates. The ones most enthusiastic about this policy were George H.W. Bush and George W. Bush, and also former U.S. Vice President Dick Cheney and former Secretary of Defense Donald Rumsfeld, since it meant sweeping elections and also maintaining new levels of growth in the economy.
The problem, however, was that the Republicans adopted this theory in a somewhat extreme fashion. With the continued industrial growth of countries in East Asia and Eastern Europe, together with U.S. military funding and other political risks, government expenses rose sharply, whereas revenues did not rise at the same rate or even close to the same rate. As a result, the deficit continued to rise to record levels and the U.S. political problem became complicated – and it grows more complicated with the passage of time.

This is because the deficit in the budget has reached extreme limits and, with the most recent crisis, the seriousness of its effects has become apparent: global financial institutions started to question whether the dollar was capable of retaining its value, and thus the value of what the United States promised to pay for its debt. The matter is no longer about the number of dollars that the U.S. government will pay for its debt, but rather about the true value of those dollars. This has caused some institutions to hint at lowering the rating of U.S. bonds, which is a serious insinuation about the ability of the dollar to retain its value. The United States’ problem with its debt is great and the solutions are hard, and thus began a bitter journey of economic talks in attempts to raise the debt ceiling – attempts Congress confronted with intense fury and disapproval, for the United States government was only supposed to reduce the level of deficit in its budget. This is where the biggest economic-political obstacle came into play and blew up the conflict between Democrats and Republicans: the conflict over taxes.

Obama presented his plan on the basis that reducing the budget deficit will not happen unless it follows one of two paths, the first of which is increasing government revenues. This in turn will not happen until the tax system is reformed by raising taxes, modifying taxes for many groups, and getting rid of many exemptions, as well as going after tax havens around the world. The second course is reducing spending to levels previously unknown: this is what was dubbed the fiscal cliff. Americans were frightened by the fiscal cliff plan, which included automatic cuts if no plan to raise taxes was passed. That is because the U.S. government will operate during the year 2013 without a higher allowable debt ceiling. So if the revenues called for are not achieved, there will be no escape from automatic cuts taking effect in the budget clauses of many departments, including the Departments of Defense, Education, and Health.

Republicans refused Obama’s plan to raise taxes on the basis that it would lead to the same economic catastrophe that would have resulted from allowing the fiscal cliff to occur with its automatic spending cuts. As a result, the Democrats’ threatening that the Republicans' inaction will lead to the fiscal cliff is ineffective. This is because the Republicans say that the increased taxes as per Obama’s plan will disfigure the economy in a way that would be very difficult to treat later, for increasing taxes and raising the average tax rates – according to the theory of the Laffer curve – will certainly cause people to orient themselves toward preferring leisure over work. Thus, as a result there will be reduced levels of production and diminished profits, and in turn government revenues will fall. Given this standoff, the federal budget remains at square one, with automatic cuts, the fiscal cliff, and a larger disaster: reduced levels of production and economic growth. The U.S. economy is set to enter a long recession or even a depression. On the other side, Republicans think the solution is for Democrats to abandon their ambitious projects aimed at health reforms, social reforms, and immigration law.

Where does the solution lie? ِAmericans have gotten used to foolhardy adventures in foreign policy, and my belief is the time has come for Americans to feel what the rest of the countries of the world do. As Obama said in his most recent speech before Congress, “We don’t need to send tens of thousands of our sons and daughters abroad, or occupy other nations.” Likewise the United States should return to its true spirit, and it should be a haven for immigrants in the world. With this Obama is saying that the United States must work in earnest to entice high-skilled workers and investors to return to the United States. Here Obama utters one of his most gripping phrases, saying that the mission of his generation is “to reignite the true engine of America’s economic growth – a rising, thriving middle class.”



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