After the deal raising the debt ceiling was signed U.S. debt increased by $238 billion putting the federal government debt over GDP at the end of 2010. Also, the Dow has dropped 300 points. The two are not directly related, but it both stories indicate that there are very severe problems ahead and there are some connections I think.
First our fiscal outlook is very, very grim. Medicare alone is going to present a very tough problem and a problem that raising taxes alone wont really solve. While a tax increase would certainly help, there are number of problems that come with them. First off, higher tax rates rarely raise the amount of revenue that is initially projected. People try to avoid taxes. Also, taxes impose a deadweight loss on economic activity. Deadweight loss is just that…lost. Nobody gets it, not the government, not businesses, not consumers. It is just gone. And this loss increases with the square of the tax rate. Higher taxes also reduce disposable income which in turn will reduce spending. And right now we see that PCE (personal consumption expenditures) have been trending down the past 3 months. Which of course brings us to the Dow losses.
A declining trend in PCE indicates that GDP will likely be declining as well. My guess is that the second quarter GDP will be revised downwards substantially from its already anemic 1.3%. The traditional definition of a recession was 2 or more quarters of declining GDP. It is a decent rule of thumb, and when you have declining GDP growth rates and the growing possibility of a quarter of negative GDP growth the expectation of a recession increase.
Now I do think taxes need to increase. At the very least we should be closing loopholes and look at various “tax expenditures” that distort economic activity. We need to cut spending. Probably not right now, but sooner rather than later. Basically a more balanced approach to solving our fiscal problems. And any such policy needs to have some sort of commitment mechanism built in. It is all well and good to come up with a budget plan to raise taxes, cut spending and so forth for the next 10 years, but if it can be quickly changed in a few years such a plan really has no force to it. It is merely cheap talk.
And I agree with my co-blogger Dave Schuler in this comment over at his website. Dave summarizes what he sees as the problems facing our country,
1. Bank malfeasance, misfeasance, and nonfeasance.
2. Tolerance of Chinese mercantilism.
3. Demographics-the retirement of the Baby Boomers.
4. Crony capitalism.
5. Overgrown healthcare, financial, education, and defense sectors.
6. A generally enormous amount of deadweight loss.
7. The collapse of the housing bubble and the serial policy errors that followed the collapse.
What will we do about these problems? My guess: nothing.
And here is a nice thought…consider that we are sitting here with a flagging economy with an unemployment rate of 9.2%. What will unemployment climb to if we go into another recession? We are 2 years into this recovery, as flaccid as it is, and looking at expansions since the end of WWII the longest is 120 months, and the shortest is 24 months, the average is 59 months. Our economy is nothing like what it was like during the Clinton boom (the 120 month expansion), so we may very well be on the brink of another recession.
