America Is Still Hurtling Towards the Fiscal Cliff

It’s time to bring meaningful reforms to America’s unaffordable and outdated entitlement programs.

It is telling that, according to a recent survey by Macro Risk Advisors, the biggest threat facing U.S. investors isn’t a meltdown in the eurozone, or a crash in China, or even a misstep by the Federal Reserve. In fact, their biggest fear is the uncertainty engendered by election season, and the “fiscal cliff” over which the United States is set to hurtle come January 2, 2013.The cliff in question is a $607 billion combination of tax increases and spending cuts, and is the result of failure by Congress in 2011 to reach agreement on how to reduce the federal deficit. Without political intervention, it will come into force just as our New Year’s Eve hangovers start to wear off. But how bad could it be?

According to the Tax Policy Center, taxes would rise by more than $500 billion in 2013, as almost every tax cut enacted since 2001 would expire. Average marginal tax rates would rise by 5 percent on labor income, by 7 percent on capital gains, and by more than 20 percent on dividends.

Almost every American will be hit. Most will feel the impact of a rise in payroll taxes and higher income tax rates, with middle-income Americans facing an average tax increase of almost $2,000. Those on low incomes will suffer the withdrawal of tax credits, while high earners will face punitive taxes on high-end health care plans and a squeeze on their investments.

You don’t have to agree with President Obama’s former advisor Christina Romer—who estimates that increasing taxes by 1 percent of GDP leads to a 3 percent reduction in GDP overall—to see that tax rises of this magnitude are likely to be very damaging, especially in the context of an anaemic and largely jobless economic recovery.

But even avoiding these tax rises wouldn’t leave the U.S. with a rational, pro-growth tax system. Policy makers desperately need to comprehensively reform the code, eliminating a maze of exemptions, deductions, and special favors, while cutting rates across the board. Unfortunately, that’s not how Washington works.

When it comes to the spending cuts, the story is rather different. Here, at least, the threat to U.S. economic health is vastly overstated. The lion’s share of the scheduled cuts come courtesy of the Budget Control Act of 2011, which mandates automatic cuts of around $109 billion a year, starting on January 2 and continuing until 2021.

That sounds drastic, but should be put in context. The federal government has run a trillion-dollar deficit four years in row, and currently borrows 30 cents of every dollar it spends. It barely raises enough revenue to cover “non-discretionary spending” on things like pensions, debt interest payments, and health care for the poor and elderly—let alone to fund national defense (where America spends five times as much as its nearest competitor, China) and other government programs. Such profligacy may be manageable now, with treasury yields at record lows, but bond markets can be capricious. The U.S. is storing up enormous trouble for its future, even before you consider the impact of inexorably rising health care costs and an aging population.

Moreover, these automatic cuts are calculated against a baseline of projected spending increases. As Mercatus Center economist Veronique de Rugy has pointed out, “After the initial cuts, spending will grow by $1.65 trillion, as opposed to $1.8 trillion, between 2012 and 2021.” Defense spending—the target of half the automatic cuts—will initially fall to 2007 levels (in inflation-adjusted terms) and then return to 2012 levels by 2018. So while these cuts will undoubtedly pose an administrative challenge, they are hardly the public sector apocalypse—or the open door to America’s enemies—that their critics would have you believe.

Indeed, the problem with the fiscal cliff spending cuts is not that they go too far, but that they don’t go nearly far enough. They entail no meaningful reforms to unaffordable and outdated entitlement programs at home, and they impose no serious restraint on America’s trigger-happy interventionism overseas. They’re a start, but that’s all. In the long run, the U.S. needs to do the same thing as every other Western state: Radically re-think government from the ground-up and question absolutely everything.

Fiscal cliff or no fiscal cliff, the 112th Congress has shown itself spectacularly ill-suited to that task. One can only hope its successor will do better.

Published at A version of this article previously appeared in City AM, a London-based business newspaper.

Posted in Uncategorized | Leave a comment

Brain Hubs and the Case for Labor Mobility

Over at The American, Nick Schultz has posted an interview with Enrico Moretti, an economics professor at UC Berkeley and the author of “The New Geography of Jobs“. Moretti’s thesis is that new jobs and opportunities are increasingly clustered around ‘brain hubs’ – cities with well-educated workforces and strong innovation sectors. While old industrial areas decline rapidly, these ‘brain hubs’ thrive. According to Moretti’s research, each new ‘innovation job’ brings with it five non-innovation jobs.

If this is true, then one obvious implication is that labor mobility is vitally important. People need to be able to move where the work is. As Moretti puts it:

The United States is a large and diverse nation. Economic differences across American cities (for example, unemployment rates and salary levels) are very large and keep growing. These growing differences mean that the economic returns to economic mobility have never been higher. But not all American workers are equally mobile. College graduates have the highest mobility of all, workers with a community college education are less mobile, high school graduates are even less, and high school dropouts come at the bottom of the list.

He goes on to make a crucial point:

Government policies are part of the problem. The unemployment insurance system does not provide any incentive for unemployed workers to look for jobs in places with better labor markets. If anything, it discourages mobility from high-unemployment areas to low-unemployment ones, because it does not compensate for the difference in cost of living. If you are living off an unemployment check in Flint, you do not have a lot of incentives to move to San Francisco to look for a new job, because your housing expenses would triple, but your check would still reflect the cost of living in Flint.

This is really one of the core problems with modern welfare states: they do not sit well alongside dynamic market economies, in which change is constant, and creative destruction drives progress and prosperity. Rather than encouraging people to seek out new opportunities, state welfare seeks to sustain people in their present circumstances. This may be more comfortable in the short term, but its long term implications are very worrying.

The solution Moretti hints at – redirecting welfare spending to help people move – reminds me of this excellent study, which was published by Policy Exchange, a British think-tank, several years ago. It advocated a hard-headed assessment of redevelopment policies, and an acceptance that once cities “have lost much of their raison d’etre… it is hard to imagine them prospering at their current sizes.” The policy emphasis should instead be placed on removing barriers to growth in prospering areas, and making it easier for people to relocate there. Rather than trying to buck the market, governments should get out of its way.

Yet that study also highlights the political pitfalls of such an approach. Policy Exchange, at that point a favorite of soon-to-be-British-prime-minister David Cameron, was widely condemned for wanting “shut down Sunderland” and other struggling post-industrial towns in the North of England. Politicians, predictably enough, couldn’t run away from the idea fast enough.

Likewise, it would take a very brave US policymaker to stand up and say that glory days just aren’t coming back for some rust belt towns, and that no amount of bailouts, subsidies, tariffs, or stimulus checks are going to change that sad fact. Nevertheless, the case for labor mobility – not just for highly-educated Americans, but for everyone who wants to work – is a case that deserves to be made.

Originally published at

Posted in Economics, Welfare & Pensions | Leave a comment

The Time-Bomb Keeps Ticking

The Wall Street Journal recently carried an essay by David Wessel, author of the forthcoming book, “Red Ink: Inside the High-Stakes Politics of the Federal Budget”. It provides an excellent breakdown of the budget crisis looming over the federal government.

Perhaps the most striking fact contained in the essay is that 63 percent of the budget is on auto-pilot: “Social Security benefits get deposited. Health-care bills for Medicare for the elderly and Medicaid for the poor are paid. Food stamps are issued. Farm-subsidy checks are written. Interest payments are dutifully made to holders of Treasury bonds.” In technical jargon, this is non-discretionary spending – unless Congress actively stops it, such spending continues every year without the need for any further authorization. Throw in an ageing population and inexorably rising healthcare costs, and it becomes clear that such spending is only heading in one direction – skywards.

What is most worrying is that the federal government currently only funds 66 percent of its spending through taxes. For the rest, it has to borrow. And while that may be bearable in the short-term, as nervous investors around the world pile into US Treasuries and push bond yields to record lows, it spells big trouble in the medium- to long-term. Every cent the government borrows now means more debt interest payments – and even more non-discretionary spending – in the future.

For an idea of just how bad it could get, take a look at this 2010 working paper from the Bank of International Settlements. Its projections indicate that without a policy shift, US public debt would rise to more than 400 percent of GDP by 2040. That would translate into annual debt interest payments equaling 23 percent of GDP – well in excess of total federal tax revenues, which have averaged a little over 18 percent of GDP since the Second World War. Such a scenario is plainly impossible: the US would be forced to default on its obligations long before things reached that point.

The policy implication here is straightforward enough: non-discretionary spending programs like Social Security, Medicare and Medicaid need urgent, drastic reform to put them on a more sustainable footing. The problem is politics: neither party is really serious about dealing with this fiscal time-bomb. Politicians’ electorally-driven time horizons are just too short to permit the sort of significant, structural changes that are required.  Perhaps a rise in Treasury yields will force the issue. Maybe another showdown over the debt ceiling will do the trick. But I won’t be holding my breath. As the Austrian economist Detlev Schlichter puts it, when it comes to debt, governments around the world are determined to “extend and pretend”.  Sadly, it is only a matter of time before reality catches up with them.

Originally published at

Posted in Economics, Healthcare, Tax & Spending, Welfare & Pensions | Leave a comment

Cheerio, not goodbye

As some readers will already know, I am moving on from the Adam Smith Institute. Friday was my final day as Executive Director here, and in June I will be moving to the United States. I’m heading for Washington, DC, where I am going to be Managing Editor at the Reason Foundation, a libertarian think tank which also publishes Reason Magazine and produces Reason TV.

I’m very excited about this new opportunity, but, needless to say, I am also very sad to be leaving the Adam Smith Institute. It has been a great five years, and I have so many wonderful memories to look back on. I will miss all the people I have worked with enormously.

We have done so much since I started in 2007, that it is hard to pick favourites. But here are few personal highlights: unveiling the Adam Smith statue back in 2008; running Freedom Week in 2011; filling the LSE with libertarians for last year’s Hayek v Keynes debate. I have also hugely enjoyed establishing a top-notch ASI lecture series over the last few years. Tour de force talks by Tara Smith and Kevin Dowd stand out as particularly memorable moments.

More broadly, there are a handful of overarching themes that have characterized my time here: the resurgence of Austrian school economics in response to the financial crisis; the emergence of unabashed libertarianism as a distinct voice in the political debate; and the creation of a fast-growing libertarian youth movement in the form of the UK Liberty League and European Students for Liberty. I will always be very proud of the role we have played in these developments.

My final words, though, must go to Madsen and Eamonn – who gave me an opportunity few people fresh out of university could dream of – and to the Adam Smith Institute’s friends, supporters, and donors, who make everything we do here possible. Thank you, and farewell.

Posted in Uncategorized | Leave a comment

The return of the recession

So it’s official: Britain has double-dipped. Is anyone really surprised?

Of course, today’s number are relatively insignificant in statistical terms, and there is every chance that the Office of National Statistics will revise them a few months down the line. So we shouldn’t put too much faith in the details of today’s announcement or try to draw lessons that aren’t there to be drawn.

But it has been obvious right from the start that this was not your average, run-of-the-mill, cyclical downturn. The financial crisis and the recession that followed it was and is the result of severe, deep-seated structural problems in Western economies. And Britain has bigger structural problems than most.

Put simply, we are addicted to debt and constant monetary expansion. This has eroded our capital base and undermined our productive capacity, and has skewed the economy disastrously towards those sectors that thrive on credit and easy money: namely housing, finance, and big government. The boom years inflated huge bubbles in these sectors; the bust years have revealed how much of that growth was unsustainable, or even illusory.

The situation we are in now can be summarized as follows. The economy remains heavily distorted: the prices of houses and financial assets are artificially inflated by government policy; banks which would have failed in the market have been kept on life support; gigantic, hugely inefficient public sectors are being sustained by money-printing and growth-sapping taxation. The savings needed to support investment aren’t there, and we’re weighed down with one of the highest levels of public-private debt in the industrialized world.

The astonishing thing is that every single one of those distortions is consciously, willfully being pursued by the government as a matter of policy. Quite frankly, it is surprising we aren’t doing worse than we are.

Not that there is all that much governments can do to create growth in situations like this. Yes, tax cuts and deregulation would give the private sector a sorely needed boost. And yes, reforming / privatizing / abolishing the public sector (as appropriate) would do wonders for Britain’s productivity. But what really matters is what governments don’t do. They have to allow the mistakes of the boom years to be unwound. They have to let markets adjust. They have to let new patterns of sustainable specialization and trade develop spontaneously, without bureaucratic interference.

That is a process – and it takes time. But unless we go through it, we won’t be returning to robust, real growth any time soon. The road we are on leads to a zombie economy. It’s time we took a different one.

Posted in Economics, Money & Banking | Leave a comment

The case for gold

City AM asked me to make the case for gold in 140-words, for yesterday’s comment pages. Here’s what I came up with:

Gold isn’t a traditional investment good: it is an alternative to paper money. From that perspective, its allure is all too clear. The purchasing power of gold is as good now as it was in 1900. The pound lost 99 per cent of its value over the same period. As a store of value, gold wins hands down because its supply is inelastic: you can’t create more of it every time you need to bail out a bust financial sector or bankroll a profligate government. Of course, I don’t know whether the gold price will be higher next week, next month, or even next year. But I do know that the things which have driven gold’s surge – uncertainty, money-printing, and fiscal incontinence – are here to stay. Monetary debasement is the whole point of a fiat currency. Make of that what you will.

Posted in Articles, Economics, Money & Banking | Leave a comment

Unprincipled politics

At a meeting of the Adam Smith Institute’s Next Generation group this week, Sunday Telegraph columnist Iain Martin talked about the various failings of the Conservative Party. His primary criticism is that the Conservatives under David Cameron abandoned their principles in favour of telling people what they wanted to hear. That might have been a decent electoral strategy when the economy was booming, but once the financial crisis hit it left the Tories rootless and incoherent, so that no-one (least of all the Tories themselves) had a clear idea of what they stood for.

I more or less agree with that position, with the caveat I’m not convinced the Tories were that principled to begin with. Even a cursory look at the Conservative Party’s history will reveal that Margaret Thatcher’s reputed ideological fervour is very much the exception, rather than the rule. Indeed, many Tories will tell you that the rejection of hard and fast principles in favour of ‘pragmatic’, case-by-case managerialism is the essence of British conservatism. And as Sam Bowman wrote yesterday, the trouble with that mindset is that it leads inevitably to the persistent, piecemeal erosion of individual liberty.

After the speech, a few people asked me what I really thought about the coalition government. My honest response is not a terribly positive one. On education and welfare reform, their policies are generally pretty good. Their deficit reduction plan, while far less impressive than the chancellor’s rhetoric would suggest, is at least better than the alternative (I think that’s what they call damning with faint praise – ed.). There have been a few good moves on tax – like raising the personal allowance and cutting corporation tax – but it is hard to ignore the fact that they’ve has robbed Peter to pay Paul and skimmed off the top while doing it.

Beyond that, I struggle to think of anything nice to say. Certainly, when it comes to matters of personal freedom, this government borders on the fascist. The commitment to civil liberties that both parties claimed in opposition seems to have gone out of the window now they’re in government – the electronic surveillance powers trailed last week are even more despicable and grotesque than anything Labour managed to come up with. And when it comes to food, drink and tobacco, the government couldn’t be more in thrall to the bully-state establishment. To be blunt, they plainly care not a jot for individual liberty.

I had hoped that coalition might mean the best of both worlds – that the Liberal Democrats’ civil libertarian, non-interventionism might be blended with the Conservatives’ fiscal conservatism and suspicion of state power.  That seems an increasingly forlorn hope.

Posted in Liberty & Justice, Politics & Government | Leave a comment