The Fiscal Cliff – Finding the Hidden Staircase – WWCD

In the previous post, I attempted to explain why the conventional wisdom may not provide the best guide to our current fiscal dilemma of balancing the budget without hurting the economy.  This dilemma based on conventional wisdom is described in some detail, including CBO projections by syndicated columnist Robert J Samuelson in the Tulsa World on January 10th under the headline “Finding the right formula”.  Samuelson’s conclusion is that the way out is for “…the private sector recovery to be vigorous enough that the deficit reduction’s dampening effects can be absorbed without causing a new recession”.  I think he’s right but the doorway leading to the hidden stairway down may not be as hard to find as he suggests.

As Samuelson points out, 4 years of the same type of government stimulus has not worked very well.  Maybe its time to examine our assumptions and consider doing something different.  My alternative would be to stop the attempted government manipulation and give the private sector a chance to find its way in a more stable environment.  I suggested in the previous post that the primary problem at this point may be too much future uncertainty brought on by government policies that are not normal and will certainly need to change.  So if I could wave a magic wand, what would I do?

  1. The Federal Reserve actions:  After 4 years of nearly zero interest rates unemployment is still not where we want it.  While high interest rates are a deterrent to business investment, low-interest rates have not stimulated it.  Maybe because low-interest rates alone are not sufficient to cause people to invest in new plant, equipment or jobs without a positive economic outlook.  It’s pushing on a rope.  Zero percent interest is certainly not a deterrent, but neither is 2-3%.  And zero hurts retirees, like my father-in-law, who are counting on interest from CDs to supplement their Social Security.  The Feds policies at this point are likely hurting demand and adding to the uncertainty.  I would have the Fed stop playing the bond market and begin to raise interest rates to the more normal 3-4% range.
  2. Taxes:  Deficits are caused by expenses exceeding revenues.  In the Federal Government case, revenue is largely generated from income taxes.  We increased the tax rates on the “rich” at the end of last year.  We have a graduated income tax structure both in terms of the rates and in terms of the collections. The people with higher incomes pay more in total although exceptions can probably be found in any given year.  Is it fair?  Is it graduated enough?  That’s a never-ending discussion since “fairness” is largely in the eye of the beholder.  But we raised taxes on the “rich” at the end of last year and “rich” don’t have enough income to balance the budget even if we took it all.  One thing to remember is that taxes are not an absolute dollar amount, but a percentage rate.  The surest way to raise tax revenue is to have the economy grow.  We can increase rates, but if that dampens growth, the revenue change might actually be less than it would have been otherwise.  And tax rates have a direct impact on investment decisions – perhaps as much or more so than interest rates.   For companies calculating investments in new plant and equipment or individuals planning for retirement, the planning horizon is probably 20 years.  It would be nice if we could count on consistent tax policy for that length of time.  Is the current tax structure exactly what I would have done?  No, but it is not unreasonable and I would leave it alone at this point.
  3. Government Spending:  Government spending is not a percentage rate, but an absolute amount.  It is the one variable in equation over which we have the most control.  In my experience, spending money is fun;  cutting spending never is fun.  In my experience, people never cut spending unless there is no choice.  Working for a large corporation which had to go through budgets cuts periodically, I’ve noticed consistent patterns in how people react.  The first response from department or program managers was …”we will have to stop doing x”.  Where “x” was whatever program or activity that they thought people would least likely want to cut out.  But if cuts were mandated, x always survived.  In fact, my experience with service organizations, is that austerity programs frequently result in higher quality service for less money.  In the 1950s, C. Northcote Parkinson published a book called Parkinson’s Law which documented how organizations always tend to grow while the productive work remains the same.  In the Spring of 1956 Fortune magazine published an article titled “How Seven Employees Can be Made to Do the Work of One”.  A New York Times reviewer said that Parkinson”s book backs up this head line with “incontrovertible evidence”.  Human nature doesn’t change much.  In a long management career, I concluded that, “show me an organization that hasn’t had an austerity program in 5 or more years and a 10% reduction in costs with no elimination of anything any one would notice is a no-brainer”.   The Federal Government hasn’t had a real austerity program in probably 50 years.  So a 10% reduction in costs would be a reasonable starting point.

Since the government put in automatic 5.1 % spending cuts in place at the end of last year, we have heard that lots of “x” programs that will be drastically cut unless something isn’t done.  During the next few weeks, we will likely hear a lot more verbage about this program or that.  Government programs were all put in place intentionally because someone would benefit.   If we try to debate which programs to cut before we start, we may be still be debating in the next decade.  In January, an economic professor wrote an article in the Wall Street Journal suggesting “across-the-board spending cuts” of 3% because he didn’t think we would ever decide on anything else and we need to do something.  Instead I would mandate an across the board 10% cut as a starting point.  My guess is we could accomplish that without anyone in the private sector noticing.  It might cut some government jobs, but probably not 10% and if it takes enough of the uncertainty about the willingness of the government to balance the budget, the resulting growth could quickly off set all of that.

Across the board cuts aren’t intellectually very attractive since most of us think it would make more sense to prioritize programs and make the necessary cuts in only the lower priority ones.  A syndicated column in todays Tulsa World by Michael Gerson suggested that cuts are necessary and that while 5% cuts might be reasonable,  “across-the-board cuts are an ethical abdication”,  He indicated he believed the media and the politicians would show no restraint in condemning it.  Part of the problem here is that neither the elected people in congress nor the leaders in the administration know where processes can be improved and costs cut without harm to intended results.  The managers and people who know how to do that are closer to the work.  But they will not likely do anything unless it’s mandated.  I would not leave any branch of government out, the Administration, the Congress and the Supreme Court.  But the trick is to decide the level in the organization to apply the 10% requirement.  We would need to allow managers some flexibility and trust that they will use it in the best interest of the country.

Five years ago the Federal Government spent $2.7 trillion.  If we could reduce current spending by 10%, the result would be about $3.2-3.3 trillion or only about 20% above the five-year ago amount.  Not enough to balance the budget so the debt limit would need to be raised.  But to the extent that we could improve the efficiency of all administrative and overhead costs before we start cutting specific programs, the fewer programs might need be cut.  So why not look for ways to improve the efficiency of all government operations before we start to prioritize and cut specific programs.  That is intellectually defensible and not an abdication of duty, but it goes against conventional wisdom.

Improving government efficiency while improving the economy by reducing uncertainty would seem like a good thing.  One would like to think we could consider this alternative without making a political or media frenzy out of it.  Unfortunately I don’t have a good answer for how to do that.

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About tjc13

BE - Chem Engineering, Vanderbilt Univ, MBA, University of Tulsa - Worked for an energy and chemical company for many years and then started a management consulting business working for both for-profit and not-for-profit organizations.
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