The Fiscal Cliff Explanation

by Wes Bridel on November 19, 2012

in Economic Updates

The Fiscal Cliff

(This is a Reprint of the November Newsletter which you can sign up for here)

You’ve surely heard that there’s a “fiscal cliff” coming.  This newsletter will probably surprise you coming from me, but my guess is that more is being made of it then we’ll actually experience.  That said, I want to cut through the clutter and explain some of the basics of what’s going on with the US Government’s financials to hopefully give you a clearer picture than you’re going to get from a politician or the media.

So we’ve had an election and pretty much everything is the same as it was.  Hopefully you didn’t get too caught up in the drama of the election since we were able to tell you in February and again in June (assuming you also follow the blog) that President Obama would win the election and why.  I remember telling family during the Christmas of 2008 that this would be the case because the Lord showed this very clearly to a friend of mine and it fit with what the Lord is doing in the world and specifically the US today.

This letter is not going to be about politics and I hope that you can step away from the dogma of either political party and take a look at the size of the problem, the so called “solutions”, and the economic realities facing us.

Four years ago, Pres. Obama lambasted Pres. Bush for allowing the US debt to grow to $9 Trillion (It grew by $4.89 Trillion in his 8 years as President.)  You should watch this video of Obama speaking four years ago because he is exactly correct in what he said…

The problem is that what he presided over was more than twice as bad as what he slammed Pres. Bush for.  The debt now stands at over $16 Trillion.  The slope of the curve of our debt has begun to go parabolic.  The Democrats will blame the Republicans and the Republicans will blame the Democrats, but this piece is not meant to assign blame, but to explain the realities of the situation we currently find ourselves in.  There is no stopping it at this point no matter which party is in power as we’ll show.

So what is the Fiscal Cliff?

The Republicans and Democrats are at a stalemate as to what the solution to our massive deficit will be.  Pres. Bush instituted tax cuts 12 years ago.  In order to get them passed by the Democrats, he had to put a sunset provision which made them go away after 10 years.  Two years ago the Democrats admitted that it would be harmful to the economy to raise taxes and so they extended the cuts for another two years.  In addition, Pres. Obama instituted new taxes within Obamacare on most people, particularly people with investment assets.  So taxes are set to increase on everyone at the turn of the New Year.

In addition to this, the debt ceiling crises was solved by assigning a bipartisan commission to come up with spending cuts in the budget.  If they did not come up with these agreed upon cuts, cuts were in place to happen in areas that each party cared about.  These are set to take place in the New Year as well.

This situation is called the “Fiscal Cliff” because when taxes go up, people will have less money to spend and invest.  Thus the economy and markets would be hurt and everyone would suffer a little bit.

Likewise, if the spending is cut, the areas of the economy that were seeing this money flow to them would be hurt because the money would dry up and they would have to look elsewhere for the money that had previously sustained their activities.

It’s therefore a double whammy on the economy and some economists have projected it would mean a 2% decrease in US GDP which would push us into recession (even though it may feel like we’ve been in recession for years, that’s not technically the case.)  So that’s the Fiscal Cliff you hear so much about.

Wisdom of an 8th Grader

My wife Kara ran for class president in the 8th grade.  She had a platform based on things that she could actually accomplish within the scope of her authority and powers if she attained this office.  The boy who ran against her promised the kids free McDonald’s burgers and fries every day of the year.

Who do you think won the election?  Do you think the kids got their free McDonald’s after the boy was elected?  Of course not.  Kara learned a valuable lesson about politics.  I wonder if the other school kids did.  My guess is probably not if we judge by the wisdom of our adult electorate as a whole.  We love to be promised things by the government without every factoring in the reality of the costs involved.

I’m going to very quickly run through the plans of each party on a very high philosophical level.  I’m not going to get into the hard numbers since those are very easy to find on your own using your favorite internet browser and it would boar most of you.  I’m sorry in advance if I offend the hardcore party ideologues of either party, but I intend to show that neither party is really serious about solving our massive problem.

The Democrats Plan

The Democrats say that if they could raise taxes on the rich, that would solve the problem of our massive deficits which result in our debt growing more and more unsustainable every year.

The reality is that if they took all the money from the rich, it wouldn’t have a meaningful effect on the debt in the short run.  In the long run, it would make the debt much worse because the people who had before then been the ones paying the majority of the income into the Treasury, would no longer have any capital to do so.  The economy would implode.

The economic fact of the matter is that a rise in taxes has a short term positive effect on the Treasury and a long term negative effect on the Treasury.  It’s actually pretty simple to figure out mathematically that the ideal tax rate for the government is between 15-17% (depending on the growth rate of individual assets you want to assume.)  This is because if people are allowed to keep more of their money, they will be vastly more productive with it than any government can be.  They will either spend it which creates profits for someone who is deserving because they have met a need in the market.  Or they will invest it which will create future profits.  Either way leads to higher taxes for the government in the future.

If the tax rates get too low (sub 10%) then the economy grows extremely well, but government taxes aren’t as high over the long haul because the tax rate is so low.  Thus 15-17% is the optimal tax rate for the government and the people’s benefit.  Again, this is pretty easy to prove numerically.

More importantly, it’s easy to prove historically.  Have you ever noticed that high tax/high bureaucracy states suffer economically more than low tax/low bureaucracy states all within the US?  And often, the high tax states have the most geographic advantages (see California).

Internationally, this truth has been proven so many times it boggles the mind that there’s any debate at all.  The more socialistic a country, the slower the economy grows and the more people suffer from stagnation.  The worst cases are when a country is openly going for communism which typically leads to mass death.

On the other side are brilliant stories of economic success that result from a government simply leaving the people their economic freedom.

For example, Ireland was the poorest country in the world for centuries.  This is the reason there are 20 times more Irish people in the world than there are in Ireland.  They always had to leave to find a better life.  The country had high taxes and government bureaucracy for decades until about the 1970’s when three men came in and laid down a new system.  They reduced the taxes and red tape dramatically.  They got rid of most of the government programs and allowed the Irish people to be free.  They then turned around and had the most successful economy in Europe for the next several decades.  You may have heard of problems in Ireland recently, but this is because the government decided (or was more likely forces to by the Eurocrats in Brussels) to bail out the banks with tax payer money.  They went back to the ways that didn’t work instead of sticking with what did.

Likewise, Hong Kong and Singapore were barren rocks a century ago.  The English showed up and established a free trade area.  (it’s a little more complicated than just saying that), but basically against all odds they’ve stayed very economically free.  The taxes are very low.  The red tape is very low.  Those places have no abundance of natural resources. (Singapore does have a great port which helps, but other than that…) They are basically big rocks in the ocean with a sign that says, “if you come here, we will let you be free to keep what you can earn.”  Because of this the poorest people of these places are much better off than just about anywhere in the world.  New jobs are created all the time.

Again, this is basic economics.  Both philosophies have been proven so many times to result in what is stated above, that there can be no doubt.  As a matter of fact, we sent the IMF to Latin America and Asia over the last few decades to strong arm them and told these countries to slash their debts and establish economic freedom.  Look what has happened.  Those countries had to suffer a little at first as discipline was established, but now those countries are doing very well.  Now, we suffer, so should we take the same advice we gave these countries or should we follow our politicians?  McDonald’s sure does sound good!

So since we’ve shown the Democrats plan won’t work, does that mean we should have elected Romney because the Republicans have all the right answers?  Absolutely, not.  Let’s look…

The Republican’s Plan

The Republicans seem to understand to some degree or another what I’ve stated above.  However, did the debt go up or down while Pres. Bush was in office?  It went way up.  Lower taxes are not by themselves the only answer.  The spending has to be dealt with in a major way and I’ll show that the Republicans like to talk about cutting spending, but they don’t really want to deal with it in a meaningful way.

Paul Ryan put forward a budget plan which incorporates spending cuts.  It is the most severe spending cut plan with any kind of mainstream following.  His political opponents make it sound as if he will be taking a pitchfork to children and the elderly if his plan is implemented.  They like to use the word “draconian”.  Sounds nefarious, doesn’t it?

The reality however is that if his plan were implemented, the spending would continue to grow over the next decade.  Here’s an article on the subject.

Since we have a massive deficit and debt and we’ve already shown that you can’t fix this problem by increasing taxes, the only solution is to decrease spending.  Since the problem is big, the cuts must be big.  Here’s the problem, the areas that must be cut are sacrosanct in this country.  No politician is going to suggest cutting them.

The biggest budget items causing problems are things like social security and Medicare.  President Bush added massively to this Medicare problem when he drastically increased the promise of prescription giveaways that can’t possibly be paid for.  These non-discretionary items make up the lion share of the budget.  Have you heard any politician promising the drastically increase the social security or Medicare retirement age?  Or are they promising to slash the value of these programs to each individual?

No, they are not.

Well, the biggest discretionary budget item is the defense budget.  Even though cutting this would have a much smaller effect than cutting the non-discretionary items, it would help some.  So are the Republicans promising to cut here?  No, they are not.

If you think that Republicans start more wars than Democrats, a fact check on that assumption might be enlightening.  But there is no doubt that Republicans like to fund the apparatus of war much more so than the Democrats.  And we simply can’t afford to be the policeman of the world.  You can certainly argue that the greatness of this country started to recede as the war machine ramped up.  But whether you think it’s good or bad that the US has troops in 150+ countries and is seemingly in one unending war after another, the cost is too high and is helping to drive this country to the economic point of no longer being able to afford a great military even on its own shores.  The long term costs of short term world dominance very well may be that we have a very average military because the cost sucked the life out of us.

I’m not going to address the other areas of discretionary spending because I feel they were dealt with in the Democrats section.

This section is meant to show that the Republicans don’t have real answers.  If you have some basic understanding of the economic truths above, their talking points may sound better to you.  But the politician’s actions leave a lot to be desired.  As a matter of fact, they leave everything to be desired.

At the end of the term, there’s not much difference between the parties.  Each offers their own red or blue special sauce on the Big Mac they dangle before you come election time.  And at the end you realize, the politician didn’t actually make your life any better.

What’s sad is that the consequences that are coming are very ugly.  We’ve talked about those plenty, so we won’t rehash those in this letter.  Nor will we cover the ways in which you can plan your financial life accordingly to protect, preserve and perhaps even grow substantially as these realities unfold.  If you haven’t made your preparations, we recommend replying to this email to see if there are ways we can help, but today’s letter is simply meant to address the current situation.  And point towards the greatest hope of all…

There is a reason we’ve come to this.  It has been long foretold.  A Kingdom is coming to reign on the earth.  The kingdom of iron & clay (the west as the remnant of Rome with the US as its head) is being broken to pieces.  (See Daniel 2)

I don’t know exactly what this will look like as it unfolds, but don’t make the mistake that those of 2000 years ago made.  They really knew that the Messiah was coming.  They talked about His coming incessantly.  But they thought he would be a political figure who would conquer Rome for Israel.  They missed the One who would give His very life so that we would once again have access to our God and King.

Spiritual changes are afoot.  There are certainly ramifications of these things in the world around us, but those are merely signs that should alert you to seek the Lord.  He is the Way and the Truth and the Light.  He is the only answer that matters.  Seek Him for the Way forward.

It’s Been a While?

I used to write this newsletter monthly, but it has been quite a bit longer than that since the last one went out.  My schedule has been much more hectic and sometimes I feel like I’m just repeating myself and don’t feel the need to do so again.  My guess is that going forward, this will probably be a newsletter that is delivered 4-6 times per year instead of on a monthly basis.  We’ll have to see as we go forward.

I actually plan to send another one soon to alert you to the new free book website that we’ve put up.  After these 2700 words, I’m not sure how many of you will still be reading at this point, so I’ll send that out separately.

Fairly soon after, I’ll probably do a synopsis of where I think we’re headed.  I’ll conclude this letter by wrapping up the above and giving you a preview of that very thing.

Will We Have a Fiscal Cliff?

My guess is that the Republicans and Democrats will come together with some agreement which dilutes what is about to happen.  I doubt things are going to instantly get a lot worse when the calendar flips.  I could be wrong, at some point, some very hard consequences are coming our way, but I think we may have a little time (maybe another year?).  Who knows for sure, but I’ve noticed that for at least three straight years, the media has really pushed the idea of “green shoots” and other similar ideas to convince us that everything will be ok at the start of the year.  American’s are generally optimistic people and my guess is we’ll go along with that for a while.  But the problems aren’t going away simply because we have a Positive Mental Attitude.  So we’ll talk more about that soon.

As always, we recommend that you seek the Lord and help Him lead you even if it means you must die to parts of yourself that you always thought were somehow related to your faith.  It’s of far less importance, but as a prudent steward of the resources God has given you, make sure your financial house is in order.

Thanks as always for reading. The Lord bless you and your family!

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Examples of higher taxes leading to less Tax Revenue | Kingdom Calling
12.20.12 at 5:03 am
Fiscal Cliff Update | Kingdom Calling
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