It's not about "cranks," it's about tax rises and high spending

The Age

By Tom Switzer

It's clear Wayne Swan doesn't understand the US economic debate.

You wouldn't know it from the media coverage, but Wayne Swan's foray into US politics showed a profound misreading of Washington's economic debate on the eve of the presidential election.

According to the Treasurer: "The biggest threat to the world's biggest economy are the cranks and crazies that have taken over a part of the Republican Party."

How so? Because their opposition to high spending could prevent Congress from resolving its budget problems, known as the ''fiscal cliff''. That would mean a major withdrawal of government spending, which — in Swan's telling — could drive the US economy into recession.

Just what a debt-burdened US needed: a lecture from an Australian Labor politician not to cut spending.

To understand the US economic debate properly, one needs to recognise two different fiscal cliffs. The first cliff is the rise in tax rates because Bush-era reductions are set to expire at the end of the year. The second cliff is the $1 trillion-plus in cuts in defence and domestic discretionary spending during the next decade as part of last year's compromise to reduce the debt.

Like most Keynesians, Swan misdiagnoses the real threat to the US economy: it's the taxes, not spending, as The Wall Street Journal consistently editorialises. Take some history: in the past three decades, Washington has made two major efforts to cut federal spending. The results: long booms.

In the 1980s, a combination of tax and spending cuts led to a decade of economic expansion. After the Republican Congress and Democrat Bill Clinton implemented budget reforms in the mid-1990s, spending began to fall as a share of gross domestic product until the early 2000s. The economy and stocks boomed.

In the Bush and Obama eras, however, federal spending has increased from 18.2 per cent of GDP to 24 per cent. In early 2009, White House advisers predicted the $830 billion stimulus package would deliver less than 6 per cent unemployment by now. Obama himself declared his presidency would be "a one-term proposition" if he did not turn around the economy.

It's been more than three years since the recession technically ended. Yet the economy is limping at less than 2 per cent growth and 8.1 per cent unemployment. Meanwhile, real incomes have declined nearly 6 per cent, the US deficit has doubled and the debt has increased by more than $5 trillion.

Contrary to Swan, what could push the US off the fiscal cliff is the scheduled tax increases by year's end. That may explain why 19 congressional Democrats have supported House Republicans to extend the current rates for another year. (Memo to the Treasurer: are these Democrats "crazies and cranks" too?)

But neither the President nor the Democrat-controlled Senate is co-operating. That means liberals are essentially backing a gigantic tax increase in the New Year, which would put the brakes on the most sluggish recovery since the Depression.

There are, of course, other risks and uncertainties involved. As Federal Reserve board member Richard Fisher conceded last week: "Nobody really knows what will work to get the economy back on course."

But if a recession occurs next year, it's a fair bet the Democrats' refusal to pass the Bush-era tax cuts, taken together with taxes on capital gains, dividends and estates on January 1, will cop a lot of blame.

All of this is crucial to understanding how Swan misunderstands the legislative debate in the US. It also helps clarify the stakes of the 2012 election. Above all else, the Obama-Romney contest represents a philosophical debate about the size and scope of the federal government.

This debate has been raging since Barry Goldwater's failed bid against LBJ's Great Society in the mid-1960s. It accelerated in the '80s with the Reagan agenda of tax cuts and deregulation.

Then the mid-1990s brought us the Republican takeover of Congress, which pushed Clinton into declaring "the era of Big Government is over" (welfare reform, balanced budgets, the North American Free Trade Agreement).

But the past decade has hurt the cause of smaller government and the US has gone down the road to higher levels of spending and regulation.

That is why Mitt Romney's running mate, Paul Ryan, the Tea Party and a new breed of Republican governors represent a refreshing change. They repudiate Obama's let-government-solve-it liberalism, and Bush's don't-rock-the-boat Republicans.

That means reforming entitlement programs (Medicare, Medicaid, Social Security) that are on an unsustainable trajectory as well as proposing tax reforms that reduce rates in exchange for closing tax loopholes. It also means finding a way to cut indecently high spending and insanely high debt while reviving a lacklustre economy.

A choice, not an echo. Get ready to hear Romney make that pitch in the first presidential debate.

This piece was originally published at The Age