Monday, November 26, 2012

Common Sense and the “Fiscal Cliff”

The "Fiscal cliff" is a byproduct of stubborn, myopic, and undisciplined government institutions, both in the executive and legislative branches, in the last 12 years or so.

Common sense, active agency, and effective participation and responses are seriously expected from the political players in the two chambers of the congress and the president.

Here are examples of what the government should consider:

1. Raise the income tax rate gradually, let's say at 1% every other year over the next 4-6 years, on people earning more than a quarter a million dollars, to a maximum income tax rate of 37% to 38% at the end of this process. A transparent and long-term tax plan should reduce businesses' uncertainty/anxiety, and increase the level of transparency, which in turn, increase spending and production and enhance sustainable economic growth.

2. Eliminate tax exemptions gradually (over the next 4-6 years) on income between $.25 million and 1 million. Eliminate all tax exemptions on incomes higher than 1 million dollar. In addition, all tax loopholes must be closed/eliminated.

3.  Reform the entitlement programs.  Americans are living longer! Ongoing medical inventions and advancements, and higher standards-of-living lengthen life expectancy; however, at increasing costs. Medicare and Social Security benefits should be reformed, to ensure their sustainability and the sustainability of the US government budget, national debt, and the U.S. economy. One example of the proposed reforms is the gradual increases in the retirement age that correspond to the increase in life expectancy.

4. Reduce/reform the excessive regulations that discourage firms (U.S. and foreign firms) from hiring or expanding in the USA. This policy should expand the U.S. economy, and switch expenditures and production from foreign goods and businesses to U.S. goods and businesses, respectively. The energy sector is a good candidate for such a reform.

5. The Federal Reserve Bank should stop injecting more money into the market through the ongoing $40 billion monthly purchases of MBS (mortgage-backed securities). The effect of injecting more money into the market is diminishing over time. There is already more than enough money supply in the market.  The increase in money supply in the U.S. market is offset by a drop in the velocity of money in the U.S., such that the effective money circulation in the economy is almost constant. The Fed’s challenge is not to increase money supply, but to increase the circulation (lending and borrowing) of money.
The above policy suggestions/ recommendations should have little to no recessionary effects; a much better scenario than the expected free-fall from the “fiscal cliff”. In the best scenario, the above policy suggestions can lead to a long lasting economic expansion, higher employment rate, and lower unemployment rates in the near future and long run. In addition, they should reduce the budget deficit and reduce the rate of increase of national debt (and even switch the deficit into a surplus and therefore lower the national debt, in the near future). Furthermore, the increase in net exports (through the expenditure switching effects of lowering business regulations) should reduce the U.S. current account deficit.

These are examples of policy instruments/actions that both Democrats and Republicans should debate, not only to avoid the fiscal cliff, but also to sustain economic growth and to improve the quality of life of the people in the U.S.