The University of Chicago's John Cochrane has a long, grim post about the fiscal cliff:
Here is the big issue. The US has already enacted European welfare and regulatory state with American characterstics -- the bloated inefficiency, legalism, and red tape that is our specialty. We have not enacted the taxes to pay for it. We will either dramatically cut back the former, or rather dramatically raise the latter. On the table now is at most $100 billion out of a $1 trillion deficit, and likely much less. The fiscal molehill.
US Federal, State and Local spending is 40% of GDP. Pay attention to state and local, that's a lot more than the 24% Federal we talk about a lot. Europe is more like 50% of GDP, so it sounds like we're behind. But our government is bigger than it looks.
We have about a trillion dollars of "tax expenditures," including the deduction for employer-provided health insurance, deduction for mortgage interest, and (small but annoying) credits for all sorts of things like checks to silicon valley CEOs to subsidize the electric cars they drive down to their private jets. These are no different than a trillion dollars of tax and another trillion dollars of spending, or another 6% of GDP. We're at 46% right here.
Our government likes mandates and rules, which affect behavior and soak up the economy's taxing capacity just as much as on-budget taxing and spending, but hide the fact. Europeans tax gas and energy, and people choose small cars and turn down the heat. We have mileage standards, energy efficiency standards, carpool lanes, electric-car sales mandates, and so on. Same real size of government. And so on.
Before the ACA, our government was paying for health care for about half the country, in our inimitably inefficient style, including medicare, medicaid, schip, and current and retired government employees. Under the ACA, we're basically all in a European style system, funded by explicit or implicit (mandates) taxes. With those uniquely American characteristics.
The fact that government overall is about half of GDP matters to our tax debate. Properly measured, the average American must then pay about half his or her income in taxes. For every dollar taxed at a lower rate, another dollar has to be taxed at a higher rate. When we tax the average dollar at 50%, any progressivity has to shift a lot of marginal rates well into the territory that destroys incentives and reduces revenue.
Europe pays for this stuff, and its middle class pays for this stuff. 30- 40% payroll taxes, 20% value added tax, $9 a gallon gas, 50% income taxes extending down to what we would call lower-middle-incomes, property taxes, estate taxes, wealth taxes. Sorry, Europe can't quite pay for this stuff, even with those taxes.
But this is our choice. European taxes, European growth, to pay for the regulatory and welfare state we've already enacted. Or a sharp cutback in that state. We can decide before or after we experience the European debt crisis.
So, the fiscal cliff is just the beginning. This will be a long hard road, and my guess is that we will lurch from crisis to crisis, with patchwork last minute deals, for another decade. It doesn't have to be so -- the economic choices are clear. But given the size of the question at hand and how little anyone is talking about the real issues, it's hard to see another way.
I'm a little more optimistic than Professor Cochrane is, for some reasons he doesn't get into. First, the European crisis he talks about isn't across all of Europe. There are parts of Europe that are doing poorly (Greece, Spain) and there are parts that are more robust (Germany, some of the former Soviet satellites, some of the countries in Northern Europe, Switzerland). Second, (and here Arthur Brooks of the American Enterprise Institute has done some interesting work), polls show public attitudes among Americans on things such as work, taxing and spending, and free enterprise differ from the attitudes of the parts of Europe that are in trouble. Third, America has defense costs that Europe does not have, and thus has the opportunity Europe doesn't to deal with the budget issues in part by trimming those defense costs. Finally, a lot of the federal budget problem has to do with the projected cost of end-of-life health care for the Baby Boom generation, and it's just hard to predict this far out what those costs will be. Some of that "cost" is drug-company marketing budgets. Some of it is home-health aides or medical office staffs who may be replaced by technology or automation. Some of it is physician compensation that is artificially high because of controls on the number of residency slots. But his whole article is worth a look.