The “fiscal cliff” refers to the impact of $503 billion in automatic tax increases and government spending cuts set to occur on Jan. 1, 2013 because of the debt ceiling deal of August 2011. Another $682 billion in automatic tax increases and government spending cuts is set to occur on Jan. 1, 2014. The Congressional Budget Office (CBO) released a projection on Nov. 8 of the potential effects of going over the fiscal cliff. According to CBO’s projections, going over the fiscal cliff would cause inflation-adjusted gross domestic product (GDP) to drop by 0.5 percent in 2013 (as measured by the change from the fourth quarter of 2012 to the fourth quarter of 2013), reflecting a decline in the first half of the year and renewed growth at a modest pace later in the year. That contraction of the economy would cause employment to decline and the unemployment rate to rise to 9.1 percent in the fourth quarter of 2013. This would amount to a loss of about 2 million jobs. Many mainstream commentators, such as the CBO, the Organization for Economic Cooperation and Development, and the International Monetary Fund, are claiming that cutting government spending could cause a recession.
President Obama is taking the position that tax rates on those earning more than $400,000 per year must be increased, while House Speaker John Boehner (R–OH) is only willing to raise rates on those earning more than $1 million per year. Very little discussion has occurred about cuts in government spending.
The political talking points and economic predictions concerning the “fiscal cliff” showcase all three of the most prolific economic fallacies: the government money fallacy, the broken window fallacy, and the fixed pie fallacy. Let us look at these fallacies and how they inform the reasoning behind the political talking points and economic predictions.
The government money fallacy is the belief that government has money of its own to spend. This fallacy stems from the ideas of central banking and currency debasement. While debasement, a form of counterfeiting, was once considered a crime worthy of death, most countries today have a central bank that has the authority to print bank notes as monetary policy makers deem necessary. This causes a belief that government has money of its own to spend, but in reality, printing money and buying treasury bonds are just forms of borrowing against the future productivity of the tax base. Of course, when there are more bank notes in circulation, the law of supply and demand dictates that each note is of a lesser value, which is an indirect form of theft from and enslavement of the citizens who are forced by legal tender laws to use the bank notes. The other method of funding government activity is to steal the money and enslave the labor of its citizens directly through taxation. Thus government has no money or resources of its own; only that which it seizes from people who live under it. To fail to recognize this is to commit the government money fallacy.
The consequence of the government money fallacy is that the idea of government spending creating and/or sustaining jobs is an example of the broken window fallacy. This fallacy, first explained by Frédéric Bastiat in his 1850 essay Ce qu’on voit, et ce qu’on ne voit pas (That which is seen, and that which is not seen), illustrates why destruction is not a net-benefit to society and why it is important to consider opportunity costs. In the case of cutting government spending, the broken window fallacy explains why jobs will not be destroyed over the long term. Remembering the lessons of the government money fallacy, a decrease in government outlays sets in motion a decrease in the diversion of real savings from wealth-generating activities to non-wealth-generating activities, which will lead to economic enrichment and recovery. Such cuts are bad news for jobs that only exist because of government spending, but after a short correction period of perhaps one or two quarters, new private sector jobs will emerge to replace them. To claim that there will be a long-term net job loss after cutting government spending is to commit the broken window fallacy.
The final fallacy of note is the fixed pie fallacy, which is the mistaken notion that there is a relatively fixed and unchanging total amount of wealth in the world. If this were true, it would mean that one person can get a bigger piece of the “pie” only at the expense of others getting smaller pieces. (To be fair, the mass of matter comprising Earth is about 5.97×10^24 kilograms and has been for a long time, but if our descendants ever get to the point of using that up, they will either not be limited to living on or near Earth, or will deserve their fate for squandering an entire planet-mass of resources. Thus we should not think of planet Earth as an immense “pie” in this sense.) For the foreseeable future, the amount of “pie” will be steadily increasing with time. To fail to account for increases in the total amount of wealth that are produced by the private sector is to commit the fixed pie fallacy.
Now, let us apply the above knowledge to the mainstream predictions concerning the fiscal cliff. The tax increases that are part of the fiscal cliff are only a surface phenomenon. When we look deeper, what matters is that an increase in revenue will lead to an increase in spending, because Congress is pathologically incapable of cutting spending. If not from direct taxation, the money for increased spending will come from currency debasement or increased borrowing. Such debasement will cause an artificial increase in gross domestic product (GDP), which makes the CBO’s predictions unreliable. This is because GDP is a measure of monetary turnover, and growth in the money supply will cause growth of GDP. Because the time between debasement and its effect (i.e. the velocity of money) cannot be precisely measured or predicted, the CBO is effectively trying to pin the tail on a moving donkey. It would actually be better for taxes to increase on middle-class Americans, because it would make the cost of statism more visible. Many people do not understand the machinations of the Federal Reserve, and the effect of borrowing is felt more by future generations than by the present generation, but a direct theft of one’s income is clearly noticeable. It should also be noted that a combination of tax increases and spending cuts acts like a tight monetary policy, which should restrict the formation of economic bubbles, the bursting of which tends to lead to recessions.
The next prediction worth examining is the CBO prediction that a loss of about 2 million jobs will result from going over the fiscal cliff. As explained above, this prediction commits the broken window fallacy because it ignores what job creators in the private sector could do if their money was not stolen by the state to fund public sector jobs. If taxes increase, the items they might have purchased will go unpurchased and the employment opportunities they might have created will go uncreated, but since there is no way to count a non-purchase or a non-job, these costs are hidden. Likewise, when the CBO and other mainstream economists claim that cutting government spending will cause a recession, they are focusing on what is seen and ignoring what is unseen. Certainly, a correction period of temporary job losses would occur, but 2 million jobs would not disappear, never to be seen again.
The fixed pie fallacy is committed by those who believe that rich people should pay more taxes, a “fair share” as President Obama calls it, because implicit in the idea that rich people should pay more taxes is the notion that the lower classes can only advance at the expense of the wealthy. The problem of income inequality is not a byproduct of the tax code, but of central banking. As Ludwig von Mises explained in Bureaucracy, “Inflation and credit expansion, the preferred methods of present day government openhandedness, do not add anything to the amount of resources available. They make some people more prosperous, but only to the extent that they make others poorer.” This is not the result of a fixed “pie,” but of creating “pies” artificially and handing them out to political cronies for 99 years, thereby devaluing the “pies” possessed by those who do not have insider access to the scam. The way to end the flow of wealth from the poor to the rich is not to tax the rich, but to end the Federal Reserve.
Of course, no matter what happens as a result of fiscal cliff negotiations or the lack thereof, there will not be a significant cut in government spending. For this to happen, Congress will have to be put in a position where it has no other choice. Fortunately or unfortunately, depending upon one’s point of view, this time is rapidly approaching. Continued fiscal irresponsibility will lead to credit downgrades, like the downgrade by Standard and Poor’s on Aug. 5, 2011 and the three downgrades by Egan-Jones since July 16, 2011. Eventually, such downgrades will lead to a rise of interest rates, as investors lose confidence in the ability of the U.S. federal government to meet its financial obligations. A historically average interest rate of 6% would mean that the current level of debt ($16.4 trillion as of this writing) would require an annual interest payment of well over $1 trillion, because interest on treasuries is always a few percent higher than the base interest rate. Such an increase in interest on the national debt would require massive budget cuts, huge tax increases, hyperinflation, or a sovereign default, any of which would lead to an end of the current era of wanton spending. Whether attempting to reach this point is the correct course of action is an open question, but the Austrian School of economics suggests that President Obama and Speaker Boehner should swan dive off the fiscal cliff and look as irresponsible as possible while doing so in order to take this path.