The long-term fiscal cliff: The federal debt

On Jan. 1, 2013, one of the most immediate fiscal cliff issues, income tax increases for all individuals, were avoided as the Bush-era tax cuts were made permanent for 99 percent of Americans. Taxes will go up for couples with income of $450,000 or more and individuals of $400,000 or more, which will include many small business entities such as S Corporations and Partnerships in which profits flow through to the individual income tax return. Yes, there will be a tax increase for some small businesses, through it will impact fewer small businesses than the $250,000/$200,000 (couple/individuals) level originally favored by President Barack Obama and Congressional Democrats. Every worker, however, will see his or her Social Security tax rate go up from 4.2 percent to 6.2 percent.     

Nothing, however, was done in terms of long-term deficit reduction, which is driven by entitlements such as Social Security, Medicare and Medicaid or fundamental tax reform in which the tax system could be made simpler and more competitive with other nations. As House Minority Whip Steny Hoyer (D-Md.) stated in his speech before the House of Representatives vote, “Compromise is not the art of perfection.” This deal was certainly imperfect, but it was necessary to get to the next step. 

Now the stage is set for a more long-term fiscal cliff debate, which will be in a few short weeks when the federal debt ceiling of $16.4 trillion will need to be increased and the two-month postponement of sequestration will expire. At this point, the real debate will begin — not as to whether the United States should end up like Greece (everyone agrees it should not), but whether our politicians have the courage and ability to make truly difficult choices on a bipartisan basis that will prevent it from happening. Many Americans will remember the summer of 2011, when capital markets gyrated and the U.S. debt was
downgraded.

The trajectory of the long-term debt of the United States can best be described not so much as a fiscal cliff, but a fiscal slide. This trajectory has been problematic for over a decade, but has accelerated over the last four years. As of Sept. 30, 2002, the federal debt was $5.7 trillion. As of Sept. 30, 2008, it was $13.6 trillion, and now the number stands at more than $16 trillion.
Unfortunately, the consequences of such a slide do not become apparent in just one episodic point in time, but are more gradual. In many ways, a gradual slide can engender not so much a sense of complacency, but a lack of immediacy that allows hard decisions to be deferred.
 
So what are the hard decisions and what are the consequences of not making them sooner rather than later? The hard decisions involve which spending to cut and what revenue to generate through taxes, and unlike numbers on a spreadsheet, these decisions impact real people. With many different politicians representing many different competing interest groups, the process is going to be hard and will require bipartisan compromise. 

But these decisions will be harder to make and the consequences greater in the future. The interest expenditure on the federal debt, which goes toward no government program that helps anyone, will increase. What’s more, the interest expenditure will be become even higher once interest rates go up. The other consequence of a long-term burgeoning national debt will be lower long-term economic growth than would otherwise be the case as resources are being shifted from the private economy to the federal government.

A basic framework for long-term deficit reduction is the Simpson-Bowles Commission framework, which can be revisited, at least as a starting point. The election is over, and part of the immediate fiscal cliff has been resolved, so now is the time to focus on long-term deficit reduction.

Phil Umansky, CPA, is an associate professor of business and department chair of the Accounting and Finance department at the Sydney Lewis School of Business at Virginia Union University in Richmond, where he has taught for 24 years. Umansky is a member of the Virginia Society of CPA’s (VSCPA). Umansky received his doctorate in accounting from VCU and has a master of accountancy degree from Virginia Tech.