We're Headed For A Fiscal Cliff. Should We Jump? : Planet Money Taxes are set to go up for most Americans next year. That's a good thing, Simon Johnson argues.

We're Headed For A Fiscal Cliff. Should We Jump?

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PAUL NEWMAN: (As Butch Cassidy) All right, I'll jump first.

ROBERT REDFORD: (As The Sundance Kid) No.

NEWMAN: (As Butch Cassidy) Then you jump first.

REDFORD: (As The Sundance Kid) No, I said.

NEWMAN: (As Butch Cassidy) What's the matter with you?

REDFORD: (As The Sundance Kid) I can't swim.

NEWMAN: (As Butch Cassidy, laughter) Why, are you crazy? The fall will probably kill you.


Hello, and welcome to PLANET MONEY. I'm Robert Smith.


And I'm Jacob Goldstein. Today's Tuesday, April 24, and that was "Butch Cassidy And The Sundance Kid" you heard at the top. Today on the show, the massive fiscal cliff that the United States is facing.

SMITH: Yes. We are going to hit this cliff on January 1, 2013. Here's what's going to happen. If Congress doesn't act, then taxes will go up for most Americans. Massive government spending cuts are also scheduled for that date. Today we are going to take one of our favorite economists to the edge of that cliff. And he says the United States needs to jump. But first, the PLANET MONEY indicator with Zoe Chace.

ZOE CHACE, BYLINE: Today's PLANET MONEY indicator - it's 12, as in 12 percent. Facebook's profits fell 12 percent from where it was a year ago, and here's why this matters. Facebook is gearing up for its initial public offering - that's in a few weeks - and that basically means that Facebook is all grown up. Remember when Mark Zuckerberg was all star-struck by Sean Parker in that movie "The Social Network"?


JUSTIN TIMBERLAKE: (As Sean Parker) The Facebook is cool. That's what it's got going for it.

JESSE EISENBERG: (As Mark Zuckerberg) Yeah.

TIMBERLAKE: (As Sean Parker) You don't want to ruin it with ads because ads aren't cool.

EISENBERG: (As Mark Zuckerberg) Exactly.

TIMBERLAKE: (As Sean Parker) It's like you're throwing the greatest party on campus and someone's saying it's got to be over by 11:00.

EISENBERG: (As Mark Zuckerberg) That's exactly it.

TIMBERLAKE: (As Sean Parker) You don't even know what the thing is yet.

EISENBERG: (As Mark Zuckerberg) This is exactly...

TIMBERLAKE: (As Sean Parker) How big it can get, how far it can go - this is no time to take your chips down. A million dollars isn't cool, you know what's cool?

JOSEPH MAZZELLO: (As Dustin Moskovitz) You?

ANDREW GARFIELD: (As Phoenix Club President) A billion dollars.

CHACE: That meeting was years ago. Now Facebook's headed towards a 100 billion dollar valuation. When Facebook was young it needed to be cool. Now that everyone's already on it, it needs to make money, and the way that Facebook makes money is by selling ads against all the data it's collected about you. And the profit is down, because advertising is cyclical. In the fourth quarter, around the holidays, ad spending goes up. In the first quarter there's usually a dip, and Facebook's user growth has been big enough to mask that over the last couple of years. Now it's user growth is slowing a bit, and its expenses are definitely growing, so Facebook is more vulnerable to the ups and downs of advertising than it was before. According to the Web site TechCrunch, almost one in eight people on earth are on Facebook, so there's only so much more it can grow. Now it needs to make more money off those people.

SMITH: Thank you Zoe. And now on to the cliff.

GOLDSTEIN: So Robert, this whole cliff thing - it sounds kind of like a Planet Money metaphor or something, but the truth is we did not come up with it. It actually came from Ben Bernanke, the chairman of the Federal Reserve. And of course he usually tends to use very subdued language, but here's what he said earlier this year when he was testifying before Congress.


BEN BERNANKE: On January 1st, 2013 there's going to be a massive fiscal cliff of large spending cuts and tax increases.

SMITH: What Mr. Bernanke is referring to - all those spending cuts and tax increases - it's the result of some serious political procrastination. Congress has put off some really tough decisions about spending and taxes until after the election, and all of those decisions come due December 31.

GOLDSTEIN: And, Robert, let's just go through three of the big ones right now. Number one - remember the whole debt ceiling debate last summer, the way they sort of resolved that was - there were going to be these automatic spending cuts. It's 1.2 trillion dollars. That starts to go into effect on January 1st, 2013, and then it stretches out for 10 years.

SMITH: Yeah, and the second thing that's going to happen at the end of the year is the payroll tax cut expires. So payroll taxes will go up for everyone who works on January 1st, and your paycheck will look a little bit smaller - if Congress does not extend the tax cut in time.

GOLDSTEIN: And number three, and this one is sort of the biggie on this list, the Bush tax cuts - the ones that President Obama extended a couple of years ago - those are also set to expire. So almost everybody's income tax rates will go up on January 1st if Congress doesn't act.

SMITH: Now you can see why Bernanke calls it a cliff. I mean, any of these measures alone - spending cuts or tax hikes - could slow down the growth of the economy, and Bernanke was warning Congress against letting it all happen at exactly the same time. He actually said, in that hearing - "I hope Congress will look at that and figure out ways to achieve the same long run fiscal improvement without having it all happen at one date."

GOLDSTEIN: You say it much better than Chairman Bernanke, Robert, I have to say.

SMITH: You know, I love it when he just comes out and just says what he really means.

GOLDSTEIN: Now, at least one economist says we shouldn't be scared of the cliff. He says the cliff is an opportunity for the country. It's Simon Johnson. He teaches at MIT, he's a former chief economist at the IMF, and he's the co-author of a new book called "White House Burning." And the book argues that when we get to the cliff we need to jump. We talked to Simon earlier this month.

SIMON JOHNSON: The most important decision to be made at the end of this year is regard to the Bush era tax cuts. If you remember, back in the early 2000s, the income tax and capital gains tax were cut under George W. Bush. The key thing about the tax cuts is they were broad. They were not just for rich people. In fact, if you raise the taxes - the top rate, for example - put it back up to 39.6 percent - 40 percent, let's call it, for the richest people, earning - the highest - this is on earned income, you will bring back about a quarter or a fifth of the revenue that was given up. It's the lower rates paid by the middle class - I'm talking income tax here - a broad swath of people earning less than 250 thousand dollars will see their taxes go up. And that's actually where the revenue is, and that's the really awkward part of this conversation. And it's the awkward part of the proposals in our book, because we're saying don't extend any of the Bush era tax cuts. And our critics say - you're proposing a large middle class tax increase? To which the answer is yes, we are.

SMITH: Then why did you do it? Why did you propose it?

JOHNSON: Well our view is you need the revenue, and the position we take in our book is that - first of all, you have to have the conversation about what does government do? What do you want government to do? What does government do in the United States today? And the big items, in terms of government spending, are the social insurance schemes - Social Security, Medicare, and to a lesser degree Medicaid. If you like those programs, if you think they work - and a lot of Americans do like them, although 40 percent of Americans who use Social Security don't think they participate in a government program and it's about the same for Medicare. When you push them - when you explain to them what the programs are, they like them. If you like those programs, our view is you should pay for them. If you look at sources of revenue - and don't pay for them through debt. Don't pay for them through having a deficit and trying to sell the debt to the Chinese or other foreigners. That's not a sustainable path. If you want to keep social insurance in place in a sustainable fashion you need revenue. Where are you going to get revenue in today's political circumstances? You can design all kinds of ideal tax schemes that might work in some other country or some other reality, but in the United States today your main chance of getting revenue is don't extend the Bush era tax cuts. Have an increase in taxes for people at the higher end for sure, but also throughout the middle class.

SMITH: I feel like you're presenting a false dilemma, in particular because when you look at projected deficits over the next decade or over the next couple of decades, it's hugely driven by a rise in health care costs. The U.S. already spends way more than other developed countries on health care. It's not clear that our outcomes are significantly better. The presumption is that those costs will continue to rise, and so rather than say we need higher taxes on the middle class to pay for that, why not say we need to fix health care and health care costs?

JOHNSON: Because I'm a realist and I'm a cynic. Of course you are right. Your statement just now was exactly, perfectly right, and you should tweet it every day and you should come down to Washington and testify to everybody who will listen to you. But here's the problem - we can't fix healthcare. We tried, that conversation went nowhere. I've talked to all the health care experts on the right and on the left, lots of reasonable people - they don't have anything for me. OK? So should I wait for healthcare to be fixed and then balance the budget or bring the budget under control and debt under control on that basis, or should I say I'll take the CBOs - the Congressional Budget Office's projection for health care cost over the next two decades - and I will give you, on the - including those forecasts, all right, as my baseline, I will bring debt to GDP down to 50 percent. That's a big fiscal adjustment. That makes us more conservative than anybody who claims to be a fiscal conservative. And I'm going to do that with revenue. I'm going to do that by raising taxes back to the level of the 1990s. This is completely consistent with vibrant private enterprise and an economic recovery, and it's not going to make me popular with anyone on the left or on the right.

SMITH: And that change you're talking about - bringing debt to GDP down to 50 percent - you get to that just by letting the Bush tax cuts expire?

JOHNSON: No, but letting the Bush tax cuts expire is about half of the fiscal adjustment, in our view, you need to make over the next two decades.

SMITH: What else you have to do?

JOHNSON: Well lots of other things that make me even more unpopular. Tax expenditures - you need to limit the deductibility of mortgage interest.

SMITH: So people can't deduct the mortgage they're paying on their home from their taxes anymore?

JOHNSON: Not to the same extent, you're going to need to reduce that. You need to reduce the deductibility of employer provided health insurance. If you've looked at your paycheck, you see that there's a big chunk of the health care costs - your insurance premium, that - it comes out of your pre-tax income. You're getting a tax break on that. The employer's getting a tax break on that. That's a big item. The unions really like that tax expenditure. A lot of middle class people like the tax expenditure that protects mortgage interest. The realtors will be jumping all over me for that one as well.

SMITH: Yeah. You've already managed to piss off anyone who pays income tax, anyone who owns a home, the whole real estate industry...

GOLDSTEIN: Anybody who gets health insurance through work.

SMITH: ...Exactly. Who else - who else do you want to go after?

JOHNSON: I only have unpalatable truths. Tell me who you want - tell me - mention a category and I'll tell you what I have for them. Look...

SMITH: Let me - look, let me ask you another - I mean, everything you're talking about is essentially increasing taxes. Whether by cutting loopholes or by raising rates. I mean, is any of your proposal aimed at cutting spending?

JOHNSON: Yes, absolutely. We are proposing to index the Social Security age - the age at which you can draw a pension - to life expectancy. We're proposing to increase the payroll tax, explicitly directly to pay for increased contributions to Social Security and increased contributions to Medicare. The...

SMITH: For the record - that's increasing taxes, not cutting spending.

JOHNSON: (Laughter) Fine, we are proposing to better fund the social insurance programs. Do I have a scheme to bend the curve on health care costs in our proposals? No. I don't think that such a scheme is on the table. If you push health care out of the federal budget, if you reduce Medicare spending - for example, putting a cap on Medicare, what you do is you shift those health care costs on to families and on to companies. And actually the CBO scored Congressman Ryan's budget last year - which had a version of this proposal in, and they pointed out it would actually increase health care costs for families and for companies, because you're taking the government out of that market where it's a big buyer, and you're shifting that on to other people who have much less market power.

SMITH: So, Simon, how did you think that this proposal was going to fly? Basically you have an entire book here - you go through all of American history, you explain the entire situation, you lay out everything about the U.S. economy, and whoever's reading this gets to the last chapter and it's like - oh, by the way, anything you're paying now in taxes - it's just going to be more, and it has to be more. And once you get to that you think - how can that fly in Washington, D.C.?

JOHNSON: Well I'm not seeking public office. I'm not trying to win any popularity contests. I'm not putting forward a proposal to be voted on. I'm pointing out to you some pretty harsh and unpleasant realities that I think have been avoided for far too long. The War of 1812 - the reference to the White House Burning is when the British captured Washington, burned all the official buildings including the White House, in August 1814. The problem there was the people running the government - the war hawks in Congress - had decided to go to war and didn't want to pay for it. And if you have a big mismatch between what you're trying to spend what you're trying to have the government do and the revenue you're trying to provide, there's a problem. That's the situation today. If you don't like my points on revenue, fine. Let's go back and revisit - what does the government do? What does it actually spend? And don't - let's talk about waste or corruption or this or that - you know, the big money is in social insurance. It's Social Security. It's Medicare. Now do you propose to cut those programs? What are your proposals? And let's have that conversation with the American people. The average draw from Social Security - pension - is 13 thousand dollars a year. You do not live well, in most parts of this country, on 13 thousand dollars a year. It is there as a backstop for when you outlive your financial assets and when your family can no longer take care of you. And Medicare is the same way. There was no private health insurance for people in their 70s 80s and 90s before Medicare was introduced, and I promise you - if you abolish Medicare, you won't get that - such a private insurance market. These people - the people who Medicare really protects are uninsurable risks. Talk to the insurance companies about that.

So you can certainly push it off the budget. You can certainly say government will not pay for the health care of 85 year olds. Do it with your own money, save more, have your families take care of you - maybe your committees - maybe your church, but you're on your own with regard to the federal government. That's a big decision, and I don't think it's an advisable decision with regard to the economics of it or with regard to the kind of society that at least I want to live in. But that's the issue. That's the heart of the issue, and the point of the book is to present this unpalatable truth to people and say look, if you want the government to provide social insurance, you have to pay for it. You can't rely on deficit spending and increasing the debt indefinitely. It doesn't work, even in such a great, exceptional country as the United States. So make up your own minds. Do you want to get the government out of the business of social insurance, or do you want to provide it with enough revenue to sustain social insurance for an aging population?

SMITH: I understand that, but I also see - there's another lesson to be taken from the War of 1812. Not necessarily that they should have been taxing more, but perhaps they shouldn't have gone to war. In other words, maybe they should have cut spending instead of spending freely and not raising the money for it.

JOHNSON: Absolutely. That's completely correct. You always have a choice. Do you want to address the spending side primarily - or exclusively - or do you want to address the revenue side. And the debt is a buffer. It gives you a break - and the big - you know, the big expansion in the role of the federal government in the United States came in the 1940s, but not particularly - or initially - for any kind of social programs. Even though Social Security was put in place in 1935, it was a small program. The big shift - the big decision was that the U.S. would not retreat, as it had retreated after World War One, back to its own borders, but it would have a global role and it would try and bring peace - and yes I - quixotic though it may sound, prosperity to a large chunk of the world, and that was expensive. And you know what? Dwight Eisenhower - among others - leading Republican of his day, felt that we should have the revenue to back this up. His advisers said to him, in 1960, let's do a tax cut to help Richard Nixon get elected, and Eisenhower said no. I would rather hand over a more nearly balanced budget to my successor rather than, you know, do a tax cut for any kind of tactical, political reason or any kind of a deep philosophical reason. We've lost track of that. We've lost track of the fact that you need revenue to back the spending, and you need to talk about and decide what the spending should be.

SMITH: Now, I think it's clear how conservatives would react to your ideas and your plans, because a lot have come out and said there will simply be no tax increases, if purely on philosophical reasons - not economic reasons, but I think you're also going to get a pushback from liberal politicians and liberal economists who would say - all of this is fine and well if you accept the premise that our biggest problem is the size of the debt. And you're absolutely right, the easiest way to reduce the debt is to allow these tax cuts to expire. But a lot of them would argue with your premise - that the biggest problem in America right now is the employment situation, is how many people have jobs. And for all the talk you go on about - about reducing the debt and how to do it, none of this addresses what many people see as the main problem. None of this gets America moving again. None of it creates jobs.

JOHNSON: Yes. I think that's exactly what people on the left are saying - and to be clear, no one's returning my phone calls, at the moment, from the right or the left. So I think I have achieved the perfect middle here. Occupy the middle ground in American politics - me and about three other people. But, honestly, you're not going to get additional stimulus passed. I think the economy is coming back. We had an awful financial crisis. The banks blew themselves up. They did massive damage. You have to - people talk about the balance sheet recession, meaning the overhanging of debt. This takes time to come back. I don't think we can throw more stimulus into the economy right now and really make a significant difference. That's my assessment. I think you need to look ahead and look at what's happening to - on the fiscal side, and I also think the left is making a pretty big tactical, political mistake by not wanting to talk about the debt and the deficit. Because they're ceding that ground to people on the right - and to many people who present themselves as centrist, but actually, remarkably, their proposals - many of these same so-called centrist proposals, are tax cutting proposals. I don't think tax cutting, at this stage of the game, is a good idea. People - the people who want to ignore the debt are not just on the left, they're also on the right. Newt Gingrich - who is a great character - an important character in our book. He's been in politics - in Congress since 1978. He's always been pushing for tax cuts. He really attacked the Republican leadership in Congress in the mid 1980s when they did the increase - they did a deal with the Democrats to increase taxes.

That was after the initial Reagan tax reductions, and they increased taxes. Newt Gingrich's proposals - currently before the Republicans in the primaries - according to the Committee for a Responsible Federal Budget, would push debt to GDP up to 140 - 150 percent by the early 20 - 2020's, which is essentially Greek levels of debt. So we have people on the left saying look, we'll fix the debt later. We worry about the debt, we'll fix it later, it's not important. We have people on the right saying, you know, we don't care about the debt. Let's not get distracted by the deficit. What we really need to do is cut taxes. I'm claiming to be in the middle. I'm saying let's have the conversation. What do you want government to do? Do you believe in social insurance? Is that something you value? Do you want it to operate more or less as it is - and we think that's viable, it certainly can happen and we think it's sensible - and what does it take to pay for that. And you're talking about the middle class paying for it - this is a middle class society. That's where the revenue is. The middle class is either going to pay for it or not. If you say well, we'll just issue debt and don't worry it's cheap, we can borrow at 2 percent. That's true today, but how long will that be true for?


SMITH: Economist Simon Johnson. He wrote the book "White House Burning" along with his co-author James Kwak.

GOLDSTEIN: As always, we'd like to hear from you. You can find us on Twitter or Facebook - Tumblr. You can also e-mail us at PlanetMoney@npr.org

SMITH: Or check out the Planet Money blog - npr.org/money. I'm Robert Smith.

GOLDSTEIN: And I'm Jacob Goldstein.

SMITH: Thanks for listening.


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