HICKS: Economy will get worse before it gets better

Four months ago in this column, I predicted we would drive off the fiscal cliff and that it would be “less injurious” than most believed, with the tax increase causing the most pain.

We have now driven off that cliff, and the dramatic reintroduction of payroll taxes makes this year’s tax increase most injurious to the working poor and the lower-to-middle-income families.

Disposable income plummeted more last January than in any month on record (we started keeping these data in the Eisenhower administration), and things will get worse before they get better.

The second step of the sequester—the spending cuts—has now begun. These are real reductions in spending, with measurable impact that the administration sought to maximize for political gain. This is becoming tiresome, so I think it useful to talk a bit about the political economy of the end game.

There are two great debates at hand: one about the size and scope of government in the long run, the other about short-run federal policy in the current dismal economic climate.

We are in a bad spot. Unemployment is high, incomes have remained flat for several years, and—in an effort to extricate ourselves from this mess—our federal government has borrowed roughly $6 trillion, or $40,000 per household.

On the faith of our eventual fiscal discipline, we can still borrow this money at about a 0-percent interest rate. Even modestly higher interest rates would be disastrous. To avoid this fate, we must demonstrate fiscal discipline.

Like most economists, I think the best way to show we are grown-ups is to handle large, long-term problems first. We could modestly change the Social Security eligibility age and impose a lifetime limit on Medicaid and other guaranteed programs.

The sequester will achieve the same goal at much higher cost. We lack the courage and gumption to tackle the big problems, so we stand in longer lines at the airport instead.

Over the long run, we wrestle with the scope of government. In 2013, federal tax revenues are on path to set a record. This will prove stubbornly inconvenient news for those who argue our federal government is plagued by a revenue problem.

Today, we borrow 49 cents for every tax dollar we collect. At some not-too-distant point, we will have to collect more than we spend, and pay down the debt. To do so, we can raise tax rates or cut spending dramatically. Either option will slow economic growth.

Conversely, we could fix our tax system, making it more fair, while shifting our spending toward things that motivate work and productivity. Given our current leadership, I’d wager we’ll take the unnecessarily painful path.•

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Hicks is director of the Center for Business and Economic Research at Ball State University. His column appears weekly. He can be reached at cber@bsu.edu.