Understanding Our Oil-Related Fiscal Cliff

The United States’ fiscal cliff is very much related to several changes we have been going through recently, and will likely continue to experience:

  1. High oil prices (more than triple their level ten years ago). High oil prices cause people to cut back on discretionary spending, leading to layoffs in discretionary industries and debt defaults. Governments get less revenue in taxes at the same time they need to increase spending for unemployment benefits, bailing out banks, and stimulus funds. Result: financial problems for governments of oil importing countries, including many Eurozone countries and the United States.
  2. More free trade with Asian countries starting about 2001, when China joined the World Trade Organization. This change sent many jobs to Asia, and also holds down wages in US industries that compete with companies using overseas labor.
  3. Lots of baby boomers becoming eligible for Medicare and Social Security, starting about 2011. This is a problem because taxes, in practice, need to cover the cost of  benefits on a cash flow basis, which is the way US handles its financial accounting. As a practical matter, this is the way the world economy works as well–the goods and services used today are created by today’s workers, with resources pulled out of the ground today. Carryovers in terms of goods are very limited–mostly a little grain.
  4. A health care industry that is able to charge fees that are increasingly out of line with the wages of common workers.

None of these issues looks likely to improve in the near future, suggesting that we are encountering a long-term problem that is only likely to get worse.

In this post, I provide charts showing that if the US funding problem is fixed through higher taxes on individuals (including proprietors), the needed fix would require additional taxes averaging approximately 15% of each person’s wages. If oil production remains relatively flat, as it has since 2005, additional tax increases even above this level will likely be needed later, as higher oil prices lead to more layoffs, and more need for government spending.

I also discuss three approaches other than higher taxes on individuals that might be used to try to fix the problem:

  1. Send programs back to the states
  2. Fix health care costs by emulating the Japanese using severe caps on medical charges
  3. Rethink taxes on imports

The first approach is being considered by others. I see drawbacks to it that others may have overlooked. The second two approaches are admittedly nonstandard, but need to be at least considered.

I am not very optimistic that a way can be found around the fiscal cliff. The problems are too much “baked into the cake”. But if we don’t understand what the magnitude of the problem is, and what is causing it, it is hard to make good decisions.

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