I Was Wrong, part I

I believe it's important to admit when you were wrong. Now that the fiscal cliff and sequester are mostly behind us, I can say that I made a few predictions that proved to be wrong.

Immediately after Obama's reelection, I said,

"First of all, expect the fiscal cliff to stay in place. After all, we just re-elected most of the people who put it there to begin with. … Any compromise will include more tax hikes than spending cuts, if spending is actually cut at all."

As it turned out, the fiscal cliff did not stay in place. The deal to avert the fiscal cliff included $250 billion in lower taxes compared to just $9 billion in higher spending, relative to what would have happened with no deal. At the time, I said,

"If you think that two month delay is a sign that the sequester will never happen anyway, I think you're right. It was never going to happen in the first place, and we lose nothing by delaying it."

This was also wrong. Not only did the sequester actually come to pass, the continuing resolution recently passed by the Senate and House and signed by Obama also keeps it in place for the next six months. While the Senate budget for fiscal 2014 repeals the sequester, the House budget does not, leaving open the distinct possibility that the sequester's lower spending is here to stay.

Color me pleasantly surprised. Even a blog called Expected Optimism wasn't optimistic enough!

Fiscal Cliff Optimism

I'm not the only one who thinks the fiscal cliff deal was a good thing.

David Henderson begins his thoughts on the deal by saying, "Pssst: Someone tell the Republicans they won." Like me, Henderson compares the deal to what would have happened without it, rather than some ideal version that never would've passed the Senate. Henderson, however, goes into far more detail than I did.

Among the many negative responses to Henderson's post I've seen, only Bob Murphy seems to understand that it's the baseline that matters--that is, what would have happened without the deal (even though Murphy still disagrees with Henderson).

Yuval Levin at NRO (ht) approves of the deal for political strategy reasons. He says, "For liberals, this was not a moment of danger to be minimized but by far their best opportunity in a generation for increasing tax rates," and they got far less than they could have just by doing nothing and going over the cliff. "Having discovered an effective political wedge in the tax debate, the Democrats have now basically used it up and gotten awfully little in return."

Finally, if you're still not convinced that the deal was a good thing, take a look at the latest newsletter from the Socialist Equality Party. The self-described socialists hate the deal. In the opening paragraphs, the author echoes Levin's observations on political strategy. In the 7th paragraph, he gives a list of reasons to hate the deal that pretty closely mirrors Henderson's reasons for liking it. If it's that bad for the socialists, it has to be good for the rest of us.

The Fiscal Cliff and Opportunity Cost

I keep seeing conservative laments about the fiscal cliff deal, like this one, which sums up a bunch from Twitter. There are far too many to link to, but so far, every single one that I have seen has ignored the economic principle of opportunity cost.

Conservatives are upset that taxes are going up and spending won't be seriously cut. But when we look at the opportunity cost for this fiscal cliff deal, we can't just look at some pie-in-the-sky "deal" where the Democrats roll over and give conservatives everything we want. We have to look at the reality of what would have happened without the deal. And the reality is, without the deal, taxes would have gone up twice as much ($478 billion compared to $220 billion), and we would've seen a spending cut that's a measly 0.3% of federal outlays.

I know this isn't how the deal is being portrayed in the media, but these are the facts. Republicans gave the Democrats $9 billion in higher spending, and got $250 billion in lower taxes, compared to what would have happened without the deal. To me, that looks like a win.

A final note on the sequester: Most of the supposed sequester cuts would not have happened for years in the future anyway. If you believe future Congresses would have abided by the sequester, then you're in luck. The sequester is still going to happen, just two months later. If you think that two month delay is a sign that the sequester will never happen anyway, I think you're right. It was never going to happen in the first place, and we lose nothing by delaying it.

Recent Reasons for Optimism VII

1. Doctors in Toronto are using ultrasound to perform brain surgery without the surgery. During the five-hour procedure, Tony Lightfoot regained his ability to use his hands without tremors as high-intensity ultrasound destroyed the tissue causing the problem. The technique can also be used to eliminate other problem tissues, including certain kinds of cancer.

2. An organization called Diagnostics for All, backed by the Gates Foundation, is producing paper-based blood tests that can diagnose liver damage within minutes at a cost of less than a penny per test. Tests for other diseases, including malaria, dengue, hepatitis and diabetes, are being developed. While they're currently working on getting these diagnostic tests to poor countries, the benefit of cheap, easy diagnostic tests for the developed world is obvious. The main hurdle now seems to be getting regulatory approval, which is easier in poor countries than in the West.

3. New estimates from the IPCC of the climate's sensitivity to CO2 suggest warming over the rest of this century will be far less than previously estimated (more here). Moreover, a new study finds, at least with wheat yields, that the benefit from higher CO2 concentrations outweighs the cost of higher temperature. What little warming actually happens may end up being a good thing after all.

4. And even if it isn't, we'll be able to adapt. Thanks to cheap air conditioning, deaths from extreme temperatures declined by 80% over the 20th century in the US. Economic growth will bring similar gains to developing countries in the 21st century.

5. Mark Perry has more examples of the increase in prosperity since the 50s, including toasters, TVs, music players, washing machines and dryers. All of these have increased in quality (quite dramatically for TVs and music players), and yet are far cheaper. Don Boudreaux is also continuing his Cataloging Our Progress series with two entries on men's wear and one based on the Sears.com homepage.

6. Also from Mark Perry, the US is now producing more oil than at any other point since 1993, and Texas oil production is higher than it's been since 1987. Also from that second link, regarding natural gas, "The United States has gone from being the highest cost major gas producer four to five years ago to the current lowest cost producer."

7. The fiscal cliff has been averted. While the deal we ended up with isn't my first best choice by any means, I think it's an improvement over the cliff. For most of us, taxes are going up a little instead of a lot, as the Bush cuts were made permanent for most people while the payroll tax is going back up.

How Accurate is the CBO?

Politicians and pundits often talk about budget projections from the CBO. Depending on how the CBO's projections mesh with the commenter's worldview, the projections are either the best possible from the nation's top budget economists, or they're crap, constrained by Congressional rules until they're useless. So just how accurate is the CBO?

A comment over at Bob Murphy's Free Advice inspired me to check out both the 2001 and 2012 "Budget and Economic Outlook" reports from the CBO. While I've got them out, I thought it'd be interesting to compare the CBO's old projections with what actually happened. Conveniently, the 2001 and 2012 reports overlap in 2011, so that's the year I'll compare.

First, Table 1-2 from the 2001 report (page 24 of the PDF), including the 2001 projection for 2011 in the far-right column:

Then, Table 1 from the 2012 report (page 6 of the PDF), including the actual numbers for 2011 in the far-left column:

How accurate was the CBO for 2011? Not at all.

Revenue: The CBO projected revenues of $3.4 trillion, while actual revenues were a full third lower than the projection, at $2.3 trillion.

Outlays: The CBO projected outlays of $2.6 trillion, while actual outlays were a full trillion higher at $3.6 trillion.

Deficit: The CBO optimistically projected an $889 billion surplus for 2011. The actual deficit was $1.3 trillion, a $2.2 trillion difference. (Of course, this error is just the combination of the two errors above. Still, it's interesting to contemplate a United States with an $889 billion surplus!)

GDP: The CBO projected a $16.9 trillion (nominal) GDP, but actual GDP was only $15.3 trillion.

Should we just write off the CBO entirely then? I don't think so. On the revenue side, the CBO could not have accounted for the Bush tax cuts or the revenue lost from the Great Recession. On the spending side, they could not have accounted for the war spending or, again, for the Great Recession, or for Obama keeping stimulus-level spending even after the stimulus was over.

I think the takeaway here, as we approach the end of the fiscal cliff negotiations, is that all projections for a decade in the future need to be taken with a grain of salt. Stuff is going to happen that no one expects. Decide for yourself what that should mean for current policy.

A final note: Some might look at the four areas above and say that in each area, the projections ended up being more optimistic than reality. I think that's a mistake. First, the CBO projected in 2001 that 20% of 2011's GDP would be soaked up by federal taxes, when it was actually only 15%. I think that's a good thing, despite what it means for the deficit.

Second, the GDP numbers above are nominal, meaning they include both real GDP and inflation. If nominal GDP is lower than expected, the cause might be lower real GDP (bad) or lower inflation (good). We've had both in recent years, so I'd have to dig deeper into the reports to see which effect dominates, and that's more playing with PDFs than I'd like to do tonight.

Taxes in the Fiscal Cliff

It is becoming increasingly clear that we are not going to make it into 2013 without tax increases. If we go over the fiscal cliff, taxes are going up, but Democrats have made clear that any negotiated deal would include increased taxes as well. Assuming we do go over the cliff, what would those taxes look like?

• New Obamacare taxes would come into effect.
• The Alternative Minimum Tax would return to full strength.
• The Bush tax cuts would expire.
• The payroll tax cut would expire.

Even if Congress reaches a deal to avoid the cliff, taxes associated with Obamacare are likely to stay in place. After all, changing those taxes as part of a deal to avoid taxes would require the Democrats to admit that Obamacare actually contained taxes in the first place. I'm not holding my breath.

On the other hand, even if Congress does not reach a deal to avoid the cliff, I expect a minor deal to avoid the AMT. After all, Congress has enacted one-year patches to the AMT every year for more than a decade, under both Republican and Democratic Congresses, as well as under the split control we've seen since 2010. This year should be no different.

On the Bush tax cuts, Obama was reelected after campaigning to raise taxes on the wealthy. If no deal is reached, Obama gets his wish; the Bush cuts expire and taxes are raised on the wealthy (and everyone else). The Republicans really don't have any leverage on this issue, so I expect any deal would only keep the Bush cuts for those below some income level, probably $200k or $250k.

The real uncertainty is the payroll tax cut. Normally, I would expect Democrats to abhor the cut on the grounds that it undermines Social Security. Republicans should celebrate it, not only as a tax cut, but because it undermines a massive entrenched entitlement. And yet, in some sleight of hand I still haven't figured out, Obama got the Republicans to oppose (and Democrats to support) a tax cut on every worker in the country. Now that the election is over, will the parties stick to these flipped roles, or revert to their principles? Or will the payroll tax cut expire with no one paying attention?

What Republicans Should Do
Whatever happens with the rest of the fiscal cliff, the rich (and people who work for the rich) are going to get hosed. Obama will probably get his way on the Bush tax cuts, and many of the Obamacare taxes are also aimed at the rich. Health costs are also going to go up, but I think the smart insurance companies have already raised their rates to compensate. There may not be a noticeable increase in premiums because the increase has already happened.

Given this, Republicans need to refocus on what good they can still do. Taxes are going up, and with Obama's reelection, that was inevitable. But if Republicans are smart and tactful, they can still keep taxes low for most of us. Give Obama the tax hike on the rich, since that will happen even with no deal, but secure the payroll tax cut and the Bush cuts for the non-rich in exchange. Obama himself is campaigning for the latter, so this should be easy to do, if Republicans are willing to do it.

Aftermath: Reflections on Obama's Re-election

Barack Obama has been re-elected President of the United States.

For starters, Gary Johnson was not a spoiler. While the results are still coming in, as of 11:30pm Pacific, there was not a single state won by Obama where Romney would have won even if every Johnson voter had voted for Romney instead.

Second, there is no mandate. While Obama won, he won with a far narrower lead in both the popular vote and the electoral college than he had in 2008. While Democrats increased their lead in the Senate, Republicans increased their lead in governorships, and the House is on track to be more or less the same as it was. This was very much a status quo election.

On the whole, will we be better or worse with Obama as president?

First of all, expect the fiscal cliff to stay in place. After all, we just re-elected most of the people who put it there to begin with. While I haven't spent too much time learning about the fiscal cliff, Wikipedia claims a 19.63% increase in revenue and a 0.25% decrease in spending, or a nearly 80-to-1 ratio of tax hikes to spending cuts. This will not end well-- and even if our new old government leaders manage to avoid the cliff, the re-elected Obama is in a prime position to extract concessions he was unable to before the election. Any compromise will include more tax hikes than spending cuts, if spending is actually cut at all.

Second, Obamacare will be implemented fully over the next few years. Expect the nation's health, freedom and balance sheet to all suffer. Although to be honest, I don't believe Romney would have done any better.

The national debt will continue to grow. If the fiscal cliff causes a second recession, expect more stimulus and bailouts, probably for Europe too. We may look back at $1.5 trillion deficits and laugh about how small they were. On the other hand, the same probably would've happened under Romney, considering his plan to index military spending to 4% of GDP.

On other long-term important issues, I don't expect Obama to do much of anything. He'll keep ignoring space (mercifully), Social Security will continue to stumble forward without reform, trade deals will be forgotten, immigration won't change. We'll mostly withdraw from Afghanistan on schedule, although the lack of attention the war gets these days means we'll probably keep troops there for the long haul, same as we've still got troops in Germany, Japan and Korea. On trade and Afghanistan, at least, Romney would have been even worse. While Romney may have avoided the fiscal cliff, his insistence to go after China on trade might have been just as bad for the economy.

The main difference between the two candidates in terms of our long-term welfare is this: With Obama's victory, 2016 will see another wide-open primary for Republicans, where we'll have another shot at nominating a true spokesperson for liberty. Had Romney won, we wouldn't get that chance until 2020. So hold onto your hats. It's gonna be a rough four years for liberty, but we made it through the last four. We'll make it this time, too.