Guest Post: The Fiscal Cliff And The Grand Bargain

Tyler Durden's picture

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

The Grand Bargain is unraveling, and a new arrangement will take the place of the Status Quo--whether we like it or not.

Correspondent Arnold suggested that I address the fiscal cliff, so here goes.
The first step is to set aside ideological blinders and confirmation bias, i.e. only looking for data that supports our current beliefs.
The second step is to look at the foundation of everything: household income.Household income is the foundation of taxes paid, consumption (spending) and savings/investment. If household income is declining, that means the pie of money that can be divided up into taxes paid, consumption and investment is shrinking.
If taxes go up, there is less pie left for spending or investment. And since the economy ultimately depends on private-sector spending and investment, then reducing those to fund government spending means there will be less private spending and investment.
If the government spent the taxes on investments that yielded a higher return than private investments, higher taxes would not devastate the economy. But the problem is that there are no feedbacks on government spending that favor efficiency or high yields.
Government spending decisions are made solely on the basis of constituency pain:the constituencies that create the most political pain for politicos and Upper-Caste government bureaucrats get funding. Efficiency and high-yielding investments are not in the political equation at all; there is no feedback in monopolies except those that favor expansion of budgets and constituencies.
Let's look at a chart of household income from Median Household Incomes: The "Real" Story (Doug Short)Household income has been negative since 2000 except for two brief spikes:
Here is another chart depicting the huge gap between nominal income and real income:while nominal income rose a seemingly healthy 25% since 2000, real income has declined almost 10%.
Median income doesn't tell us who is getting most of the income, so let's look at this: All the increases in income since 1970 accrued to the top 10%.
But we have to remember that median income includes all income, including the wealthy. Real income has declined by 8%-9%. The pie is smaller, period.
Some of that is due to a declining full-time workforce, which has dropped to 115 million workers:
Now let's look at the size of government spending and taxation. In terms of the overall economy (GDP), government spending's share of the economy has been rising for decades. The Internet and housing bubbles briefly "grew" the economy faster than government spending, but once these one-off expansions faded, government spending quickly returned to its trendline (ever higher).
Federal spending rose exponentially until it exceeded the carrying capacity of the economy. For context, recall that Social Security costs $817 billion, Medicare and Medicaid costs total about $800 billion annually, and the Pentagon/National Security budget is around $690 billion. Add in interest on the ballooning national debt, and the vast majority of the Federal budget goes to these four. You could eliminate all other Federal spending and these four consume all the tax revenues and then some.
Tax receipts, meanwhile, topped out at $2.4 trillion, leaving a structural gap of $1.3 trillion.
OK, so now we see why government spending can't keep following an exponential path higher: households are earning less income.
Next up: the welfare/cartel State. Some welfare flows directly to individuals ("transfer payments") and some flows to cartels: defense, sickcare, the education cartels, etc.
The problem here is the number of citizens who are dependent on government transfers and spending now exceeds the number of full-time workers. Recall (see chart above) there are 115 million full-time workers in the U.S.
Of the roughly 150 million workers in the U.S., 38 million earn less than $10,000 per year, 50 million earn less that $15,000 a year and 61 million earn less than $20,000 annually. All these numbers are drawn directly from Social Security Administration payroll data.
100 million wage earners, or 2/3 the entire workforce, earn less than $40,000 per year.
In practical terms, only the 115 million full-time workers pay significant taxes, and of those, The top 25% (those earning more than $66,193) paid 87% of the taxes. The bottom 50% of taxpayers, roughly 70 million people, earned 13% of the income and paid 2% of the income taxes collected.
(The top 1% of taxpayers reported almost 17% of all taxable income and paid 37% of all income taxes. The top 5% reported 32% of all income and paid 59% of the taxes, and the top 10% earned 43% of the income and paid 70% of the taxes. Where Do You Rank as a Taxpayer?)
There are roughly 127 million people dependent on government transfers: 61 million recipients of Social Security and Medicare (That Which is Unsustainable Will Go Away: Medicare May 16, 2012) (or Medicaid for the 11 million people drawing lifetime SSI Social Security disability) and 66 million people receiving welfare (SNAP food stamps, housing credits, Medicaid, etc.): When Work Is Punished: The Tragedy Of America's Welfare State(Zero Hedge)
That means there are 1.1 government dependents for every full-time worker in the U.S. Please read the linked stories above if you believe this is sustainable.
In my analysis, there has been a Grand Bargain reached by the 3.5 classes in the U.S. The Three-and-a-Half Class Society (October 22, 2012)
The top 1/2th of 1% owns most of the productive assets of the nation and most of its machinery of governance (this is the "half class"). Most of the income not siphoned off by this "we own the important stuff" class goes to the next 19.5% who pay most of the Federal taxes (class #1).
Class #2 is the dwindling "middle class" (also known as the working poor) which receives no government transfers and lives off earned income. This is perhaps 30% of the households.
Class #3 is the lower 50% who depend on transfers, subsidies, etc. because they are retired, don't make enough at their jobs to support their families or are disabled (legitimately or otherwise).
The Grand Bargain was this: we at the top will pay significant taxes as long as we get to control the levers of financial and political power. We in the top 19% will pay much of the taxes as long as we and our children can continue to live well and accumulate wealth. We in the "middle class" will continue to work hard as long as we have hope of bettering our lifestyle and the lives of our children. We in the bottom 50% and retirees agree not to threaten the top .5%'s power and the wealth of the top 19% as long as we can get by on our government transfers.
This Grand Bargain is now fraying as the promises made to everyone cannot possibly be met. Claims on welfare and disability programs are skyrocketing at the same time that the demographics of an aging populace are causing 10,000 people a day to enter Social Security and Medicare, the two costliest government programs. The triple-whammy is the upper-middle class that pays most of the taxes has been slammed with lower income and a devastating drop in their net worth.
That which is unsustainable will be replaced by another more sustainable arrangement. Everyone who slips off their ideological/self-interest blinders knows the Status Quo is unsustainable, and so everyone in the 3.5 classes is shifting nervously: will I get taxed to the point of "uncle" or will my bennies get slashed?
By heavily taxing earned income, the system extracts the highest taxes from the most productive citizens, leaving the less-productive with essentially no income taxes and the super-wealthy with the huge tax break offered to capital gains and other unearned income.

In essence, this is a vote-buying scheme by the Status Quo: the top .5% control the policies of the State in alliance with the State's own Elites, and together they buy the complicity of the bottom 50% to passively accept their dominance.

In other words, the bottom 50% pay relatively modest taxes or are recipients of Central State aid and the top .5% who "own" the political process limit their taxes by favoring unearned income (what they collect from sales of securities, stock options, rents, etc.). Thus the productive quintile (top wage earners) pay the highest tax rates and most of the taxes.
It's a partnership of "Tyranny of the Majority" and "entrenched incumbents Elites."If the political Status Quo alienates the majority by making them pay more taxes, they risk losing power in the next election. If they alienate the top .5% who fund their multi-million-dollar campaigns, then they will also lose power. So they heap the tax burden on what remains of the upper-middle class.
When that 20% rebels, falters or opts out, the system collapses for want of tax revenues. Not coincidentally, that happens to fit the Pareto Distribution: the 20% "vital few" exert outsized influence on the 80%.
The Grand Bargain is unraveling, and a new arrangement will take the place of the Status Quo--whether we like it or not.

My new book Why Things Are Falling Apart and What We Can Do About It is now available in print and Kindle editions--10% to 20% discounts.

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Ignorance is bliss's picture

Most of the income not siphoned off by this "we own the important stuff" class goes to the next 19.5% who pay most of the Federal taxes (class #1).


I am being ripped off and want something more sustainable. I was not born to be a beast of burden. How am I suppose to retire? I am being taxed at the Federal level, the state level, and the local level. My pay and therefore my efforts are eroding on all sides.

"I will figure out how to escape the system" You can write that on my tomb stone.

pods's picture

You forgot the biggest eroder (is that a word?) of your life, inflation.

The most insidious thief of your life and liberty; it is done right in front of you but yet remains unseen.


q99x2's picture

Awh you can say what you like but I know, "It works if you work it."

lemonobrien's picture

sounds like a prostitute.

A Lunatic's picture

Perhaps I missed it but were Taxpayer subsidised jobs ( teachers, firemen, public servants, etc,) taken into account here?

Winston Churchill's picture

We know exactly whats being planned to replace the current Faustian bargain.

DHS now has 1.5 billion assorted rounds on order.

Dr. Engali's picture

Tthe official story is that those rounds are for target practice. Of course they didn't specify what the targets are.

Shell Game's picture

Let them eat (yellow)cake...

mdtrader's picture

Boehner fixed the fiscal cliff earlier haven't you heard. ;)

Being Free's picture

Cliff Notes version:  Your all fucked.  I'll be ok if you buy my book.

A82EBA's picture

sad to think first time voters in 2016 will have only known the BO admin since they were 10 yrs old.

ebworthen's picture

What a joke.

"Grand Bargain" my ass.

They will agree to tax us out the ass and cut already taxed entitlements.

Take more in capital gains and sequester 401K's and IRA's and bail out the banks and corporations again.

Fucking joke.

Fucking clowns.

Rot in Hell Washington and Wall Street.

BraveSirRobin's picture

""Grand Bargain" my ass."

You have to look at it from the government's point of view. They let you keep some of your income and wealth, and for your acquiescence, they do not kill you. That's a pretty grand bargain, again, in their eyes.

So shut up all you milk cows, and keep up production. The slaughter house is only one truck drive away.



farooq902's picture

Best piece I have read on the fallacy of Government spending, tax receipts and declining household income.

assumptionblindness's picture

This is all laughable.  Within 1 hour we get the following on CNBC:

1.  Are you wearing your fiscal cliff "Rise Above" pin?

2.  Nassim Taleb says that the 'fiscal cliff' is GOOD because it contributes positive volatility to the markets. Watch how often that soundbite is replayed...  

3.  President Obama waves his pen saying "I'll sign the current deal if only a few Republicans join in the cause"...c'mon Repubs!  Step up and save the middle class!

4.  In a scene reminicent of the TARP days, Senator Conrad (if I remember correctly) discussed how business leaders demanded that Congress take action in order to avoid unrest in the markets and another recession.

5.  Finally, the CEO from Aetna conveying the same threat in a post-meeting press conference.  

6.  S&P breaches 1,400!  Yay!

In a world where cause and effect are virtually impossible to coorelate we accept virtually any 'reasonable' explanation as to the nature of things.  We are slaves to cognitive biases and those biases are now being systematically taken advantage of on a large scale. 

I suppose that if a team of magicians with varied skills (sleight of hand, mentalism, hypnosis/power of suggestion,  palm readers, visual illusuionists, escape artists, and mediums) were asked to comment as a group on techniques that they recognize from following a few hours of CNBC then the list would be long.  Most of us function today as nothing more than unwitting audience members to the daily market magic show. Sorry folks!  It today is any indication then we can expect that the magic show will continue with an ever-increasing variety of entertainers and acts.... George Carlin was right...there IS a big club and we ain't in it!

blunderdog's picture

Relatively few people care what's happening with the markets, except as a bit of a diversion.  If you take a look at the breakdown of income levels, it's pretty easy to understand why.

Titus Flavius Caesar Vespasianus Augustus's picture


By heavily taxing earned income, the system extracts the highest taxes from the most productive citizens, leaving the less-productive with essentially no income taxes and the super-wealthy with the huge tax break offered to capital gains and other unearned income."     Yep - and it's a fundamental, terminal problem.  Those disagreeing are exactly the fuckers making it worse with each dose of economic quackery. Can't keep a system running forever where more and more wealth is transferred away from those doing productive work to those who are compensated for gambling, trading debt, or sitting at home watching soap operas. Rome didn't fall in a day.
seek's picture

As an evil member of the 1% and the massive-tax-paying 20%, I'm getting progressively closer to the opt-out option, or at least the opt-for-minimum-workload option.

Over the past 10 years my real tax rate, e.g. fed+state tax paid/income, has averaged 34%. Yesterday I wrapped up my 2013 tax planning, and I'm looking at a real rate of about 42-43%. That's before all the other nickle-and-dime taxes like property taxes, car registration fees, sales taxes, etc. I know for myself, I'm to the point where enough things are paid for and I'm over the "toy" phase that I'm just banking retirement cash and money to pass on in inheritance (which gets taxed again!) At a tax burden of 50%, it's just not worth my fucking time to work harder so someone welfare troll (be it GM, GE, or someone with an EBT) has more to spend.

Talking with my peers, a lot of them are in the same frame of mind. I really don't think they can push the class tax warfare angle much further without massive negative returns, all of which seems to support my notion that things go boom around 2015-2018.

blunderdog's picture

You'll probably be a happier person if you worry about money a lot less.  Given your income, it's not like you have money problems.

BraveSirRobin's picture

One reason a person worries about money is that the productive tend to have quite a lot of obligations. Employees, vendors, etc. Having owned a business at one time, I knew that I had to pay absolutely everyone else before I gave myself a single penny. I put my life savings at risk, and sometimes I did not make money, but dipped into cash reserves to pay everyone else to include employees, the tax man, rent, professional fees, utilities, inventory vendors, etc, etc, etc. And if you fail, a lot of people other than yourself lose their livelyhoods, and maybe there homes, marraiges, and families.

So, there is a great deal of pressure, and when you get a reward, after doing all this, it's really a killer to your moral when the tax man comes and takes half of what you earn. Notice they do not make good half your losses (unless you are a politically connected croney), they only take your earnings, which makes it harder to expand your business, give your employees more money and benefits, or weather the bad times.

So, he could worry a lot less about money, but if he is a high earner, the result will be a lot more people will worry about money, because they will not have any.

Hate the successful if you want, but that's the way world works.

blunderdog's picture

I don't hate the successful at all. 

I kinda hate whiners, that's all, whether they whine because of LACK of money or TOO MUCH money.

Some folks aren't cut out for the "pressure" of having lots of money.  If you're not, the right thing to do is admit it and do something with your life that won't make you miserable.

natew's picture

I am so tired of seeing those income level tables.   They are completely misleading and any statistics professor would give you an F if you handed that in.   That table completely ignores the most important aspect...the individual.

95%+ of the Top 1% were not in there in 1970, which means it is a completely different set of people and they nearly all came from the bottom 90%.  Those who were in the top .1%, nearly all are now in the bottom 90%.   The same case for the top 10%. Nearly all the top 10% top were not in there in 1970.  Unfortunately the successful bottom individuals can't stay in the bottom 90% to represent them, instead they are moved to a new group, leaving a vacuum.  Sort of how a good Houston baseball player goes to play on the Yankees.  Or a successful persons moves out of urban area for bigger house/yard.  They leave a vacuum.  How do you compare a group of people when they are not the same people?  Only a socialist can rationalize that.

Lastly, it's a game of numbers and marginal growth within percentiles.  If 500K people make over $400K in 1970, and now 2 million are over $400k, or say 1.2%, but the percentile is cut at 1%, you have a .2% spillover to the next percentile, increasing the lower percentile.  Also, the top .1% is such a small sample, that billionaires completely distort that metric.  Add the fact that this is household data.  The number of workers in a home varies greatly, education changes, welfare state changes, and individuals change, making this data completely misleading and bias conclusion.  --end rant

blunderdog's picture

What's misleading about pointing out that the vast majority of the country has shitty income?