Fiscal Cliff Diving

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Anyone who has tuned into the news recently has noticed the fiscal cliff. From the way politicians and pundits describe it, the United States is hurtling towards the edge. Like the chicken scene from Rebel Without a Cause, we are locked in, gathering speed, and the end is inevitable and irreversible. If nothing changes before December 31, we are doomed.

Fortunately, we’re not dealing with a real, geographical cliff and the danger is significantly less. The “cliff” was a deadline created by Congress in the 2011 Budget Control Act. If we hit the cliff, automatically some tax cuts will expire and some spending will be slashed.

The numbers don’t look good. A recent report from the White House Council of Economic Advisors projects that the tax increases will reduce consumer spending by around $200 billion and shave 1.4 percentage points off of economic growth. In spite of increasing consumer confidence and job growth, hitting the cliff could plunge the country back into a recession [1].

Still, every cloud has a silver lining. The policies to be enacted in early January would reduce the federal budget deficit by $607 (about 4% of GDP) between the fiscal years of 2012 and 2013. However, the economy would undoubtedly weaken. The tax base would shrink as unemployment rose, and taxable income would decrease. With these effects considered, the Congressional Budget Office projects the deficit would be reduced by $560 in the fiscal years. In terms of calendar years, the deficit would be cut by about 5.1% of GDP [2].

Few people are arguing that these cuts should take place: a sizable decrease in the deficit probably isn’t worth a second recession. However, everything else is left to debate. What counts as a spending cut differs between parties—no one can agree on a baseline [3].

It sounds like certain doom. Luckily, while Congress may be playing political chicken with budget talks, there isn’t a real cliff to drive over.

For instance, hitting the fiscal cliff would result in rapid, but not instantaneous change in tax policy. Supposing no compromise is reached and all the Bush tax cuts expire on January 1, 2013, it is unlikely that families with incomes around the poverty line will face a sudden tax increase. There is a possibility that the deadline will be extended if a compromise isn’t made. While the issues are looming and need to be tackled, Congress will likely take more time to reach an agreement than send the economy into shock [4].

While the U.S. Probably won’t dive off the fiscal cliff, there will be an economic in 2013. Taxes will have to rise, even if they don’t rise for everyone. As U.S. Senator Saxby Chambliss, R-Ga., said in a recent interview, “revenues are 15 percent of GDP—it’s still in the range of the lowest it’s every been.” His claim needs to be taken in context of the New Deal and war time America, but otherwise rings true. Spending will also have to be cut, and there will have to be long term entitlement reform [5].

Hopefully, a bipartisan and multifaceted compromise can be made in the next few months. Either way, a fiscal cliff dive is relatively unlikely.

 

[1] http://www.latimes.com/business/money/la-fi-mo-economy-fiscal-cliff-20121126,0,7839105.story

[2] http://www.cbo.gov/sites/default/files/cbofiles/attachments/FiscalRestraint_0.pdf

[3] http://www.washingtonpost.com/blogs/fact-checker/post/bridging-the-fiscal-cliff-gap-over-spending/2012/11/20/d82ed942-3352-11e2-bfd5-e202b6d7b501_blog.html

[4] http://news.yahoo.com/fiscal-cliff-notes–a-study-aid-for-the-budget-shell-game-26083862-173528170.html

[5] http://www.politifact.com/georgia/statements/2012/nov/12/saxby-chambliss/senator-says-urges-plan-avoid-fiscal-cliff/

Image from http://adrenalineart.com/portfolio/mike-wilson-cliff-jumping-trip-to-bermuda/

 

About author

Alison Shanahan

Alison is an economics and psychology major from Saint Paul, Minnesota. She spent last summer working on a local campaign and interning with an activist nonprofit. Her main political interests are the economic analysis of public policy, particularly when it relates to poverty, education, and the environment.

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