Tag Archives: budget

The “Fiscal Cliff” is Really a Slope

I wrote earlier about how the “Fiscal Cliff” is a bad name for it. It’s really a slope, albeit one with increasing steepness. Unless fear turns it into a chasm.

This is from the Associated Press:

“If New Year’s Day arrives without a deal, the nation shouldn’t plunge onto the shoals of recession immediately. There still might be time to engineer a soft landing.

So long as lawmakers and the president appear to be working toward agreement, the tax hikes and spending cuts could mostly be held at bay for a few weeks. Then they could be retroactively repealed once a deal was reached.

The big wild card is the stock market and the nation’s financial confidence: Would traders start to panic if Washington appeared unable to reach accord? Would worried consumers and businesses sharply reduce their spending? In what could be a preview, stock prices around the world dropped Friday after House Republican leaders’ plan for addressing the fiscal cliff collapsed.”

 

 

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The Mis-Named Cliff

“Fiscal Cliff” is a bad name. It’s one of those terms that the media love, because it sounds dramatic and terrifying. People stay tuned when they hear terms like “Fiscal Cliff”.

That’s not to say that the Fiscal Cliff isn’t serious or important. It is. But it’s not a cliff.

A “cliff” is something sharp and jagged and high, something that, should one fall off it, one plummets hundreds of  feet to one’s inevitable death. (“Fiscal” just means having to do with finances. I’m okay with that part.)

When pundits and politicians speak of “going over the Fiscal Cliff”, they mean essentially passing the milestone of midnight on December 31, 2012, the implication being that as of 12:01 on January 1, 2013, the U.S. economy will immediately be in free fall, plunging precipitously toward our collective death.

The reality is less dramatic and less headline-grabbing. If Congress and the President fail to resolve the current political impasse, on January 1, 2013, there will be substantial spending cuts to many federal programs, and tax rates will increase significantly for most Americans.

How much of an immediate impact this would have depends mostly on how long it lasts, and on how consumers and firms react to it. If the impasse lasts just a day or three, or even a week, into 2013, the direct impact would be relatively small. Even a spending cut of 10 percent and a tax increase of 20 percent would only represent a small sliver of GDP, if it only lasted for one-fiftieth of the year.

What’s more substantial are the indirect, psychological effects, particularly from news anchors throwing around ominous-sound words like “cliff”. Firms already are balking at future investment spending, and consumers who are already edgy about their future prospects are going to be very leery about spending money over the holidays if the impasse remains unresolved. Uncertainty is rarely a good thing for an economy.

One thing we don’t need is fear-mongering and over-dramatization. The current political standoff about federal spending and taxation is many things, but a “cliff” is not one of them.

Let’s call it for what it is: A Fiscal Impasse. No one’s falling off of anything on January 1.

Fiscal Cliff Talks Underway; Both Sides Upbeat

Negotiations on the Fiscal Cliff have started, and both sides are sounding positive. According to the Washington Post:

The four Republican and Democratic leaders of the House and Senate were unanimous after the initial round of talks in saying they were confident that they and the White House could agree on measures to raise federal revenue and cut spending before a Jan. 1 deadline, when draconian provisions originally designed to force a compromise are scheduled to take effect.

The stock market was cheered by the positive tone of the news, with the S&P 500 index closing up by half a percentage point today, after having trended downward since the election on November 6.

Fiscal Cliffnotes: The Crisis in a Nutshell

With the election over, politicians in Washington are scrambling to avoid the “fiscal cliff”.

So what is this ominous-sounding escarpment?

Because the Republicans and Democrats were unable to agree on reducing the deficit, they passed the Budget Control Act in August 2011. This provided for automatic spending cuts if budget negotiations by a “super-committee”  failed. The negotiations did fail, so now Congress and the President have to find a new solution or else those increases and decreases will kick in beginning in January.

At the same time, “temporary” tax cuts passed by earlier Congresses are due to expire at the end of 2012 as well.

The fiscal cliff will effectively cut federal government spending by about $70 billion in 2013 and by $150 billion in 2014, increasing to nearly $500 billion in 2022. At the same time, taxes will increase by more than $300 billion in 2013 and by more than $380 in 2014, increasing to nearly $700 billion more in 2022. Together, these will decrease the deficit by more than $1 trillion in 2022.

So why is decreasing the deficit such a bad thing?

It’s not a matter of just decreasing the deficit. It’s how the fiscal cliff would do it: suddenly and indiscriminately.

According to the nonpartisan Congressional Budget Office, the fiscal cliff will drive the U.S. economy into another recession next year, and increase the unemployment rate from its current 7.9 percent to 9.1 percent by the end of 2013. Also, GDP will drop by 0.5 percent in 2013.

As Forbes points out,

The cuts hit all areas of the federal budget, including a $55 billion reduction to the Pentagon’s budget in 2013, a reduction of payments to physicians participating in Medicare, substantial cuts to FEMA and the Dept. of Education budget along with a host of serious reductions across the wide ranging operations of the federal government.

And let’s not even talk about the horror of those huge tax increases hitting in the midst of this fragile recovery.

Congress passed this plan never intending it to actually go into effect. It was supposed to be so horrible that both Democrats and Republicans would do anything in order to avoid it, forcing everyone to compromise. As of yet, that hasn’t worked, and time’s running out.

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The bets are that the fiscal cliff still will be avoided one way or another. The most likely outcome is a cop-out compromise that kicks the problem further down the road. Perhaps some spending cuts and a few revenue increases that make no one happy but attempt to show goodwill on each side’s part.

Both Democrats and Republicans are posturing heavily, putting on their game faces in hopes of cowing the other side into compromise. President Obama has announced that he won’t accept any agreement that doesn’t include tax increases on the wealthiest Americans. Meanwhile, as of late 2011, 238 of the 242 Republicans in the House of Representatives and 41 out of the 47 Republicans in the Senate had signed agreements to “oppose any and all efforts to increase the marginal income tax rate for individuals and business”.

Some see President Obama as having an upper hand, given his recent election victory and the pickup of 2 seats in the Senate. However, this is hardly a solid mandate by any historical standards. Yet Republicans have a lot to lose if defense and other funding is cut dramatically. It’s also been suggested that President Obama has little choice but to play hardball in negotiations, or else he’ll be paying for any signs of weakness through the next four years.

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A big part of the equation, as with all budget impasses, is which side would be able to paint the other as the real obstructionists. The bottom line is that no one really wants this impending fiscal cliff, and everyone has an incentive to want to avert it. But depending on the political and interpersonal dynamics, it’s still possible.

No one’s questioning the need to reduce the deficit eventually. No government can continue to borrow an increasing amount at an increasing rate indefinitely. The real issue is how best to do it. As with everything in economics, there are trade-offs, and people with different values have different view about which trade-offs are worth it.

At the end of the day, all we can do is hope that our politicians can rise above politics to find a solution – and contact them regularly to tell them we want them to do so.