How I Learned to Stop Worrying and Love the Fiscal Cliff

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Taking a header off the "fiscal cliff" might be the best thing that could happen to the United States.

It sounds crazy, given all the dire predictions economists are making about the "Taxmageddon" that will arrive on Jan. 1, 2013.

While true, no one is talking about what would happen to the economy after the fiscal cliff crisis of 2013.

If Congress fails to act and allows all the bad things to happen – the expiration of the Bush-era tax cuts and the payroll tax cut, as well as the enforced spending cuts (sequestration) agreed to in the budget deal last year – the federal budget deficit would start shrinking dramatically.

And the fiscal discipline, while brutal in the short run, would jump-start the economy by early 2014.

It's all in a recent Congressional Budget Office (CBO) report, "Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013."

The CBO ran projections based on two scenarios.

One looks at what would happen if Congress does nothing and lets the country go over the fiscal cliff. The other scenario looks at what would happen if Congress dodges the fiscal cliff by extending most, if not all, of the current policies.

Choosing to take a leap off of the fiscal cliff–as has been widely reported– would slam an already faltering U.S. economy. The CBO report says GDP would shrink by 1.3% in the first half of 2013, pushing the country back into a recession.

On the other hand, extending current policies would push GDP up 5.3% in the first half of 2013.

That may sound great, but a funny thing happens after those first six months.

In the CBO's fiscal cliff scenario, GDP turns the corner in the second half of 2013, rising 2.3%. Then, in 2014, GDP jumps up 5%, followed by an astounding 6.4% increase in 2015.

The initial growth spurred by extending current policies, however, starts to peter out after six months. By the second half of 2013, the CBO says GDP would slow to 3.4%. From there, slower growth would continue through 2016.

"Postponing the fiscal cliff would simply move economic activity from 2014-2016 into 2013," say Jason M. Thomas and David M. Marchick in a May 31 report for the Carlyle Group. "The result would be faster growth in 2013, slower growth between 2014 and 2016, and no change in cumulative growth rates over the next four years."

The Cost of Ducking the Fiscal Cliff

fiscal cliff
Given that avoiding the fiscal cliff only borrows a little growth from future years, at first blush it looks like a winner. But its impact on the national debt would cripple future economic growth.

The CBO looked at that, too.

Extending the policies of tax cuts and high government spending would drastically accelerate the national debt. The CBO says federal debt held by the public, about 73% of GDP as of this year, would rise to 93% by 2022 and about 200% by 2037.

But if America plunges off the fiscal cliff, the debt held by the public declines to 61% in 2022 and just 53% in 2037.

Those who believe debt doesn't matter much may dismiss this fact, but the CBO also projected how the ballooning debt would increasingly stunt economic growth in the decades ahead.

"Large budget deficits would reduce national savings, thereby curtailing investment in productive capital and diminishing future output and income," the CBO report says.

Policies that avoid the fiscal cliff would reduce GDP 1.8 percentage points by2027 and 6.7 percentage points by 2037.

The CBO's numbers for the gross national product (GNP) look even worse. GNP differs from GDP in that it includes the flow of profits and interest both to and from foreign countries.

According to the CBO, the rising debt will cause more foreign capital to enter the United States, which will eventually lead to higher payments of profits and interest to foreigners.

Extending current policies would take 4.4 percentage points out of the GNP by 2027 and a startling 13.5 percentage points by 2037.

The CBO warns: "Debt cannot continually increase as a share of the economy: Policy changes would be required at some point. The longer the necessary adjustments in policies were delayed, and the more that debt increased, the greater would be the negative consequences."

Congress Must Face the Fiscal Cliff

Which path the country takes is mostly in the hands of Congress.

The CBO recommends that lawmakers take a middle road that softens the blow to the economy in 2013 while still addressing the long-term debt issues that would undermine the economy.

But that will require bipartisan cooperation, a commodity in short supply on Capitol Hill.

"I will again insist on my simple principle of cuts and reforms greater than the debt limit increase," Speaker John Boehner, R-OH, said last month at a fiscal summit sponsored by the Peter G. Peterson Foundation. "This is the only avenue I see right now to force the elected leadership of this country to solve our structural fiscal imbalance."

That statement elicited this response:

"I would far prefer to see these issues resolved sooner rather than later, but it's hard to be hopeful about that in light of comments by Speaker Boehner," Rep. Chris Van Hollen, D-MD, ranking member of the House Budget Committee, told Politico. "Instead of talking about coming together and finding common ground, he is laying down reckless economic ultimatums."

It sounds like another round of gridlock, but this time the stakes are much higher. Last year's debt ceiling battle cost the United States its AAA credit rating.

Whatever Congress does — or doesn't do — about the fiscal cliff before Dec. 31 will have much more far-reaching consequences.

"We don't know how to price the risk of the fiscal cliff, particularly after last year," Jerry Webman, chief economist at Oppenheimer Funds, told Politico. "And if last year they [Congress] were playing with matches, now they're playing with flamethrowers."

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Join the conversation. Click here to jump to comments…

  1. CP | June 8, 2012

    Why not keep tax cuts and cutting gov spending at the same time? None of this will happen because if it could, it would have been happening all along. It's just more jabber in an election year.

  2. fallingman | June 8, 2012

    CBO projections, like every other government generated numbers, are almost entirely worthless, therefore this entire discussion is worthless. Even if you acknowledged that the CBO approaches their analysis with few biases or wacky assumptions, which I don't, you still can't have any real confidence in static projections that are linear in nature. You have the effects of millions of feedback loops they can't possibly hope to account for, even if they wanted to. And simply put, stuff happens that will change the calculus before the time period in question even arrives.

    Lastly, when have government projections of this sort EVER been correct? Ever? The CBO actually projected that Opuppet's Disease Care Cost Shifting and Insurance Company Relief Act would actually save money for the Feds. The projections the government made for the costs of Medicare back in '65 were so far off base, it's laughable. It's actually cost greater than 100 times more than they said it would by this date.

    So this latest scheme will save us money, huh? Right, and New Orleans is cool and breezy in August.

  3. NumbersDontLie | June 8, 2012

    I will tell you what is coming…higher taxes AND reduced spending. This is the only way to make meaningful progress. I don't understand why no one in the political arena says the obvious. Boehner sort of did, but tell us what each needs to be. We will make a plan to get there.

    It will happen one way or the other. The only question is will we choose our own path or will someone else dictate it to us? Time will (literally) tell.

  4. DaveR | June 8, 2012

    The scenarios painted by the author and CBO are both hypothetical, albeit being based on sound economic analysis and projections. Missing from both is the fact that Congress and Presidential Administrations are highly unlikely to leave any long term economic / budget / taxation plan in place when current politics dictate personal and party advantages to espousing other spending programs to buy re-elections. Obama understands those principles very well and that is why he supports spending now [stimulus] and cuts [in the rate of increase of spending and debit and debt accumulation] for the future, much of which plan if followed would occur AFTER completion of his second term as president.

  5. Richard Mondale | June 10, 2012

    I choose Plan C, throw out the tax system and do something better.
    I call it The Banker's Tax. For details see me web site, RichardMondale.org

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