Countdown to Armageddon: 28 days to the fiscal cliff

We're about to go over the fiscal cliff. As long as we can't get off the ride, let's look at the scenery and ask how we got here.

WASHINGTON, D.C., December 3, 2012 — Unless Congress acts to prevent it, the country will go over the “fiscal cliff” in 28 days. What can Congress do? And what is the fiscal cliff?

The Budget Control Act of 2011 was a temporary fix to the 2011 debt-ceiling crisis. Had the debt ceiling not been raised, the United States government would have “maxed out” its credit cards; unable to borrow further to pay for ships, salaries, Social Security, or anything else. It would have been forced to cut spending immediately and drastically, to cut entitlement payments, or even to default on debt. 

The Budget Control Act immediately raised the debt ceiling by $400 billion, with the President able to raise it by $500 billion more, subject to a congressional motion of disapproval which the President could veto. It requires that government spending be cut by $917 billion over ten years (which means of course that growth of government spending over those years would be cut by that amount; actual spending would continue to grow), and it requires other measures to cut the federal deficit. 

The Act contained a provision designed to ensure that Congress would meet the obligatory deficit reduction targets: If Congress failed to act by December 31, 2012, the government would be forced to sharply cut spending in over 1,000 government programs, including Medicare and defense (“sequestration”); eliminate the payroll tax cuts enacted last year (a 2 percent tax-hike for most workers); end the 2001-2003 tax cuts (the “Bush tax cuts”); change the alternative minimum tax so that it would hit more Americans; eliminate some business tax breaks; and immediately impose taxes contained in the Affordable Care Act (Obamacare). 

That, in a nutshell, is the fiscal cliff. Federal Reserve Chairman Ben Bernanke coined the term in testimony to Congress. The combination of large tax hikes and spending cuts is predicted by many macroeconomic models to provoke a severe recession, reducing GDP by up to 5 percent and increasing unemployment rolls by 2 million (to an official rate of over 9 percent).

Congress has limited options in dealing with the fiscal cliff.

1. Congress can let the Budget Control Act provisions play out - it can let the country go over the cliff. That sounds bad, but it would have the benefit of cutting the deficit immediately in half as a percentage of GDP. Not all economists agree that going over the cliff would cut GDP by the predicted 5 percent. The deficit reduction would undoubtedly promote new businesses and increase confidence that the U.S. will not follow the path of Greece.

2. Congress can vote the fiscal cliff out of existence. That is, it can pass legislation extending the tax cuts and eliminating the obligatory spending cuts, effectively repealing the Budget Control Act of 2011. (In Washington, “obligatory” means only that Congress is obliged to do what it doesn’t decide not to do.) That would avoid the immediate negative impact of tax hikes and spending cuts, but the debt would continue to grow at rates that would make America the punchline of a very bad economic joke.

3. Congress can reach a compromise. By some mixture of tax hikes and spending cuts, they can cut the growth of the deficit - though not by as much as going over the cliff would. The spending cuts won’t be as deep, nor the tax hikes as high.

What most Americans are hoping for is option three. Congress is likely to give it to them. The most likely outcome is for Congress to pass a stop-gap measure, then return to the issue after a new Congress is sworn in (the fiscal cliff has to be dealt with by a lame-duck Congress). Congress has demonstrated a strong preference for deferring difficult decisions, and a compromise must include some very difficult decisions indeed.

In order to cut a deficit, spending must fall, tax revenues must rise, or both. Congressional Democrats and President Obama strongly favor raising taxes on the “wealthy.” If we define “the wealthy” as households earning more than $250,000 per year (not wealthy at all in cities like New York and San Francisco), then a 100 percent tax would raise an estimated $1.4 trillion per year. That’s less than half the federal budget (almost $4 trillion). More realistically, taxing those households at an effective rate of 40 percent (not realistic at all, really) would cover only a third of the federal deficit. The tax hikes being proposed by Democrats will result, as Charles Krauthammer has put it, in reducing the deficit by a rounding error.

Cutting the deficit in any serious way therefor means cutting spending. Where? The military budget consumes the largest share of discretionary spending, but eliminating it entirely would eliminate only a third of the deficit. Entitlements are where the real money is; cutting spending enough to reduce the debt means going after Medicare and Social Security.

Democrats have announced that they’re willing to discuss cuts in Medicare after a stop-gap solution (which will include tax hikes) to the fiscal cliff is passed. Republicans are understandably concerned that if they give in on taxes, there will be no reason for the Democrats later to cut entitlements. And the Democrats have taken Social Security off the table. 

The most recent Democratic proposal involved giving Obama the authority to raise the debt ceiling on his own, when he pleases. GOP leadership laughed at it. In return, they propose that tax collections go up by closing loopholes, but not by raising marginal tax rates. These are opening positions that, for better or worse, will change. Communities writers await and will discuss those changes with considerable interest.


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Jim Picht

James Picht is the Senior Editor for Communities Politics and teaches economics and Russian at the Louisiana Scholars' College in Natchitoches, La. After earning his doctorate in economics, he spent several years working in Moscow and the new independent states of the former Soviet Union for the U.S. government, the Asian Development Bank, and as a private contractor. He returned to Ukraine recently to teach principles of constitutional law and criminal procedure at several Ukrainian law schools for a USAID legal development project. He has been writing at the Communities since 2009.

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