Fiscal Cliff

The "fiscal cliff" is not a cliff

They put the band back together. The Gang of Six – now a Gang of Eight, with Lamar Alexander and Michael Bennet added to the roster of Crapo, Coburn, Chambliss, Warner, Durbin and Conrad, met in Virginia yesterday, aiming to create a grand bargain of tax increases, spending cuts and vaguely worded “entitlement reforms” (you can call it cuts, it’s OK) that would reduce the deficit by $4 trillion over the next ten years.

The impetus this time is the set of expiring measures known in Washington as the fiscal cliff, which if allowed to expire entirely could throw the economy back into recession.

But the word “cliff” does a lot of work here. If there is a drop-dead date, a point of no return where the unwinding of the damage would be too great, then the sense of urgency generated by the Gang of Eight would make more sense. But it actually doesn’t work that way. The economy won’t fall off a cliff, but amble down a slope, in a way that allows for much more deliberative conversation about the best practices for the economy today, not just in the future.

“The slope would likely be relatively modest at first,” Chad Stone, the chief economist at the Center on Budget and Policy Priorities, a research group based in Washington, wrote in a recent analysis. “A relatively brief implementation of the tax and spending changes required by current law should cause little short-term damage to the economy as a whole.”

The annual effect of the automatic tax increases and spending cuts would be enormous. The Congressional Budget Office has estimated that the budget deficit would shrink by more than half a trillion dollars from fiscal years 2012 to 2013 and that the economy would very likely enter another recession [...]

But both Democrats and Republicans have said that going over the fiscal cliff might put them in a better negotiating position. And confidence in policy makers’ ability to get a deal done is low.

In the event that New Year’s Day came and went without a legislative fix, confidence, investment, markets and household spending would be hurt, analysts said. Still, there would be time for Congress to strike a deal before the economy started contracting. The economic effect would accumulate day by day, and much of it might be reversible.

This recognition of reality really cuts the Gang of Eight off at the knees. There is no point of no return for the economy. In fact, while I don’t totally understand the Republican position for letting everything expire, the Democratic position, at least as it relates to the Bush-era tax cuts, makes perfect sense. Republicans will refuse to increase taxes under any circumstances. But if Democrats allow them to rise automatically, they can come back with a series of tax cuts and still raise overall revenue, making the tax system marginally more progressive. And indeed, you would have over a year to restore any tax rates without any disruption. The withholding would be higher in the short term, but that would bounce back with a larger refund the following April. Patching the alternative minimum tax for 2012 is an example of how this would work; right now that has not been patched for the entire year, but as long as it gets done by January, nobody will see any effect.

With Chuck Schumer blowing the whistle on the trap of Bowles-Simpson-type tax reform that lowers the rates and broadens the base, this gives the Gang of Eight even less to talk about.

This is an important concept to internalize. It’s a slope; there’s no big need to fear it, at least if it forces policymakers into an undesirable deal.

Photo by Santheo under Creative Commons license