I just want to add on to what Dean Baker says here. It’s not just that the people trying to hype the fiscal cliffas a scary, terrifying prospect shouldn’t be trusted given their track record. It’s that the short-term impact, say one month, of expiring measures really does approach zero.
Here’s Dean’s base case as it relates to taxes:
…consumption is unlikely to respond in any measurable way to a one-month tax hike. There is a big debate among economists as to how much consumption responds to temporary tax cuts, like the Make Work Pay tax cut that was part of the initial stimulus package. Many economists, especially those who seem to be most worried about the “fiscal cliff” right now, argue that consumption responds little or not at all to tax cuts that are scheduled to be in effect for a year or two. One doesn’t have to agree with this strong position to accept the view that a one month increase in taxes will have a minimal impact on people’s consumption patterns.
This is especially likely if the tax increase is likely to be reversed the next month, which would almost certainly be the case, as the column acknowledges in the next sentence. So, this arithmetic exercise gets us essential zero hit from jumping over the fiscal cliff.
Baker also bats away the assumptions of how the market will react to “going over the cliff.”
But there’s more to say here. The thing nobody is taking into account is that the executive branch has tools at their disposal to make the short-term impact of the major expiring tax and spending measures completely negligible.
For instance, OMB Watch has delivered a report showing that the automatic sequester can be mitigated through a series of simple strategies, like front-loading and accelerating appropriated spending, using “carryover” funds from previous years, prioritizing the most urgent activities, and delaying new federal contracts (which are subject to the sequester) and focusing on existing ones (which are not). You can basically delay any macroeconomic impact, including layoffs, for several weeks.
Similarly, Treasury has the authority to freeze withholding rates in place if changes are imminent. You don’t have to do a behavioral economic study; the actual macroeconomic impact can be minimal.
That doesn’t mean non-existent. Clearly, letting the payroll tax cut expire will operate like a 2% wage reduction. And for the long-term unemployed, the end of the year really is a fiscal cliff. I hope that gets dealt with in the lame duck session; it’s the most critical, pressing item right now. And as Dean writes, the economy is weak right now and we shouldn’t be focused on deficit reduction whatsoever, not when borrowing costs are low and the Atlantic Coast is ruined and there are all kinds of construction personnel out of work.
But the bigger fiscal items, the ones that can allegedly send the economy into recession, really will have no impact in the first several weeks. If you believe, as the Democrats do, that they receive more leverage from moving into January 2013 without a deal, there’s no compelling reason not to do it.