One thing is certain in these waning hours of the presidential and congressional election campaigns: it is Barack Obama and the current members of Congress who will have to make the initial decision on what to do about what we have come to call the fiscal cliff.
The new Congress and the next president will not be sworn in until January 21, by which time the Bush tax cuts will have expired, and spending programmes been pared. Only Obama and the lame duck Congress can prevent what many believe will be an inevitable recession.
If the Bush cuts expire, taxes on families earning less than $250,000 a year will go up by a total of $173bn, and on those earning more than that by a total of $75bn. In addition, funds for several government programmes will be cut—“sequestered” in political jargon—by $87bn. Those tax rises and spending cuts would take about 2.1% out of GDP.
That’s not all that is scheduled to hit the economy at the year end. Expiry of the temporary cut in the payroll tax ($127bn), Obamacare taxes ($24bn), and other scheduled tax increases ($184bn) will bring the grand total of tax increases and spending cuts to $668bn (rounded). That comes to 4.3% of GDP in additional taxes and reduced spending, a hit about the size of that imposed on Greece by Germany and its eurozone allies, and equal in one year to the cuts Britain plans to absorb over three years, according to Larry Lindsey, former Federal Reserve Board governor and one-time White House chief economist.
The Congressional Budget Office (CBO) estimates that cutting $668bn from the economy will cause it to shrink at an annual rate of 1.3% in the first half of 2013, before recovering in the second half to produce a full-year growth figure of 0.5%, best described as indiscernible.
Until recently, everyone seemed to agree that this scenario is unacceptable, so unacceptable that a plunge over the cliff is a mere scare tactic aimed at forcing the politicians to craft a deal. At the very least, the president-elect and the lame duck Congress would agree to kick the can down the road, to use the phrase made famous by eurozone bureaucrats who specialise in that sport. Then, after the new Congress and a president are sworn in, serious negotiations would produce a compromise that avoids the cliff. That consensus has changed.
The cliff is no longer seen as threatening. Indeed, it just might be the medicine the country needs to cure its economic ills, the new reasoning goes. We face large deficits. If we go over the cliff, the deficit will decline by 5.1% of GDP according to the CBO, a huge reduction of more than half. That would produce a short, mild recession. GDP declining at an annual rate of 1.3% in the first half of the year and then growing in the second to produce full-year growth of 0.5% would, the argument continues, be a small price to pay for cutting the deficit and setting the stage for sustained recovery.
Burton Abrams, professor of economics at the University of Delaware, summed up the case for driving over the cliff in an op ed in The Washington Times: “It just might be that . . . the fiscal cliff will better serve the long-run interests of the United States than a short-term congressional compromise that fails to get to the core of the problem. It’s not a perfect solution, and it doesn’t solve the long-term budget problem, but it’s a start.”
If only life were so simple. The CBO’s forecasting record is, er, spotty, and if we have learnt anything from watching the eurozone it is that rapid and substantial tax increases and spending cuts do not raise the growth rate, at least not soon, and that their negative effects are always greater and more enduring than anyone expected.
Moreover, a recession once started cannot be counted on to morph into renewed growth as quickly as the CBO is forecasting, especially when monetary policy is already so accommodative that it can’t be eased further to offset a fiscal contraction, Europe is heading into recession, and the Chinese economy is no longer the growth engine it once was.
Worse still, despite an emerging recovery in the housing sector, and a spurt of car purchases by Americans who want to replace vehicles in a fleet with an average age of 11 years, the American economy is in no condition to withstand the battering a fall off the cliff would produce.
Even though the job market seems to be improving, the unemployment rate is stuck at 7.9%, about where it was when Obama was sworn in. The private sector did add 184,000 jobs in October, earlier reports were revised upward by 84,000, and the labour force participation rate ticked up as some unemployed workers re-entered the improving labour market. Better news than in the recent past.
But 23m Americans are looking for full-time work or are too discouraged to do so. Until businesses start investing, which they won’t do until uncertainty about the fiscal cliff is removed, the economy will remain unable to add the 300,000 jobs every month that are needed to get the unemployment rate down to the 5%-6% range.
A bipartisan group of eight key senators is hoping to remove that uncertainty. With support from 80 chief executives banded together as “Fix The Debt,” they are searching for the votes needed for a compromise. They reason that a re-elected Obama would not want to start his second term with a recession, or that a newly elected Romney would be able to persuade enough Democratic senators who face re-election in 2014 to support a compromise.
Perhaps, but only perhaps. This has been a bitter election campaign, with the president himself playing the role of mud-slinger-in-chief.
Democrats believe, really believe, that fairness demands soaking the rich. Republicans believe, really believe, that raising taxes on successful entrepreneurs will doom America to slow, europaced growth.
These partisans just might lock arms for a bracing plunge off the fiscal cliff.