Kevin Glass

One of the items at the top of the CBO's analysis is the scheduled cut in defense spending. The Budget Control Act specified that defense spending will be cut by $75 billion over the next two years. While this is a relatively small amount of money compared with the size of the cuts that will be made elsewhere, the CBO writes that the defense cuts will have the largest per- dollar impact on the economy - from between $0.50-2.00 per dollar spent and would cost between 200k-700k jobs. Simply put, averting the planned defense cuts would be the most valuable thing that Congress could do.

Tax cuts are also on the docket. With the Bush tax cuts set to expire and a fight set up on upper-income cuts, the CBO modeled both extending all the cuts and excluding upper-income cuts. Their findings include that tax cuts are less of a boon to the economy on a per-dollar basis than some of the other provisions of the fiscal cliff, but the sheer size of the tax cuts involved create an outsize effect on the economy.

The tax cuts would total $750 billion over the next two years and the CBO's median estimate is that they'd increase GDP by 1.4 percent and create 1.8 million jobs. The high-income cuts that President Obama is fighting against, meanwhile, compose $80 billion of the two-year cost and the CBO estimates they'd have between a negligible effect on employment or create up to 300,000 new jobs. As they write, the high-income cuts are slightly less effective than the package as a whole, but the difference is small:

The difference in the estimated effects of the two sets of policies are small (and therefore are generally not visible in the rounded numbers...) in part because the tax savings on income above the specified thresholds are a small share of the total tax savings under the broader option and in part because high-income taxpayers are presumed to save only a modestly larger portion of reductions in their taxes.

Now, the CBO's estimate of a strong response to upper-income tax changes - 300,000 jobs - is nothing to sneeze at. In the larger scheme, however, the CBO finds that the effects of increased marginal tax rates on upper-income earners are small. This may presage a protracted fight in Congress between Republicans who take a hard line in support of the tax cut and Democrats who have been pushing for increased taxes on high-income-earners going back to John Kerry's presidential campaign.

Another major component of the fiscal cliff is the lapse in a temporary payroll tax cut. Originally passed as part of President Obama's stimulus, the measure was given a one-year extension last year. Extending this payroll tax cut for two years would cause the federal government to forgo $205 billion over the next two years. The CBO finds that this would result in an employment boost of between 300,000-1.3 million jobs - and would be a more valuable boost to the economy per-dollar than the other tax cuts, but not quite as effective as the increased defense spending.

It's important to keep in mind that the CBO's analysis represents a standard Keynesian framework of looking at the issues involved with the fiscal cliff. Their analysis overstates the effects of both the spending and tax provisions relative to a non-Keynesian framework. It does, however, represent a very credible and important part of the analysis involved here that needs to be taken into account. The bottom line: the expiring Bush tax cuts comprise by far the lion's share of the economic effects of policies scheduled to pass at the end of the year, and if the fiscal cliff is averted without offsets - via either revenue raises or spending cuts - or down the road, we'll see an increasingly dire fiscal situation that will have far larger economic effects than a recession.


Kevin Glass

Kevin Glass is Director of Policy and Outreach at the Franklin Center for Government and Public Integrity


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