One More Time: The Stakes of the Fiscal Cliff

Posted: Dec 26, 2012 1:44 PM
President Obama is on his way back to Washington, as the Associated Press reports that he's "cutting short his traditional Christmas holiday in Hawaii, planning to leave for Washington on Wednesday evening... expected to arrive in Washington early Thursday." Most Americans probably won't sympathize that the President has a short vacation - after all, at work, he didn't get that big project finished in time for the holidays.

The elements of the fiscal cliff can be roughly divided into four categories: defense spending cuts, non-defense spending cuts, income tax hikes, and payroll tax hikes. Of these, what has gotten the most attention are the income tax hikes, and rightly so: they are by far the largest part of the cliff. In the next two years, expiring tax provisions, including a patch for the Alternative Minimum Tax, will be worth $750 billion to taxpayers.

Included in this large tax portion are hikes on capital gains and dividends taxes. These may be the most dangerous parts of the tax hikes, but all of them have the potential to seriously harm the economy. The tax hikes that Democrats are gung-ho about, for example, on the top income-earners alone, may cost 300,000 jobs over the next two years.

One of the smallest but most valuable parts of the fiscal cliff are the cuts to defense spending. Over the next two years, the defense spending sequester would cut defense spending by $75 billion and cost 700,000 jobs on their own.

The payroll tax cut, a tax cut mostly supported by Democrats that has effects mostly on lower income-earners, doesn't appear as if it's got much support for renewal. Earlier this year, Treasury Secretary Tim Geithner said he saw no good reason to support its extension. Since Republicans haven't exactly shown enormous enthusiasm for the payroll tax cut, it's likely not to get much traction.

Make no mistake: every piece of the fiscal cliff has the possibility to affect the economy and unemployment over the next two years. According to the Congressional Budget Office, even increased spending on unemployment insurance is still likely to generate more economic growth.

This all comes with the caveat that a full fiscal cliff fix will help the economy in the short-term, averting a recession, but cause long-term harm to economic growth. The CBO has also estimated that GDP will be on a permanently lower trendline by 2020 if the fiscal cliff is averted without future offsets.

What deficit hawks have been hoping for is a "grand bargain" that makes long-term tax and entitlement reforms. It's looking increasingly unlikely, however, as President Obama has been dead set on his way or the highway, refusing to take any proposal from John Boehner seriously or encouraging Harry Reid to work with Republicans' proposals.

Going over the cliff by even a few days will cause tangible harm to the economy. Progressives have advocated such an approach because it will be good for Democratic priorities. Unfortunately for Republicans, kicking the can own the road is increasingly looking to be the most likely outcome - to the detriment of long-term economic growth.

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