You are using an outdated browser.
Please upgrade your browser
and improve your visit to our site.
Skip Navigation

Over the Cliff

The most important congressional debate this year, and maybe for many years after that, will probably take place right after the election. At that point, the lame-duck Congress will take up two huge issues: Automatic spending cuts, set to take place as part of last summer’s debt ceiling deal, and the expiration of the Bush tax cuts.

Pretty much everybody agrees that allowing those two things to happen would undermine the recovery and possibly cause a new recession by sucking so much money out of the economy. Ideally, Congress and the President should work out an alternative: An arrangement that would postpone these two dramatic changes while putting in place policies reducing deficits in the future.

But how much time would the president and Congress have to negotiate such a package? In particular, are they risking calamity if they don’t work out a deal before January 1, when those changes take effect?

Chad Stone, chief economist of the Center on Budget and Policy Priorities, thinks the answer is no. In a new paper, he argues that the effects of the expiring tax cuts on automatic spending cuts would be more gradual than most observers seem to realize:

Policymakers, media, and others widely refer to the tax and spending changes slated to take effect at the start of January as the "fiscal cliff." Those changes will not produce an economic calamity, however, if the measures most damaging to the economy in the short term are in effect for only a few weeks or even a month or so while policymakers work toward an agreement. If current law initially takes effect — causing various income and payroll tax cuts to expire on January 1, emergency unemployment insurance (UI) to expire while joblessness remains very high, and across-the-board spending cuts to kick in on top of the discretionary cuts that the 2011 Budget Control Act caps mandate — the economy will indeed start down a slope that could ultimately lead to a recession in 2013. But that's a far cry from the economy falling off a cliff and plunging immediately into recession.
In fact, the slope would likely be relatively modest at first (and then much steeper if 2013 unfolds without a fiscal resolution). This means that if there is no agreement by January 1, policymakers will still have some (although limited) time to take steps to avoid the serious adverse economic consequences that the Congressional Budget Office (CBO) outlines in its recent analysis of what will happen if the expiring tax cuts and new spending cuts take effect on a permanent basis. That is, they will have some time to work out the needed compromises and craft a budget and economic package that can support the recovery over the next few years while putting in place a balanced package of spending and revenue measures that will stabilize deficits and debt (relative to the size of the economy) over the coming decade.

The strategic implication here is pretty obvious. The automatic cuts threaten defense spending more than non-defense spending. And, over the long run, the expiring tax cuts will cause much more pain to high-income Americans than they will to middle-income Americans. Overall, Republicans fear these consequences of inaction more than Democrats.

That should, in theory, give Obama and his allies more leverage to demand a balanced deal—that is, a fiscal package that pairs short-term stimulus with long-term deficit reduction, through a combination of spending cuts and tax increases. (Ideally, lawmakers would let all the Bush tax cuts expire, then restore a temporary extension of those for only the middle class. That's a story for another time.)

Of course, the Republicans will also have some leverage: The government is likely to hit the debt ceiling again in February. As Ezra Klein notes, Republicans are likely to hold out for severe spending cuts, just as they did last summer.

But if the Center on Budget paper is correct, Obama and the Democrats can hold out on the automatic spending cuts and the Bush tax cuts past January 1, at least for a little while. Maybe that will make the difference between a good deal and a lousy one.

follow me on twitter @CitizenCohn