Will Going Over the Fiscal Cliff Make a Budget Deal Possible?

By :: October 2nd, 2012

This afternoon, I moderated an Urban Institute panel on taxes and the fiscal cliff. The fundamental question on the table:  Will Congress have to tumble over the precipice in order to build the political consensus it needs to do a budget deal?

To put it another way, will it take the fear of a financial market collapse and a cliff-driven recession to change the karma on Capitol Hill? Or, can Congress find an easier route to fiscal sanity by ducking the coming showdown?

There are huge dangers to both options, and no clear answer. But in the current political climate, it is hard to see a road to a long-term budget agreement, whether or not Congress falls over the edge.

Lawmakers will reach taxmaggedon in just three months. The tax cuts enacted in 2001, 2003, 2009, and 2010 will expire absent congressional action. The Tax Policy Center estimates this would raise taxes by $500 billion in 2013 alone—an average tax hike of nearly $3,500 per household. At the same time, the automatic spending cuts adopted as part of the 2011 debt limit deal would kick in.

At today’s panel, Bob Greenstein, president of the Center on Budget and Policy Priorities, argued that tumbling off the cliff might sufficiently focus lawmakers’ minds to drive a fiscal agreement. While Bob was certainly not rooting for an end-of-the-year crisis, he felt that one, or at least its imminent threat, could encourage a two-part deal. Either in December (right at the edge of the precipice) or in early January, lawmakers would agree to forestall deep year-long tax hikes and spending increases in exchange for an agreed-upon target for long-term deficit reduction, including revenue-raising tax reform and cuts in entitlement programs.

In Bob’s view, the cliff is something more like a gradual—and reversible—slide. Thus,  a relatively quick deal in 2013 would limit the economic consequences of any short-term spending cuts or tax hikes.

Doug Holtz-Eakin, president of the American Action Forum and former top domestic policy adviser to the McCain for President campaign, disagreed. Doug insisted toppling over the cliff would throw the economy into recession. And, he added, Congress would never raise taxes or cut spending while the economy is dead in the water.  Thus, going over the cliff would be entirely counterproductive.

Doug’s alternative: Congress should extend today’s tax rules for all (including high-income households) and abandon the automatic spending cuts. Deficit reduction could still happen, he figures, once Washington feels pressure from Wall Street and the rating agencies to do a long-term fiscal deal.

To me, this creates a strange paradox. Doug is right that Congress would never agree to fiscal austerity in the midst of another recession. And Bob is right that Congress needs to understand there are consequences to its continued inaction on the deficit. So, somehow, we need to thread the needle: Make the markets think lawmakers will topple over the cliff without it actually happening.

On the other hand,  the newly elected (or re-elected) president and Congress could show some actual leadership and work for a fiscal agreement everyone knows is necessary—without waiting for the next  crisis. They could. But there is little evidence they will.

5Comments

  1. Jack B  ::  6:26 am on October 3rd, 2012:

    After watching the panel discussion on line,I think Mr. Greenstein’s view is more plausible. In this political climate, congress won’t start acting responsibly until force is applied.
    I also think that his fiscal slope is a more apropos metaphor.

  2. Tax Roundup, 10/3/2012: abbreviated edition « Roth & Company, P.C  ::  8:17 am on October 3rd, 2012:

    […] Gleckman, Will Going Over the Fiscal Cliff Make a Budget Deal Possible? […]

  3. Michael Bindner  ::  5:23 pm on October 3rd, 2012:

    The only rationale for keeping the spending cuts is as a pay-for for making some portion of the Bush tax cuts permanent. If the tax cuts are allowed to expire, the sequester can be cancelled. Holtz-Eakin has it exactly wrong and someone should have called him on it. He is showing how desperate the right wing is in this process, because they know if one dollar of spending cuts is assigned to tax cuts at the low end then the Democrats have an incentive to take the spending cuts already enacted and the matching tax cuts and let everything else expire with no action and no compromise. The prospect of this happening is why I believe we will still see a deal BEFORE November 6th. The Republicans are losing the House, so they are the only ones with an incentive to deal. The Democrats have no such incentive given their likely electoral fortunes.

    Only one percent of taxpayers pay the average tax amount. The vast majority pay much less (and can eat the cost which will be offset in annual inflation adjustments – which will surely be paid this year if taxmaggedon happens). The richest 2% will lose a lot – they are donors and they will be the ones insisting on an immediate deal, since it is their skin in the game.

  4. Phil  ::  8:02 pm on October 8th, 2012:

    I think the country would be wise to go off the cliff. The pain is small compared to the reward. The CBO says GDP will decrease only 1.3% the first half of 2013 (depression) and increase 2.3% the second half (+0.5% total for 2013) and continue increasing after. Only 6 months of pain to start paying off the dept. See below for the problems ‘the cliff’ would avoid (from CBO). TPC had a good article on this.

    -Rising debt would cause a growing portion of people’s savings to go to purchase government debt rather than to finance investments.
    -Higher amounts of debt would necessitate higher interest payments on that debt, which would eventually require either higher taxes or a reduction in government benefits and services.
    -Rising debt would increasingly restrict policymakers’ ability to use tax and spending policies to respond to unexpected challenges.

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