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The Real Work Comes After the Election

12:00 PM, Nov 3, 2012 • By IRWIN M. STELZER
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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. By the time the new Congress and the next president will have been sworn in on January 21 of next year, the Bush tax cuts will have expired, and spending programs 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 per year will go up by a total of $173 billion, and on those earning more than that by a total of $75 billion. In addition, funds for several government programs will be cut—“sequestered” in political jargon—by $87 billion. Those tax increases and spending cuts would take about 2.1 percent out of GDP.

That’s not all that is scheduled to hit the economy at year end. Expiration of the temporary cut in the payroll tax ($127 billion), Obamacare taxes ($24 billion), and other scheduled tax increases ($184 billion) will bring the grand total of tax increases and spending cuts to $668 billion (rounded). That comes to 4.3 percent of GDP in additional taxes and reduced spending, a hit about the size of that imposed on Greece by Germany, and equal in one year to the cuts Britain plans to absorb over three years, according to Larry Lindsey, one-time Federal Reserve board governor and former chief White House economist.

The Congressional Budget Office estimates that cutting $668 billion from the economy will cause it to shrink at an annual rate of 1.3 percent in the first half of 2013, before recovering in the second half to produce a full-year growth figure of +0.5 percent, 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 cliff-avoiding deal. At minimum, 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 specialize in that sport. Then, after the new congress and a president are sworn in, serious negotiations would produce a compromise that avoids the cliff, to the relief of all concerned. That consensus has changed.

The cliff no longer is 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 percent of GDP according to the CBO, a massive reduction of more than half. That would produce a short, mild recession. GDP would decline at an annual rate of 1.3 percent in the first half of the year, recovering sufficiently in the second half to produce modest full year growth of 0.5 percent. This, the argument continues, would be a small price to pay for cutting the deficit and setting the stage for a 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.”

Would that life were so simple. The CBO’s forecasting record is, er, spotty, and if we have learned anything from watching eurozone experience 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 the fiscal contraction, Europe is headed to recession, and the Chinese economy is no longer the growth engine it once was.

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