Only 21 days left until the U.S. turns into a fiscal pumpkin at the stroke of midnight, and the media is still bombarding the American public at every turn. Yet, a recent Business Insider Poll showed that by a wide margin, 47 percent versus 12 percent, Americans believe a full-on fiscal cliff would actually increase the deficit rather than decrease it.
What?
In the spirit of providing clarity on this apparently misunderstood issue, the so-called fiscal cliff amounts to the dual threat of automatic across the board cuts to federal spending and tax increases, enough to dip the economy back into recession in 2013.
The U.S. deficit is defined as the annual difference between federal outlays and receipts. As such, dramatic decreases in expenditures and increases in revenues would, therefore, decrease the deficit. In fact, a full-on U.S. version of an austerity bomb would reduce the deficit from $1.1 trillion in 2012 to a projected $650 billion in 2013.
This would amount to the single largest annual drop in the deficit since 1969.
Conversely, if we extended all of the current policies, including contemporary tax rates and levels of expenditure, the deficit would reach $1 trillion for the fifth consecutive year. This is a moot point, however, as the spending cuts and tax rate increases were part of the Budget Control Act of 2011 signed by both Congress and the White House.
But by and large, the largest portion of the deficit discrepancy between the polar fiscal scenarios lies in the extension of tax policies enacted in 2001 and 2003.
At this point, however, the debate centers squarely on whether the wealthiest Americans should pay more in taxes. Since this slice of the debate has received considerable attention, I will forego providing, once again, my own two cents.
Now, most economists are concerned that cutting the deficit too fast too soon would be detrimental to an already fragile economy in the midst of a moderate recovery. It is certainly clear that something must be done as the growth rate in the debt to GDP ratio is clearly unsustainable in the medium to longer term, but timing is key.
The current administration wishes to extend all Bush-era tax cuts for marginal tax rates below 98 percent of income earned.
As Timothy Geithner, the current U.S. secretary of the treasury has remarked recently, even for the top 2 percent of income earners, only their income above, say, $250,000 would be taxed at a higher marginal tax rate. All income below that threshold would receive the extended preferential tax treatment from the Bush-era tax cuts.
Likewise, all individuals whose income falls below the threshold would also benefit from the extension of the marginal tax rate cuts.
So, shouldn’t we set caps on federal spending as a percent of GDP? No. This would imply that funding to help our economy weather the storm of inherent contractions and recessions would mechanically be cut when GDP fell. This is policy that flies squarely in the face of all economic intuition and places a stranglehold on the sole entity that has the flexibility to dampen the degree of such costly downturns.
There is an old doctrine asserting that increases in government spending crowd out what would have been an equal amount of private-sector investment. But interest rates are at rock bottom and firm level investment is still inadequate.
Even though the degree of displacement, if any, is extremely sensitive to the position of the economy on the business cycle, this doctrine would imply that cuts associated with the fiscal cliff would spur an equal amount of increased investment from the private sector. This is a tough sell given the projected health of the economy next year.
So, let’s get Congress and the White House together, brew some coffee and lock the doors until a deal is hatched out. Better yet, let’s go full bore off the fiscal cliff. This will finally show what narrow-minded brinkmanship can accomplish for this country: a recession.
Dr. Nicholas J. Mangee is an assistant professor of economics at Armstrong Atlantic State University and can be reached at Nicholas.mangee@armstrong.edu.