Fiscal Cliff Doesn’t Look So Bad After the Fall

By Caroline Baum  

 

Just when you thought you could forget about the fiscal cliff and focus on the Republican and Democratic conventions instead, along comes the Congressional Budget Office to remind us of the impending threat.
In its midyear budget and economic outlook last week, the CBO tweaked its forecast in the event Congress fails to prevent an array of tax increases and automatic spending cuts -- $1.2 trillion over 10 years -- from kicking in at the start of 2013. Such “fiscal tightening” would cut gross domestic product by 0.5 percent next year, with the hit concentrated in the first half, and increase the unemployment rate to 9 percent.

About Caroline Baum

Caroline Baum, a columnist for Bloomberg News since 1998, is the author of "Just What I Said: Bloomberg Economics Columnist Takes on Bonds, Banks, Budgets and Bubbles."
More about Caroline Baum

Enlarge image

Photographer: Rick Friedman/Bloomberg

It will also provide a short-term budget fix. If Congress does nothing -- that’s what a do-nothing Congress does, right? -- the 2013 federal deficit, under the CBO’s baseline scenario (the policies dictated by current law), will be $641 billion, or 4 percent of GDP, following four years of annual deficits in excess of $1 trillion.
Yes, there will be pain. But there’s plenty of that already. At the current pace of job growth, it will take as long -- seven years -- to return to the pre-recession employment peak as it did following the Great Depression, according to Steven Wieting, head of economic and market analysis at Citigroup Inc. in New York. Viewed in that context, the Federal Reserve’s pledge to hold interest rates near zero until late 2014 doesn’t seem so odd, he says.
So far, only 46 percent of the 8.8 million jobs lost have been recouped.

Better Off

Beyond the headlines in the CBO report, there are good arguments for letting the fiscal cliff pass without creating an escape hatch.
“The CBO report says that in 2022 we will be better off if we go over the fiscal cliff,” says James Kwak, associate professor of law at the University of Connecticut School of Law in Hartford. Things will get worse in the short term, but 10 years from now GDP will be higher, and interest rates, the budget deficit and government debt will be much lower. The unemployment rate is projected to be the same.
The improvement in the deficit is largely the result of an increase in revenue from expiring tax cuts, a reduction in Medicare payments to doctors and an expansion in the number of households subject to the alternative minimum tax. Such a static estimate, which doesn’t account for behavioral changes, will irk the supply-siders and may end up producing less revenue than advertised. No one ever said long-term projections were reliable.
Still, the CBO is forecasting a jump in revenue to 20.3 percent of GDP by 2015 from 15.7 percent this year. Outlays, on the other hand, remain well above the historical norm, averaging 21.7 percent of GDP over the next decade compared with 22.9 percent in 2012. Even with the automatic spending cuts, “spending grows,” says Sean West, a director at the Eurasia Group, a political-risk advisory firm. “Spending shifts down, then it grows again at a rate below inflation.”
Only in 2013 will there be an outright cut in discretionary outlays. After that, the cuts are in the growth rate of spending.
The combined effect will reduce the federal deficit, projected to be 7.7 percent of GDP in the fiscal year that ends Sept. 30, to 1 percent by 2016, where it will remain, the CBO says. That should please even the staunchest deficit hawk, no?
Hardly. The problem lies with mandatory spending on health care and retirement programs, which by the end of the decade will be growing faster than the economy and account for 14.4 percent of GDP in 2022 compared with 13.2 percent now.

Permanently Temporary

Fixing the short-term deficit would give lawmakers time to solve the problem of entitlement spending. That’s no guarantee that they will. Time to craft serious solutions is also time to ignore the problem altogether. But it can’t be ignored forever. Mandatory spending, including Medicare, Medicaid and Social Security, accounted for about one-quarter of federal outlays in 1962. Last year, it was 56 percent. And the direction is up.
Another reason to rappel down the cliff is to teach Congress a lesson. Yes, we suffer the consequences of their actions, but voters need to understand how we got into this mess. Lawmakers use sleight-of-hand accounting to make laws appear affordable when in reality they aren’t. They craft tax breaks for favored constituencies. I have written previously that “targeted, temporary and timely” should be eliminated as fiscal-policy options and replaced with the three F’s for tax rates: flatten ’em, fix ’em and forget ’em.
There’s one final reason to allow policies to continue as written. It is said (by whom is unclear) that we get the government we deserve. Look at what we got. It wasn’t that long ago that Democrats and Republicans, liberals and conservatives, found ways to work together. A president (Ronald Reagan) and a speaker of the House (Tip O’Neill) collaborated to enact major tax reform. Senators with diametrically opposing views -- Utah’s Orrin Hatch and Ted Kennedy of Massachusetts -- were willing to compromise.
Nowadays, Republicans sign a pledge never to raise taxes, and Democrats pretend that “saving Medicare as we know it” is an option.
We deserve better. Vote on Nov. 6.