THE “FISCAL CLIFF” AND THE ECONOMY

ABSTRACT: The federal budget’s “fiscal cliff” is looming on December 31, 2012. If Congress and the President let us fall over its edge, it will significantly harm our fragile economy. It cuts annual spending by about $100 billion per year and increases taxes by about $350 billion per year. The result would be a significant reduction in the annual deficit, from about $1 trillion to about $600 billion. However it would also negatively affect the economy: a recession or projected growth of only 0.5% versus growth of between 1.7% and 4.4% if the fiscal cliff were completely eliminated. The negative impact on the economy would make it harder, over the longer-term, to reduce the deficit.

There are many ways to soften the cliff’s impact. One would be to eliminate the tax increase on income under $250,000. Another would be reducing the spending cuts. It’s clear that the US government’s stimulus package helped soften the US recession; it’s equally clear that austerity is not a route to economic recovery. Austerity in Europe has turned a slow recovery into a stalled economy with recession in some countries. We need to call on Congress and the President to soften the fiscal cliff. Right now, the primary focus needs to be on strengthening the economy and creating jobs, which, over the longer-term, will help reduce the deficit.

FULL POST: The federal budget’s “fiscal cliff” is looming on December 31, 2012. If Congress and the President let us fall over its edge, it will significantly harm our fragile economy. Under current law, annual spending cuts of about $100 billion per year would occur and the Bush tax cuts of 2001 through 2003 would expire, which would result in an annual tax increase of about $350 billion.

The result would be a significant reduction in the annual deficit, from about $1 trillion to about $600 billion. However, it would also negatively affect the economy; projections range from a recession (i.e., negative economic growth as economic output shrinks) to growth of only 0.5%. If the fiscal cliff is completely eliminated, in other words if all the tax cuts are extended and the spending cuts are eliminated, projected economic growth would be between 1.7% and 4.4%. [1][2] The negative impact on the economy would make it harder, over the longer-term, to reduce the deficit.

There are, of course, many ways to soften the impact on the economy and on specific groups or agencies. The fiscal cliff’s increased taxes would affect almost everyone and, therefore, hurt consumer spending. Some people are proposing eliminating the tax increase on income under $250,000. This would reduce the tax increase to about $200 billion per year (instead of $350 billion). In addition, it would significantly reduce the impact on our economy (which is 70% consumer spending) because those with incomes over $250,000, who would see their taxes increase, spend only a fraction of their income on goods and services in the local economy. The real job creators in our economy are the vast middle class; their consumer spending is businesses’ revenue and increased business revenue is what leads to job creation. [3]

Reducing the spending cuts would soften their impact. The fiscal cliff’s spending cuts would be split roughly evenly between the military and social programs. Some of the loudest voices arguing for reducing the spending cuts are opposing the $50 billion cut to military spending despite the facts that:

  • Military spending has more than doubled since 2001,
  • We’re winding down two wars, and
  • This represents less than 7% of the over $700 billion per year military budget, which is roughly half of discretionary spending.

One argument that is being put forth is that a cut to military spending would cost jobs. Ironically, this argument is being put forward by many of the same people who have said that government spending doesn’t create jobs and that the way to improve the economy and create jobs is to cut government spending. Yes, cutting military spending will cost jobs in the military-industrial complex. But because military spending creates fewer jobs per dollar than other types of spending, cutting it will cost fewer jobs than cuts in other areas, or, if these cuts will allow spending elsewhere, more jobs will be created than those lost, resulting in a net gain in jobs. [4] (See 11/17/11 post: Defense spending: Can we afford to cut it?)

It’s clear that the US government’s stimulus package helped soften the US recession; it’s equally clear that austerity – cutting government spending and benefits often while raising taxes in an effort to reduce government deficits – is not a route to economic recovery. [5] While deficits do need to be addressed over the longer term, doing so while our economy is weak will only exacerbate the problem. Austerity in Europe has turned the slow recovery of 2009 into, at best, a stalled economy and recession or even depression in some countries. Demands for austerity in exchange for financial aid have occurred five times in Europe, with Greece, Portugal, Ireland, Spain, and Italy. Each time the austerity measures have deepened the economic crisis and weakened the country’s economy. Cutting public spending and benefits, while increasing taxes, decreases employment and incomes. This reduces consumer spending which hurts businesses and kills jobs. As a result, tax revenue falls, increasing (not reducing) government deficits. [6]

We need to call on Congress and the President to soften the fiscal cliff. Right now, the primary focus needs to be on strengthening the economy and creating jobs, which, over the longer-term, will help reduce the deficit. There is ample evidence that austerity will only make the economy and the deficit problem worse.

My next post will examine strategies for reducing the deficit in both the short and the long-term that would be less damaging to the economy than the fiscal cliff.


[1]       Businessweek, 8/2/12, “A decade of tax cuts and deficits,” Bloomberg Businessweek

[2]       Lipschutz, N., 8/22/12, “Even if ‘fiscal cliff’ gets resolved, outlook is anemic,” The Wall Street Journal

[3]       Reich, R., 8/30/12, “Labor Day 2012 and the election of 2012: It’s inequality, stupid,” http://www.RobertReich.org

[4]       Pemberton, M., 8/16/12, “Top 10 myths of the jobs argument against military cuts,” Institute for Policy Studies

[5]       Loth, R., 9/1/12, “The value of public-sector jobs,” The Boston Globe

[6]       Kuttner, R., 9/10/12, “Angela Merkel’s bad medicine,” The American Prospect

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2 comments

  1. Thanks! This was a really helpful explanation.

    1. I’m glad you found it helpful. Thanks for letting me know.

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