Politicians, pundits, and the press corps are turning their attention to the so-called "fiscal cliff," the host of expiring tax provisions and scheduled spending cuts that will collectively push the U.S. economy into a double-dip recession in the first half of 2013 if they all materialize. The "fiscal cliff," however, is a terrible metaphor -- it implies an all-or-nothing choice between continuing all current budget policies and running smack into the legislated trajectory for fiscal policy. As explained in our new briefing paper, a better framework for understanding the impending drags is a "fiscal obstacle course." Running into certain hurdles would all but guarantee a double-dip recession, whereas some other policies would only act as speed bumps moderately slowing growth -- and policymakers can choose à la carte how to navigate this path. More critically, policymakers can fully (or more than) offset any of the adverse economic impacts associated with implementing long-term deficit reduction, particularly tax increases, with more efficient temporary fiscal support.
Economic growth will largely be determined by fiscal policy over the next few years, but currently, fiscal policy is poised to stifle recovery. The Congressional Budget Office projects that the economy will shrink 0.5 percent in 2013 under current law, weighed down by a 2.9 percent contraction in the first half of the year. The Federal Reserve has exhausted its conventional policy levers and is no position to cushion fiscal economic headwinds of this magnitude. Growth is paramount to both economic recovery and fiscal sustainability, but the economy must expand at a sufficient clip -- 2.5 percent annually as a rule of thumb -- to lower the unemployment rate and alleviate the persisting jobs crisis. So how can policymakers best keep fiscal policy from sparking a double-dip recession and instead help restore full employment?
Understanding the economic, rather than budgetary, impacts of the fiscal choices ahead of Congress is critical for sustaining economic recovery, but expensive policies are regrettably being assumed to be effective policies. Much of the fiscal cliff discourse is narrowly focused on the expiration of the Bush-era tax cuts and the automatic "sequestration" spending cuts scheduled to be triggered in 2013 by the Budget Control Act (BCA), i.e., last summer's debt ceiling deal. Concern with the economic impact of the former is unfounded and overhyped while concern with the latter is merited but insufficient; meanwhile, warranted concern is ill-advisedly missing from several substantial fiscal drags, notably expiring fiscal stimulus. Avoiding a double-dip recession does not necessitate extending the Bush tax cuts; despite their huge budgetary cost, the tax cuts offer minimal economic support, were never designed as fiscal stimulus, and have a dismal economic track record.
Maintaining the remaining ad hoc fiscal stimulus -- the payroll tax cut, emergency unemployment benefits, and recent expansions of refundable tax credits -- would add 1.4 percentage points to growth relative to current law. This would be enough to mitigate roughly half the economic slide projected for the first half of 2013. Reversing the spending cuts from the BCA would add another 1.1 percentage points to growth, but it's important to note that more than one-third of this impact comes from the (widely ignored) discretionary spending caps rather than the higher-profile looming automatic sequestration cuts. These parts of the fiscal obstacle course have the biggest economic impacts per dollar, and we project that collectively dodging them would sustain real GDP growth of 2.0 percent for 2013 -- a faster pace than the 1.8 percent annualized growth rate for the first half of 2012.
Maintaining the Bush-era tax cuts, on the other hand, would add only a meager 0.5 percentage points to growth, most of which comes from more targeted provisions for lower-income households (the 10 percent bracket and refundable credits). Allowing the upper-income tax provisions and estate and gift tax cuts to expire on schedule would shave a trivial tenth of a percentage point from growth (while saving $1.4 trillion over the next decade). The other handful of current budget policies typically renewed on an annual basis (patching the alternative minimum tax, extending business tax cuts, and preventing Medicare physician reimbursement cuts) would similarly add 0.5 percentage points to growth. Continuing only the Bush tax cuts and these other routinely renewed budget policies would produce anemic growth of just 0.5 percent for the year, with a likely contraction of 1.9 percent for the first half of the year.
This menu, however, is in no way exhaustive of the fiscal choices ahead of Congress. Enacting more targeted fiscal stimulus, such as infrastructure investments and aid to state governments, could smooth over any of these fiscal drags -- particularly the smaller headwinds from the pending expiration of tax cuts. Well-targeted fiscal stimulus can deliver more than four times the economic boost per dollar as poorly targeted economic policies (e.g., Bush income tax cuts). Consequently, well-targeted fiscal stimulus could produce the same economic benefit of dodging all of these fiscal obstacles for roughly $318 billion (43 percent) less than their budgetary cost.
There are three major takeaways from this decomposed fiscal obstacle course. First, extending the upper-income Bush-era tax cuts would do next to nothing in terms of avoiding a double-dip recession -- yet expiration would produce substantial savings over the coming decade. Second, the expiration of temporary, targeted stimulus and the implementation of BCA spending cuts both pose substantial impediments to growth that should be mitigated as cost effectively as possible. Lastly, various fiscal drags from implementing long-term deficit reduction, particularly on the tax side, can easily be offset with efficient temporary fiscal support.
The current law fiscal trajectory would, if followed, induce a recession in 2013. However, panic over this scenario (which nobody thinks will come to pass) should not be allowed to be exploited politically to maintain tax policies that provide only minimal support to the economy while turning a blind eye to the real threats to economic and employment growth over the coming year.
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Secondly, repealing the Bush tax cuts for those earning over 250k will likely reduce GDP in 2013 by about 1%, nearly enough to cause a recession. In 1993, Bill Clinton's retroactive tax increase on top earners did indeed 1993's GDP growth to 2.9% from over 3.5% in 1992.
BTW the economy is on the verge of another recession RIGHT NOW. ECRI, much derided about their 2012 recession predictions, were correct. 3Q 2012 growth will be best 1% and 4Q will be negative.
http://policyinterns.com/2012/09/21/what-are-the-bush-tax-cuts/
And they will... 99% on the basis of politics and 1% on the basis of pragmatism.
"This would be enough to mitigate roughly half the economic slide projected for the first half of 2013."
Glad you're thinking long term.
I wonder how refundable tax credits and unemployment benefits are going to help reduce our trade deficit and put us on a path to producing as much as we consume. It is not a simple growth of expenditures, as measured by GDP, that is needed - it is the growth of our diminished productive capacity, relative to consumption.
1951: 14.2%
1959: 18.8%
1992: 22.2%
2000: 18.2% That 4% decline represents $400b annually in capital that the govt was not sucking up and denying the private sector. Right there is the main reason for the 1990s boom. And oh yeah Bill Clinton cut capital gains taxes in 1997.
2010: 25.2% of GDP Largest increase in federal spending since 2000 and the slowest decade of growth since the 1930s
Tax Revenues:
1950: 14.5%
1955: 16.5% here is what 91% top rates produce
1967: 18.4% height of the 1960s boom with a 70% rate.
Lowering the rate increased revenues after 1964.
My source is the WH itself.
Bottom line, you want more Keynesian policies.
1) there was tremendous waste (fraud to be proved later) ) and inefficiencies last time and the time before that.
2) the Nation's $17 trillion deficit is essentially Keynesian economics, ie; an injection of borrowed, printed, or created money. How is that working for you?
The economy would fire up again with a massive rollback of regulations, all but essential regs.
We are burdened / overwhelmed with vast amounts of obstacles, so many extraneous demands from gov. filings, paperwork, fees, permits, regulations, uncertainty of the playing field from year to year.
American's are ready, willing and able, but the geniuses in DC have us shut down.
Worse, they can't seem to see this....they want to force more of the same upon us.