It should be obvious to anyone who follows the news even cursorily that the biggest issue in Washington right now is the matter of the upcoming “fiscal cliff.” If this seems like an overly dramatic expression, it’s because the issue itself is extraordinarily dramatic and, if allowed to transpire, threatens to unleash a host of devastating repercussions not only on this country’s economy, but also on that of the entire world. What happens in the coming weeks – before January 1, when most of the fiscal cliff’s provisions are scheduled to take place – will be crucial. The fate of the economy’s health in the year 2013 rests in the hands of the Obama administration, Senate Democratic leaders, and John Boehner, the House Speaker. None of these players wants the fiscal cliff to occur, and yet key disagreements may make it inevitable.
So what exactly is the fiscal cliff? It refers to rises in taxes and drastic cuts in spending that were written into law and scheduled to occur on January 1, 2013. The tax increases and spending cuts that will take place on that day are staggering in severity: all the Bush tax cuts will expire; there will be across-the-board cuts totaling trillions of dollars over several years as specified by the Budget Control Act of 2011; the reversion of the Alternative Minimum Tax thresholds to their 2000 tax year levels; the expiration of measures delaying the Medicare Sustainable Growth Rate from going into effect; the expiration of the 2% Social Security payroll tax cut; the expiration of all federal unemployment benefits; and the imposition of taxes through Obama’s Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010.
The projected effects are as staggering as the preceding list is complicated. The Congressional Budget Office forecasts that all these changes to taxes and spending would, while dramatically improving the 10-year outlook on American debt (by eliminating as much as $7.1 trillion of the national debt), immediately push the United States into recession, wiping 0.7% of GDP in the entire year 2013. Unemployment would rise sharply to 9.1%, and the White House estimates the average family of four with an income between $50,000 to $85,000 would pay an additional $2,200 in federal taxes. Defense sequestration would reduce defense spending between 2012 and 2021 by $445 billion, prompting many in the armed forces to sound alarm bells about America’s ability to adequately guarantee its security during this time. Since the economy is still in a fragile state and ongoing shocks from Europe’s prolonged financial crisis threaten to tip the entire world economy into recession, the impact of the fiscal cliff in the United States would be felt and measured virtually everywhere.
So what are the administration and House leaders doing about this? There is broad agreement that taxes on the middle class should not rise. Any agreement that would emerge from the two sides would prevent this from happening. The major disagreement that prevents them from achieving this common ground in practice is the issue of the Bush era tax cuts for individuals making $200,000 or more a year, and married couples making $250,000 or more a year. Republicans, who still control the House after this month’s national elections, want to preserve the Bush-era cuts for everybody, including these higher earners. Democrats generally want to allow taxes for them to rise. And this is where the terrifying Russian roulette game begins.
The president has made clear that he will not sign any measure emerging from Congress that does not raise taxes on the highest income earners. The House GOP leaders insist that allowing the rates to rise will be detrimental to job creators and the general engines of prosperity, although they did indicate they will be open to more revenue through eliminating various loopholes and deductions in the convoluted tax code. In response to this concession, the president said he would not accept it, declaring that raising revenue through such means would not yield enough.
Lowering taxes is great economic policy. Leaving more capital in the private economy is good for investment, for consumption, for confidence, and for making sure that limited resources are invested in ventures that are needed in the private economy. Higher taxes leave fewer resources for investment, distort economic production by leaving decisions about investing resources in the hands of centralized authorities, and reduce consumption by leaving fewer wages in earners’ hands. No country has ever taxed itself to prosperity, and countless instances of economic literature attest to the desirability of a simplified tax code characterized by generally low rates. However, on this issue, the Republicans are incapable of winning. The Democrats credibly claim a mandate for their position on this issue after the elections, and any refusal by the Republicans in the House to contort their position would result in them being blamed politically for the United States going off the fiscal cliff. No one disputes the importance of preventing taxes abruptly rising for the vast majority of this country’s wage earners, including the middle class. Although raising taxes on the top earners is
notdesirable economic policy, Republicans should accept that that is a lesser evil than allowing taxes to rise for all. On this issue, they should throw in the towel and agree to the president’s demands. Refusing to do so would not only be disastrous economically, it would virtually guarantee their loss in the 2014 House elections and contribute to an even more gridlocked atmosphere in Washington.
