The 'fiscal cliff' isn't a cliff at all

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by Brian Montopoli, Alain Sherter / CBS News

KMOV.com

Posted on November 27, 2012 at 12:56 PM

You're going to be hearing the phrase "fiscal cliff" a lot over the next few weeks: The phrase has emerged as a shorthand way to describe the combination of tax hikes and spending cuts set to start kicking in at the end of the year. Lawmakers are now feverishly negotiating over how to keep many of those spending cuts and tax increases from kicking in - to keep from what is often described as "going off the fiscal cliff."

Yet if no deal comes, the nation won't actually be going over a metaphorical cliff. The word cliff implies an all-or-nothing situation - once you go over a cliff you plummet to earth. There's no going back.

But the situation the nation faces is not like that. The so-called "fiscal cliff," in fact, would be more accurately described as a "gradual fiscal slope." Though that admittedly doesn't have quite the same ring to it.

There are two parts to the so-called fiscal cliff. The first is the scheduled expiration of the tax cuts enacted in 2001 and 2003 under President George W. Bush, the payroll tax holiday enacted under President Obama, and a host of other tax breaks. The second is $1.2 trillion in automatic spending cuts to defense and domestic programs that are looming due to a 2011 deal that resulted from House Republicans' reluctance to raise the debt limit.

Now, it's true that if lawmakers fail to work out any sort of deal, there will be severe long-term consequences for the economy: According to the Tax Policy Center, going off the "cliff" would affect 88 percent of U.S. taxpayers, with their taxes rising by an average of $3,500 a year. Many economists, as well as the nonpartisan Congressional Budget Office, say the combination of spending cuts and tax hikes that are set to take effect would tip the economy into a new recession. The Congressional Budget Office has forecast that implementing all the mandated government spending cuts and tax hikes would reduce real GDP by 0.5 percent in 2013, with growth sinking in the first half of the year before resuming at a modest clip later in the year. The CBO forecasts that inaction would push up the unemployment rate to 9.1 percent by the end of 2013.

But here's the thing: If the nation goes over the cliff - but then lawmakers work out a deal in, say, late January - it will not be nearly as bad as all that suggests. It's true that many of us would see slightly more money coming out of our paychecks at the start of the year, but lawmakers could retroactively reverse the tax hike once they work out a deal. (You'd then effectively get a bonus in your next paycheck.) Since both parties agree that the Bush-era tax cuts should be extended for the vast majority of Americans, it's unlikely that most of us would end up taking a serious hit over the long run.

But here's the thing: If the nation goes over the cliff - but then lawmakers work out a deal in, say, late January - it will not be nearly as bad as all that suggests. It's true that many of us would see slightly more money coming out of our paychecks at the start of the year, but lawmakers could retroactively reverse the tax hike once they work out a deal. (You'd then effectively get a bonus in your next paycheck.) Since both parties agree that the Bush-era tax cuts should be extended for the vast majority of Americans, it's unlikely that most of us would end up taking a serious hit over the long run.

The spending cuts, meanwhile, are phased in gradually - which is why the "slope" metaphor makes more sense than the "cliff" one. It's not as though $1.2 trillion would suddenly disappear from the economy at the end of the year: The cuts, while undeniably significant, are set to be phased in over a decade. In addition, there are budgetary maneuvers that can be taken to at least somewhat soften the blow of both the tax hikes and spending cuts. (The Treasury Department could, for instance, freeze paycheck withholding levels.) Certainly, total inaction on the "fiscal cliff" over the long term would likely have a deeply negative impact on the economy. But if a deal comes in January or February, after the deadline - as it well could - the structural damage could be relatively small.

"We're not going to fall off the edge of the earth at the beginning of next year," said Ed Yardeni, president and chief investment strategist for institutional investor advisory Yardeni Research. "When you fall off a cliff you die. So it's a bit of an exaggeration to say that's what we're facing here."

What would happen on Jan. 2, when the fiscal measures are scheduled to kick in, without a deal? Most households facing higher taxes would see a relatively minor hit to their income. That could weaken demand and constrain spending in the short term, but it's unlikely to push the economy off some sort of proverbial ledge. And some of the tax increases wouldn't be felt for months. For instance, taxpayers newly subject to the alternative minimum tax, which tends to affect upper-income households, wouldn't pay those increased taxes until they file their returns in April.

For the broader economy, meanwhile, the incremental reduction in people's purchasing power would be far smaller than the full revenue increase the tax increase would generate over the entire year.

Many Democrats hate the "fiscal cliff" metaphor because they feel that they have more leverage to negotiate if the year-end deadline comes and goes without a deal. If and when taxes go up in January, Democrats would be in a position to put forth what is now a tax cut for 98 percent of Americans - and Republicans would face the prospect of opposing a major tax cut if they refuse the deal. (The GOP wants to extend the Bush-era tax cuts for the highest earners as well, something Mr. Obama strongly opposes.) The doomsday notion that America is poised to go off a cliff at the end of the year creates more pressure on Democrats to come to a deal before January, which would seem to help Republicans.

So which brilliant Republican operative came up with the "fiscal cliff" terminology? It wasn't an operative at all: The coinage appears to have come from Federal Reserve Chairman Ben Bernanke, who was re-nominated to his post by none other than Mr. Obama. Via Paul Waldman, here's Bernanke testifying to Congress in February: "Under current law, on January 1, 2013, there's going to be a massive fiscal cliff of large spending cuts and tax increases. I hope that Congress will look at that and figure out ways to achieve the same long-run fiscal improvement without having it all happen at one date."

One argument for the "cliff" metaphor is that a lack of action before the end of the year could cause the markets to go haywire and/or erode Americans' confidence about their financial prospects during the holiday shopping season. Shoppers' mood, which had been buoyant in recent months, soured in October, according to the latest Reuters/University of Michigan consumer sentiment index.

Yet it's worth noting that the "cliff" metaphor itself could be partly responsible for all this, since it may very well spook shoppers and investors who might otherwise take into account the likelihood of a damage-limiting deal in January or February. The metaphor would, distressingly enough, gain some legitimacy in part because it makes people think the situation is worse than it is.

"If the reality is we're going to go off the cliff, then we shouldn't get panicky about it," Yardeni said. "We should conclude that we'll survive and that it may even be good for us in the long run if that's the only way to exercise fiscal discipline."

 

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