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Fiscal Cliff

The phrase is often credited to Ben Bernanke, but variations of it have been around for decades.  The “Fiscal Cliff” that went largely unmentioned during the campaign now dominates the talk out of Washington.  It is probably the most important thing that will happen in the next Congress, and it will certainly set the tone for the end of the Obama administration.  Yet almost no one has taken the time to explain what’s at stake in plain language.

There are three major deadlines approaching, all of them somewhat negotiable.  The first deadline is the expiration of many tax cuts, including the “Bush tax cuts” and the payroll tax reduction all expire on 31 December 2012.  Then, on 1 January 2013, the “Budget Control Act” passed as part of the Debt ceiling negotiations in August, 2011, mandates massive spending cuts – $109B from Defense and the same from non-defense discretionary spending – if no other deal is reached.  Finally, sometime in February 2013, the debt ceiling will have to be raised again from $16.394T or the federal government will run out of borrowing authority.

All of these deadlines are artificial and can be changed.  However, simply kicking the can down the road to a much later date will continue to spook Wall Street, which has become very nervous about gridlock and the inability to control the massive deficits that are being run.   Most agree that a preliminary agreement designed to pacify jittery investors will be passed to give Congress and the President more time to forge a real agreement.

What will any agreement look like?  There are two schools of thought – a massive patch or a process that creates more fundamental fix.  The patch is actually much harder to imagine, especially given Republican reluctance to go along with Obama’s plan to raise taxes on the wealthy.  Speaker Boehner has signaled a new willingness to allow taxes to increase by eliminating many deductions, as have many Republicans.  No one – Republican or Democrat –  is sure if enough such deductions can be found yet, however.

The longer, more fundamental process is the Simpson-Bowles framework for negotiations.  No one has proposed any other comprehensive solution.  This was created by the National Commission on Fiscal Responsibility and Reform by President Obama in January 2010, but their recommendations have languished as being too much for a divided government to take on.  Support has been building gradually since then, however, and the framework has its supporters, especially among Senate Democrats like Chuck Schumer of New York.

The sticking points, no matter what, are “entitlements”, specifically Medicare and Medicade.  These programs, costing $835B in 2011, are projected to increase at over $10B per year with no changes – and many agree that these estimates will be revised upwards.  Obamacare improved its long-term health, but there are fundamental problems that remain.  Republicans are unwilling to enter negotiations without these on the table.

With all these actions pending, there is no agreement as to how the next few months are likely to play out.  Support for the Simpson-Bowles framework is growing, but everyone agrees that it will take months of negotiations to reach fruition.  That means that the three components of the Fiscal Cliff will have to be delayed with continuing legislation.

The problem will be how it plays out in the press.  A delay in the negotiations in order to buy time for the Simpson-Bowles process to play out would probably be received well by a very nervous Wall Street, but only if the politicians involved appear serious about making it work.

What remains important about the Fiscal Cliff, however, is that this is almost entirely a political problem.  It is one of artificial deadlines and perceptions as to how Washington will put the nation on a path to fiscal sanity and reduce the current deficit, now at $1.1T every year.  Without any action, it would continue to rise to $1.7T annually by 2020 according to most estimates.  Without a deal, the need for continued borrowing by the Federal government would dominate the bond market and make a sustainable recovery difficult if not impossible.  There are many ways to reduce this deficit, particularly with the roughly $700B Defense budget on the table, but gridlock has prevented anything substantial from happening.

There are many paths to avoiding the Fiscal Cliff, but all of them require cooperation between the parties and branches of government.  That is the issue in its entirety.  How it will play out is still unknown, despite deadlines that are less than 50 days away.   Investors are already spooked badly, but Washington has finally taken notice.  Something big will happen – one way or the other.

This article is only a summary designed to help understand the Fiscal Cliff and its implications. If you have something to add please do! This is a critical issue that will determine the near-term future of our nation like nothing else.

23 thoughts on “Fiscal Cliff

  1. This is a good summary, thank you. Is it really a political problem alone? There is nothing other than the inability to agree so far & how it scares wall street?

    • I have come to the conclusion that this is entirely a political problem, yes. The debt is very real and continuing to borrow as we are is totally unsustainable – but with all the ways to solve this there is no reason we cannot. So “scaring Wall Street” is a rather real problem in many ways, but letting this fester has not been good at all.

    • Largely, you are correct. Obama is there to craft a solution that is not as bad as Romney would have foisted on us, but yes – the debt has tied the hands of government and made it nearly impossible to do anything substantial.
      I support the Simpson-Bowles plan largely because once we put EVERYTHING on the table I think there will be a big change in how we think about our priorities across the board. The need to raise taxes on the wealthy will be obvious and I do think the Defense budget will look unaffordable.
      But in the short term we are screwed no matter what, IMHO.

  2. There is no immediate need to drastically cut the debt because we are in a depression. I favor stop gap measures.

    What is needed are pro-growh policies because unemployment is too high, and growth is too low. The fiscal cliff is nonsense. Obama and Congress should focus on drafting their pro-growth bills so they can pass them next year. The markets can go to hell.

    I favor extending all the Bush era tax cuts during the lame duck session.
    Entitlement reform and tax reform should be tackled in the next sesson in my view since that should be done in committee. These big deals are just too hard to cut. Just give the committees their targets.

    • “The fiscal cliff is nonsense. Obama and Congress should focus on drafting their pro-growth bills so they can pass them next year. The markets can go to hell.”
      I wanted to say something like this, but telling the markets to “go to Hell” seems to have pretty serious consequences. I haven’t totally thought through that yet. I want to encourage growth – yes, absolutely – but as much as I think GS and JPM are disconnected from reality I still mostly OK with the stock market on balance.
      More in response to Anna, below, but let’s keep talking here.

  3. I am glad to agree with Smithson that this is nonsense. An agreement that puts us on a balanced budget in 6, 8, or even 10 years would be a good idea. Doing it right now is insanity and nearly impossible. We are going to grow into what ever solution there is and as we grow we can see what has to be done.
    This is all Tea Party insanity and we should not be talking like this right now. We can cut a few things here and there and raising some taxes is going to be OK on the very rich so we can start getting it under a plan. But more than that would deepen the depression.
    I do agree that we are borrowing too much but a big move in the right direction would keep the bond market happy for now I think. They are over reacting on Wall Street and Obama should go there and try to calm them down. It would be great to see him make a speech on the floor or something.

    • I agree that this is a long-term process, and as a Simpson-Bowles kind of guy I see no problem phasing in a many year plan that slowly reduces the deficit. I think we all have to agree that growth has to be part of it, and I also think that restructuring generally has to be part of this. I can’t see spending 7X China on defense forever, for one.
      Smithson’s view that you send targets out to the committees and let ’em fight for a year or more is interesting. I think a little action right now might buy time to make that happen, but I don’t want to do anything drastic immediately.
      Obama needs a Robert Rubin, IMHO, who can talk to bond traders and at least figure out what will pacify them. You have a good approach here and I’ll bet something like this will happen.
      But I think we all agree that this is an artificial deadline and the real problem is how it’s built up into some mythological big deal.

  4. As a measure of goodwill, if I were John Boehner, I would agree to 3/4 of the tax increases that President Obama wants. That what he believes in and he should get. The Tea Party should keep quiet, to the extent that they can, and do what he says. Beehner is the house leader and from Ohio, no doubt. Some Tea Party person can run against him in 2 years if they are so upset.

    Simpson Bowles should be accepted in principle. We just need some broad airy principles that help people later do the nitty gritty.

    • I hope Boehner gets some guts, but I always wondered how many votes he could actually deliver. That’s probably the problem – he can’t deliver doodley-squat.

  5. What Republicans want is a mild assurance that when they propose entitlement reform that Democrats go along with it. Repubs hate being slammed for entitlement reform ideas. Maybe some of their reform ideas are too radical, but it is not nice to keep slamming them about Medicare and Social Security when it needs to change. Personally I don’t like FICA taxes.
    We should have progressive taxes to fund those 2 bedrock programs. Also, It’s not bad to tell people to retire later when everyone is living longer anyway.

    • To tell you the truth, I thought Ryan’s plan wasn’t all that radical and as an opening position was really not all that bad when we talk long term reform. The problem was that the Republicans also ran away from it in an election year. The Dems have yet to get serious about reform at all, which really bothers me – waiting for it to be a crisis is not in anyone’s best interests.
      I agree on progressive taxes for FICA as well, and I keep thinking about how to calculate how that might look. It’s all based on an 80 year old model that should at least be looked at seriously. No one has ever seriously proposed that reform, which is not good at all.
      A “grand bargain” seems like an idealistic daydream right now, but I do think that as a “framework” Simpson-Bowles should be a way of approaching all this that we can attack as we can. We do need a grand overhaul of nearly everything, IMHO. That’s pretty scary, but it’s either that or hit the wall when we can’t afford it.

  6. “Entitlement reform” is just code language for more inequality and injustice.

    Recall that there were substantial Federal surpluses, in current accounts, when Clinton left office. If things had continued as they were, by now there could have been a substantial paydown of the Federal “debt.” But I think paying down the dept is the very last thing the owning/loaning classes actually want. Isn’t that really why the more right-wing and evil the administration, the bigger the deficits? (Reagan, Bush II….)

    We know, if we want to, that health, education and environmental spending, what the Repugs most want to cut, yields large socio-economic benefits. Almost every evaluation of those programs shows they cost far less than the cost of not doing them. Of course, some of those evaluations are self-serving, but the basic point is valid. Likewise infrastructure maintenance. As a trivial example, it costs, what to fix a pothole–$50 bucks? Leave it open for a few weeks and the collective damage to numerous vehicles runs in the thousands……

    The whole “conversation” is so off-track as to be pointless. Am I supposed to believe that Obama has nothing to say because he doesn’t know these things?

    • Unfortunately, you are right that “entitlement reform” is used as a bludgeon where a scalpel is needed. These programs have dedicated funding sources and needs that rise and fall (generally just rise) that do need attention from time to time – but they have been neglected for many years at this point.
      The closest I have seen to a Dem position is that Obamacare will produce substantial savings and that more savings can be squeezed out with deeper implementation. If that is true, then great! But as they stand now it is a football. Obama has NOT showed enough leadership on this for my liking, either.
      If we wait until there is a real crisis there will almost certainly be deep cuts. I’d like to avoid that.
      The conversation is very much off track and has had nowhere near enough leadership from Democrats. It’s as if we hope the whole thing will go away.

  7. Current entitlements are a way of reducing inequality. For those who are not poor during their working years, social security and medicare is a form of saving, albeit through a transfer from current workers.

    Food stamps and medicaid and health spending for pregnant women and for children are good. Now the affordable health care act expands medicaid to above the poverty. From the liberal perspective this a reward for work. The question from Republicans is how can you create a new benefit when other programs are not actuarially sound.

    Social security has its own assets, from payroll taxes. The revenue stream in the out years is below the payout.

    Take a look at this chart


    There is nothing nefarious about a lack of revenue for the program.You just have to have enough productive workers providing the revenue for current retirees.

    If the money is not projected to be there, we owe it to future retirees to adjust the benefits to match the revenue.

    For me I don’t favor federal cuts to education and environment.

    • It is perfectly reasonable to me to revisit this in many ways. Extend the retirement age? Sure, why not – perhaps even have options for reduced benefits at 65 and full if you retire at 72. Should we change how we fund it? I think that has to be on the table, ideally done with a progressive tax code and something that takes away the 7.62% employer contribution – a tax on employment that only contributes to employee overhead.
      But these are just huge issues that we are nowhere near mature enough to discuss rationally. It’s disheartening.

  8. I can see the same debate about the economic crisis in the Europe as well as in the US. It is based on the same austerity vs. spending paradigm, which is currently the main topic of the economic and politics debates. It is really hard to find the truth or the solution, since both of them has a particular advantages. I think it is well described in the blog How to fight Global Economic Crisis. If we want a more risky existence, then we should go for the tax cuts. If we prefer safety and bigger state, then we should increase the taxes. There is no mathematical equation for that. Just common sense.

    • Bingo. I recommend the link highly, everyone read it!
      The problem is that we have run such high structural imbalances we’ve really tried to have it both ways – and we can’t do that. We do have to choose what kind of nation we will be, I think that is a very wise way of looking at this.

  9. I am less enthusiastic about the blog essay that John B provided. I would give it a grade of C.

    It has some reasonable points. However:

    The essay didn’t really argue that tax cuts are risky. It was more about cutting budgets to cut deficits vs. having larger budgets to provides higher quality and quantity of services and public investments.

    A lot of people did view the presidential election as tax cuts vs. public investment.

    I suppose we can say Romney was for tax cuts and austerity. I don’t think he would have wanted large immediate cuts, wily nily, just to cut the budget deficit. I think it is more fair to say he wanted to tax reform. Most people want tax reform–what kind? That is the question

    To be fair I think both Obama and Congressional democrats and republicans have pro-growth ideas. We ought to be interested in holding them accountable for good ideas in this area.

    It also mentions irresponsible banking and lack of financial regulation. I’ll buy that , althought government guarantees play a role. The role of the dollar, interest rates play a role. These things have all been discussed in

    • Growth is the key, and to me that starts with restructuring – what we can do to support the changing economy and get us more quickly to whatever new economy will replace the old one. Simply put, the technology that we thought would allow us to grow at a higher rate through productivity gains got ahead of us and wound up simply making a lot of workers redundant. Wrap that up with a globalized labor market and workers are really cheap.
      It won’t last forever, but getting us from where we are to where we have to be as quickly as possible has to be the goal. Where is “there”? A good question. We know something about it, but not a lot.
      Tax reform is the big thing that government should be focused on, IMHO. I do think that a very simple system designed to raise appropriate revenue and little else is probably the best in a time of great turmoil – it allows the free market to go off in the direction it needs to.
      What can government do to hustle things along? I guess it’s time to write about that again, but I feel like I’ve done that a lot already.

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