Fiscal Cliff Insanity

by Benjamin Studebaker

Back in August, I wrote a piece called “Fiscal Cliff Madness” about the set of consequences produced by the law enacted by the government that will severely reduce spending and raise taxes. Today, new research has surfaced from the non-partisan Congressional Budget Office (CBO) that gives us a clearer idea of just what exactly the fiscal cliff might do to the United States’ economy if it comes to pass. The new information is even more dire than the information we had in August, and so the “madness” has now been upgraded to “insanity”.

As we recall from “Madness”, there are several key results of the fiscal cliff:

  1. A recession in 2013 in which the economy contracts by 0.5% during that year (compare that to our most recent quarterly growth rate of 2%).
  2. An unemployment rate that rises to 9.1% by the end of 2012 (compare that to our current unemployment rate of 7.9%).
  3. The deficit is reduced by $500 billion from its 2012 level to $641 billion in 2013.

The argument in favour of the fiscal cliff is one which justifies the recession and the higher unemployment by focusing on the deficit reduction. These results are achieved, in principle, by the following methods:

  1. Medicare starts paying doctors less.
  2. Extensions of unemployment benefits end.
  3. The reduction in payroll taxes expires.
  4. Most of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 expires.
  5. Many provisions of the Budget Control Act of 2011 come into effect.

That’s all old stuff. What the new CBO report tells us is what sort of benefits the economy might expect to receive from not doing the various things entailed by the fiscal cliff. For instance the CBO projects:

Eliminating the automatic enforcement procedures established by the Budget Control Act of 2011 that are scheduled to reduce both discretionary and mandatory spending starting in January and maintaining Medicare’s payment rates for physicians’ services at the current level would boost real GDP by about three quarters of a percent by the end of 2013.

That’s three quarters of a percent of GDP in growth next year that the fiscal cliff surrenders by cutting pay for doctors and cutting spending via the Budget Control Act. The CBO has more projections, however:

Extending all expiring tax provisions other than the cut in the payroll tax that has been in effect since  January 2011—that is, extending the tax reductions  originally enacted in 2001, 2003, and 2009 and extending all other expiring provisions, including those that expired at the end of 2011, except for the payroll tax cut—and indexing the alternative minimum tax (AMT) for inflation beginning in 2012 would boost real GDP by a little less than 1½ percent by the end of 2013.

Extending all of the various tax cuts, even leaving out an extension of the payroll tax cut, gives us 1.5% additional growth next year. That’s more growth and more jobs that the fiscal cliff will take away. Lest this seem like an endorsement of extending the Bush tax cuts for the rich, the CBO clarifies that only 0.25% of that additional growth is due to lower tax rates on high incomes:

Extending all expiring tax provisions other than the cut in the payroll tax and indexing the AMT for inflation—except for allowing the expiration of lower tax rates on income above $250,000 for couples and $200,000 for single taxpayers—would boost real GDP by about 1¼ percent by the end of 2013. That effect is nearly as large as the effect of making all of those changes in law and extending the lower tax rates on higher incomes as well.

The CBO also includes a projection for what would happen if the payroll tax cut were also extended further along with the unemployment benefits:

Extending both the current 2 percentage-point cut in the payroll tax and emergency unemployment benefits—extensions that are not assumed in the alternative fiscal scenario—would boost real GDP by about three-quarters of a percent by the end of 2013. Making those changes along with making all of the changes in CBO’s alternative fiscal scenario would boost real GDP by about 3 percent by the end of 2013.

Cumulatively, this shows that, with the fiscal cliff, we are not only condemning ourselves to a recession with higher unemployment, we are giving up quite a bit of economic growth–3% in total. If three percent does not sound like a lot, recall from yesterday just how long it takes most modern nations to accumulate that much economic growth.

All of this is being done for a reason, of course–fear of a debt crisis modelled after the one that has been raging in Europe. In the past, I have dismissed this argument in reference to the reality that the United States is not experiencing borrowing costs that are comparable to Europe and has many more tools at its disposal for extending its ability to borrow. Of course, those arguments were made some time ago based on old figures. Is it still true that US borrowing costs are extremely low?

Yes it is. Borrowing costs for the United States government are lower than ever:

The reduction in the deficit does not justify a recession, a loss of three percentage points worth of GDP growth, and a 9% unemployment rate. It does not justify hurting  the unemployed, everyone who pays payrolls tax, doctors, and all people impacted by the repealed laws and taxes. We still have an economy that has an employment rate just under 8%, we still have a growth rate that, while much better than other nations, is not as high as it could or should be, and here we have a congress and a president wilfully ignoring those problems to solve a debt crisis that does not exist. Where do they get off undoing all the work of the last four years to gradually reduce unemployment and restore the economy to sustainable growth? Why on earth should all of that be wiped away when the government has never, since records began to be kept, been able to borrow money so cheaply? There is no argument for it whatsoever. It is utterly ridiculous. Don’t be one of the fools who believes it.