Fiscal Cliff: Sense and Nonsense

November 9, 2012

by Mario Rizzo

The above table is from the November 8th issue of the Wall Street Journal. The figures for the fiscal cliff consequences are usefully stated for next year and not for the next nine years as those who want to suggest that the numbers are truly impressive (or want to scare children) typically use.

Consider the following facts or likely scenarios:

1. If the Congress and the White House do not agree on something before the end of the calendar year, the  first-year consequences will be as the table indicates.  But how likely will they fail to come to even an illusory agreement for the entire year, let alone the next nine years. Not very likely, I should think.

2. Note how the consequences are stacked in “favor” of tax increases and not spending cuts. The “scheduled” spending cuts amount to only $136 billion out of a federal burget of about $7 trillion for next year. The tax increases are $532 billion. The Democrats are horrified that half of these come from domestic spending. The Republicans are horrified that the other half comes from defense spending.

3. It is true that many federal workers under this scenario would face pay cuts of about 8-9%, presumably to ensure that substantive programs can be cut less. These have the political effect of pinching well-organized people immediately who will then let us all know how much they are suffering.

4. The most interesting aspects of the cliff are: First, the GOP agreed to tax increases that are more than four times the amount of spending cuts. Does this portend later tax-increases-to-spending- cuts ratios? Second, the political system can’t seem even to handle relatively small spending cuts. How will it get the fiscal house in any order, especially since no-one (least of all Obama) has prepared people for serious cuts.

5. What I think will happen is this. There will be tax increases of one sort of other and there will be illusionary spending cuts. There will efforts to improve Medicare and Medicaid’s “efficiency” without cutting benefits. They will give impressive numbers to these efforts — over a ten year period, of course. There will be other spending “cuts” — probably just reductions in rate of increase — but even these will be mostly concentrated in the latter half of a ten year period.

6. There will probably be defense cuts for now. But should the US encounter “unexpected” expenses, including any new war, they will be quickly eliminated. Unexpected events that increase the defense budget will definitely occur. The only thing that is uncertain is the precise events that will arise.

7. There is no real political will here. Therefore, even if something that looks good is agreed to in the next few months, it will not last throught the end of the next calendar year. And if a decent economic recovery occurs, watch the politicians find new worthy programs. (One of these “worthy programs”, of course, will be paying more interest on the national debt as interest rates begin to rise.)

Nothing significant will happen to improve the US fiscal situation until the impact of the fiscal situation truly becomes a crisis with sharp economic effects. Too bad. It does not have to be that way.

13 Responses to “Fiscal Cliff: Sense and Nonsense”

  1. Roger McKinney Says:

    I’m a little more pessimistic. Chances of a recession in 13 are pretty good. The new Fed recession probability index has us already at 20%. Another recession will drive the deficit much higher and throw Congress into chaos. I agree that nothing good will happen until crisis hits and the US cannot borrow at low rates.

  2. rjsigmund Says:

    @ Roger McKinney…seems quite obvious that the Fed determines the rates we “borrow” at; the Fed sets the target & the bond markets have no rate setting power against them…

  3. Allan Walstad Says:

    I’m afraid the only real question is how individuals and families can shield themselves from the coming nightmare. One remaining large reservoir of plunderable resources is in retirement funds. When the recession hits and stocks tumble, look for the pols to make a grab for that money under the rubric of “protecting” us all from the vagaries of the market.

  4. Hayekian on the Hill Says:

    It is not correct to say that “the GOP agreed to tax increases that are more than four times the amount of spending cuts.” Most of the scheduled tax increases are from the expiration of tax policies that have been around for a few years or more than a decade but were extended in bipartisan agreement. A smaller portion are Obamacare taxes, which no Republican agreed to.

    During the July 2011 debt ceiling talks, or maybe during the Supercommittee negotiations, Pelosi reportedly proposed increasing the eligibility age by one month per year for Social Security (OASI) and Medicare (not clear what the end point would be), but Boehner wanted two or three months per year. Of course that’s not enough, but if early/normal OASI eligibility and Medicare eligibility increased by two months per birth year to 67/70/70, that would improve our long-term fiscal outlook substantially with minimal political pain in the near term.

    I’m cautiously optimistic that actual progress will be made, simply because I’ve seen that policymakers have had some time and incentive to think about the options. And the political will is increasing, although maybe not yet sufficient.

  5. Allan Walstad Says:

    Yes, gradually raising the age to collect SS benefits is the way to get out from under SS. Unfortunately, it’s a bit late in the game now.


  6. Kudos to Mario for the post.

    There is zero chance that Congress will address the long-run fiscal problem. Any “fix” will be kicking the can down the road.

    I suspect there is pre-packaged deal for FY2013 worked out before the election. The election campaign was posturing. For reasons of politics within the Democrat Party, the capital gains rate will stay close to the current 15% (Chuck Schumer and the hedge funds). Maybe it goes to 20%.

    On the personal side, cuts in deductions but rates don’t go up. On the corporate side, rates may come down and deductions are cut.

    I also think there is a pre-packaged deal on immigration. Another topic, for another post.

  7. Roger Ream Says:

    You write: ‘The “scheduled” spending cuts amount to only $136 billion out of a federal burget (sic) of about $7 trillion for next year.’ The 2013 federal budget is only $3.8 trillion, about half the number you use.


  8. [...] Think Markets has an excellent piece on the Fiscal Cliff. [...]

  9. Roger McKinney Says:

    rjsigmund: “the Fed sets the target & the bond markets have no rate setting power against them…”

    The Fed only sets the shortest rates. Long term rates, such as 10-yr treasuries are determined by the short rate plus risk plus inflation.

  10. rjsigmund Says:

    @ roger; i was referring to the various aspects of QE, especially operation twist, which the Fed has obviously used to control rates on the long end as well: http://advisorperspectives.com/dshort/updates/Treasury-Yield-Snapshot.php

    you cant fight the central banks; officals with the bank of england are even talking about retiring some of the debt they’ve bought…


  11. [...] What is the fiscal cliff? (ThinkMarkets) [...]


  12. [...] a blog run by NYU academics, recently posted a rebuttal to the popular Wall Street Journal infographic that shows the dire dollar amount tied to the fiscal cliff in detail. In “Fiscal Cliff: Sense and [...]


  13. I didn’t really fully understand the fiscal cliff until now, thanks for the info. ~ Wanye


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