The fiscal…something

October 10, 2012

Originally, Hill staffers called it "taxmageddon." Then Ben Bernanke called it "the fiscal cliff," and it stuck. The Center on Budget and Policy Priorities says that's the wrong metaphor: The damage doesn't happen all at once, so it's more of a "fiscal slope." The Economic Policy Institute decided this still made the situation sound too cliff-y and began calling it "the fiscal obstacle course."

EPI's imagery is a little strained -- Does the fiscal obstacle course include a fiscal climbing wall? A tax-cut rope swing? -- but its explanation of the fiscal whatever-you-want-to-call-it is the most useful.

At the end of this year, two economic priorities are going to crash into each other. The first is stimulus -- or, if you prefer a more poll-tested term, "protecting the recovery." The second is deficit reduction. EPI puts this very clearly:

Given perpetual (and often misplaced) concern that federal budget deficits are failing to decline rapidly enough, it is important to be clear about the precise danger the fiscal obstacle course presents: It is simply that the budget deficit would shrink too quickly—that is, public debt would stop rising fast enough—to maintain economic growth, let alone an adequate pace of growth to lower the unemployment rate

The "fiscal cliff" is, at its heart, a collision between these two priorities. We can let the Bush tax cuts and the payroll tax cut expire, and we can let the automatic spending cuts hit, and the deficit problem is pretty much solved. Unfortunately, we will likely have thrown the economy back into recession. 

Conversely, if we just kick everything down the road, that's better for the recovery, but it means we've made no progress on the debt, and if you believe in the confidence fairy, she's not coming because we haven't given anyone any reason to be confident in our political system or the future shape of their tax burden.

EPI's take on this is optimistic: The good news, they argue, is that if you look at the various components of the fiscal cliff separately, you'll see that the parts that do the most for deficit reduction do the least for the recovery, and vice versa. This suggests an "a la carte" approach to the fiscal cliff, in which we extend the most stimulative policies and wave goodbye to the most costly policies. 

You can see EPI's menu, so to speak, in this table (click on the image for a larger and more readable version). The most stimulative policies are, predictably enough, the policies that were intended to be stimulus. Among the least stimulative policies are the Bush tax cuts. Somewhat to my surprise, the spending sequester is a really nasty hit to the economy.

That menu, if anything, understates the cost of policies like the Bush tax cuts. Those numbers are only for 2013. The Bush tax cuts, if they're extended, are likely to be extended at least for the next decade, which means their cost will be 10 times higher than what's on the menu (actually, it'll be even more than that because of inflation and economic growth, but let's not get too complicated here).

By contrast, most everyone agrees the stimulus policies should end when unemployment returns to more normal levels. So they won't be around for 10 years, making their total impact on the debt a small fraction of the Bush tax cuts. When it comes to the deficit, a cost that recurs every year is a much bigger deal than a cost that ends after one or two years.

Moreover, because the Bush tax cuts weren't built for stimulus, they're not very stimulative. That raises the possibility that we could simply replace them with something cheaper and more stimulative. According to EPI's calculations, "just $58 billion in well-targeted stimulus in 2013 could provide the same fiscal boost to the economy that the $202 billion worth of Bush-era income tax cuts and estate and gift tax cuts would provide."

The fact that we could navigate the fiscal cliff in an intelligent, thoughtful way that balances deficit reduction and stimulus does not, of course, mean that we will. But EPI's look at the various policies and their economic costs at least clarifies the actual question here: How do we best balance deficit reduction and the recovery? The fiscal cliff isn't a drop to be avoided at all costs. It's a series of choices to be made, in which we have to decide whether a set of policies do enough for the economy to justify their cost.

So if there's room for yet one more name, how about calling it "the fiscal collision"?

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Sarah Kliff · October 10, 2012