‘Fiscal cliff’ deal falls short under three economic theories

Tax breaks for rum producers and racetrack owners are some of the growth that lawmakers have added to the ”Fiscal cliff” deal. The Washington Post’s David Fahrenthold talks about some of the lesser known measures in the new legislation and how the deal could be blocked or amended. (The Washington Post)

Economists generally offer three theories for what’s hampering the still-sluggish U.S. economy: the Keynesian theory, which would like to see lower taxes or more government spending; the spending/debt theory, which would like to see both of those reined in; and the uncertainty theory. Under none of them can the deal to avert the “fiscal cliff” be considered an economic success.

The deal will not inject more consumer spending power into the economy this year compared with last year — in Keynesian terms, it does the opposite. It won’t reduce government spending, and it will boost the national debt by trillions of dollars compared with what would have happened if lawmakers had not reached a cliff deal. It resolves only a slice of the policy “uncertainty” that many business leaders say is chilling investment in America.

The best economic case for the agreement, from each of those standpoints, appears to be that things could have been worse.

The deal will prevent scheduled increases on marginal income tax rates for American familiesearning less than $450,000 a year, delay planned domestic and defense spending cuts (known as “sequestration”) for two months, maintain a variety of business tax breaks (such as one for wind-
energy production), and extend unemployment benefits by a year for one-sixth of the 12 million people still looking for work.

Those measures amount to improvements over the fiscal contraction that was set to begin going into effect if Congress had failed to approve an agreement. That comparison, and that comparison alone, is what allowed the White House to proclaim in a fact sheet on Tuesday that the agreement “grows the economy.”

Outside economists don’t share that assessment, largely because they’re focusing on what the agreement doesn’t do. From the Keynesian perspective held by many Democrats, it won’t stop a 2 percent jump in payroll taxes, which will sap almost as much consumer demand as extending middle-class tax cuts will preserve. Brad DeLong, a University of California at Berkeley economist who advised President Bill Clinton, calculated on Tuesday that the agreement would drain nearly two percentage points from growth of the gross domestic product this year.

The deal answers one major uncertainty question — what will marginal tax rates be? — for investors and business executives. But it also sets up several new policy showdowns in the coming year, outcomes uncertain, starting with an immediate fight over raising the national debt limit. A similar fight in 2011 triggered a spike in a policy uncertainty index compiled by economists at Stanford University and the University of Chicago.

“The failure to extend the payroll tax cut until the unemployment rate drops below 6.5 percent or interest rates rise is a big negative,” DeLong said Tuesday by e-mail. “And the sequester is still lurking out there. And if you do worry that markets fear uncertainty, the failure to get rid of the debt ceiling is a big minus as well. Add those all up and the government is on net exerting a substantial drag on a still low employment, slowly growing economy.”

The deal also works against the “cut-and-grow” theory advocated by many congressional Republicans, who say reducing spending and debt will unleash new investment. The deal raises taxes, prolongs higher deficits than most alternative scenarios and includes no changes to safety-net spending programs such as Medicare and Social Security.

“The deal appears to offer no entitlement reforms, no tax reform, and higher marginal tax rates,” Harvard economist Greg Mankiw, a former adviser to President George W. Bush and Mitt Romney, wrote on his blog Tuesday. “After all the public discussion over the past couple years of what a good fiscal reform would [look] like, it is hard to imagine a deal that would be less responsive to the ideas of bipartisan policy wonks.”

All that disappointment shouldn’t surprise anyone. Wall Street analysts have predicted for months that growth will slow in the first half of the new year thanks to government policy — even while assuming Congress would reach a deal on the fiscal cliff.

Analysts for Nomura confirmed that assessment Monday when news broke of the agreement’s components: “We continue to anticipate a significant economic slowdown at the start of the year in response to fiscal drag and a contentious fiscal debate,” they wrote. A follow-up report on Tuesday said the deal tackles the easy parts of the cliff but not the “big issues.” By anyone’s theories, that’s true.

Jim Tankersley is the editor of Storyline, where he explains complex public policies and illuminates their human impact. He's from Oregon, and he misses it.
Comments
Show Comments
Most Read Business