Washington's deficit hawks are hoping that the fiscal cliff will be a springboard for Congress to finally make good on its promise to carry out major deficit reduction. But others are already betting that isn't likely to happen.
Research analysts at the Bank of America are predicting that the most likely outcome will be a compromise that consists of relatively modest spending cutbacks and minor changes to the tax code. It would be enough deficit reduction to avoid the sequester, allowing about half of the $720 billion of the cliff's contraction to take effect in 2013. But the report anticipates that Congress will only agree to moderate deficit reduction as a substitute for the cliff, rather than using the looming fiscal contraction to maximize it, as the deficit hawks want. As such, the bank's analysts say the most likely outcome would be a far cry from the sweeping plans from Simpson-Bowles or the Gang of Six that would fundamentally reform spending, entitlements and taxes.
In a new research note, the Bank of America explains that lawmakers will most likely agree to delay most of the fiscal cliff for about two or three months in exchange for what they deem to be "modest initial austerity" — letting the payroll tax holiday expire, as well as possible extended unemployment benefits.
That would only be a temporary reprieve from the cliff, however. Under this kind of "multi-stage deal," Congress will have a few more months to come up with a relatively bigger deficit reduction package. But unlike the "grand bargainers," the bank's analysts don't expect that this will entail anything close to the kind of $4 trillion comprehensive deficit plan they're hoping for.
Rather, the firm expects that Congress will agree to a more modest package of reforms: "a small cut in discretionary spending (substituting for the sequester) and a token tax increase on upper incomes (perhaps through some loophole changes)." The overarching goal would be to avoid the sudden impact of the cliff by substituting it with a moderate deficit reduction package, rather than use it as a platform for something much bigger.
That said, even modest austerity measures could have a significant impact on economic growth next year. Under the most likely scenario of medium-size growth through a multi-stage negotiating process, GDP growth in the first half of 2013 would be "just above 1 percent," the Bank of America estimates. And whether Congress decides to go big or small, the analysts predict that it's likely to be the end of extended unemployment benefits and payroll tax cuts — the parts of the fiscal cliff that "have the biggest impact on broad-based consumer spending."