Reading the headlines this week, you might get the impression that the country was hurtling towards a huge deficit catastrophe on Dec. 31. From the front page of Thursday's New York Times ("Back to Work: Obama Greeted by Looming Fiscal Crisis") to today's Wall Street Journal ("Pressure Rises on Fiscal Crisis"), the rhetoric suggests that the U.S. is facing a crisis akin to problems that have engulfed Europe. (A Yahoo headline from 2011: "The U.S. Fiscal Crisis: Just Like Greece, With One Exception.")
In fact, the problem with the fiscal cliff is precisely the opposite: The tax hikes and automatic spending cuts that would kick in after Dec 31 would sharply curb our federal deficit through enacting major, sudden austerity measures that would save the U.S. government about $720 billion in 2013 alone, according to the Bank of America's estimates, which would be about 5.1 percent of GDP.
"If we let all of those changes [happen], there would be a sharp reduction in the budget deficit—in decline in debt to GDP, falling deficits as a share of GDP," says Chad Stone, chief economist at the Center for Budget and Policy Priorities. "It's all a dream for people who want really sharp austerity."
So the reason that the fiscal cliff could push us into another recession in 2013 is because it enacts too much deficit reduction upfront, not too little. By contrast, the reason that Europe became mired in a fiscal crisis in the first place is because profligate nations haven't done enough to curb their spending and raise revenue to their more fiscally responsible neighbors' satisfaction.
The folks who want to avoid the fiscal cliff for fear of its impact on a still-faltering economy are effectively arguing that now isn't the time to enact austerity measures: Instead of taking money out of government programs and people's paychecks, the government should be putting that money into the economy. And certain parts of the fiscal cliff bring more bang for the buck than others, CBBP's Stone points out: Payroll tax cuts and unemployment benefits are more effective way to boost economic growth in the short-term than the Bush tax cuts for upper-income Americans, according to a new report from the Congressional Budget Office.
So if it's immediate austerity that we want to avoid, and stimulus that should take its place, why is there so much talk about the need for major deficit reduction as a solution to the fiscal cliff? It's because lawmakers decided months and years ago that they wanted this austerity crisis to happen as a way of creating leverage for more sensible, long-term deficit reduction measures.
Despite all their hand-wringing over the fiscal cliff, it was Congress and the White House that decided in the summer of 2011 that we would raise the debt ceiling only on the condition of reducing the deficit by over $2 trillion, with some cuts upfront and the rest attached to the supercommittee with a sequester trigger. (As President Obama reminded us in his speech today, "Last year, we cut more than $1 trillion in spending that we couldn't afford.") It's also because lawmakers decided nearly a decade ago that the Bush tax cuts would be phased out in 2010, which Obama and Congress then extended for another two years because of the weakness of the economy.
The essential dilemma, as both the U.S. and European countries like Greece have begun to discover, is that weak economies don't respond well to immediate austerity measures. The deficit hawks arguing for a bipartisan "grand bargain" or similarly ambitious deficit-reduction plan want to replace the kind of austerity that we're facing now with austerity that takes effect further down the road, not undo it altogether. Others simply want to put austerity off for at least a year by extending all the tax cuts and suspending the sequester.
All of these solutions affirm one underlying truth: The reason the fiscal cliff is so scary is that it's an austerity crisis.