The first reason to avoid going over the “fiscal cliff” is economic. The $500 billion of tax increases and spending cuts scheduled for early 2013 would probably cause a new recession. The Congressional Budget Office predicts the unemployment rate, now 7.9 percent, would go to 9.1 percent by year-end 2013. It might be worse. David Stockton of the Peterson Institute — until recently a top Federal Reserve economist — argues that another recession, when the economy hasn’t recovered from the last one, would profoundly damage the nation’s psyche. Fearful consumers and businesses would curb spending. Stubbornly high unemployment might persist for years.
The second reason is political: President Obama and congressional leaders need to demonstrate to Americans that they can govern in the larger national interest. Confidence matters, and political stalemate has devastated confidence. The lesson hasn’t yet taken hold. Obama is escalating his demands for tax increases, stiffening Republican opposition. More brinkmanship seems to loom.
It’s a pity, because the outlines of the needed deal are clear. Consider:
● Obama and congressional leaders cancel most fiscal-cliff tax increases and spending cuts. Instead, they agree to a package that gradually reduces the budget deficit from 7 percent of the economy (gross domestic product) in 2012 to 2 percent in 2020 — and then balances the budget soon thereafter.
●Republicans accept immediate higher taxes on the “wealthy” — couples with more than $250,000 of income and singles with more than $200,000. Obama won the election, and that’s his minimum demand. However, it doesn’t require permanently increasing today’s top 35 percent tax rate to 39.6 percent. Instead, Obama accepts a one-year surtax or limit on deductions. During that time, Congress and the administration pledge to pursue a tax overhaul that would cut the top individual and corporate income tax rates to 30 percent.
●To get to 30 percent without reducing taxes on the wealthy, Republicans agree to higher taxes on dividends and capital gains (profits from the sale of stocks and other assets). These are now taxed at no more than 15 percent — a huge benefit for the rich. Taxpayers with incomes exceeding $200,000 of income receive about 90 percent of the benefits, says the nonpartisan Tax Policy Center.
●Republicans support an increase in the federal debt ceiling of at least $2 trillion. The limit, now $16.4 trillion, will be reached early next year.
●Obama endorses sizable cuts in Social Security and Medicare — and pledges to campaign for them. This is Democrats’ quid pro quo for Republican tax concessions. In 2011, Social Security and Medicare cost $1.2 trillion and represented 36 percent of noninterest federal spending. Excluding them would make any deal too small or too reliant on tax increases and cuts in other programs. Eligibility ages must rise; benefits for wealthier retirees must fall.
●Recognizing that a balanced budget requires more spending cuts and higher taxes, the White House and Congress create two task forces: one to study an energy tax; the other to study controlling health costs, now a quarter of federal spending.
Neither party alone could pass a package like this. Meaningful budget changes will require “going outside everyone’s current comfort zone,” as economist Timothy Taylor says on his blog. Only a centrist coalition can neutralize opposition from both partisan extremes. Liberal groups are already mobilizing against cuts in Social Security and Medicare. Republican hostility to tax increases runs deep.
These objections are overblown. Millions of comfortable retirees can afford Social Security cuts or higher Medicare premiums and remain comfortable. Likewise, modest tax increases have “a small [economic] growth impact when tax rates are low or moderate,” argue economists Nir Jaimovich of Duke University and Sergio Rebelo of Northwestern University in a study. It’s only when “tax rates are high [that] further tax hikes have a large, negative impact on growth performance.”
Still, ideological purists won’t become pragmatists. Their opposition is one obstacle to a budget deal.
Public opinion is another. The U.S. economy resembles a sick patient who’s been put on a powerful drug: budget deficits. If the drug is withdrawn too abruptly, the patient relapses. That’s the fiscal cliff. But if the drug is never withdrawn, the patient may face highly toxic side effects. That’s a future financial crisis that occurs if lenders refuse to lend at low interest rates. It seems confusing, because it is confusing.
Curb those deficits — but not too fast. No one has adequately explained the messy choices to Americans. Not the president. Not major economists. Not congressional leaders. We are now as far away from the next election as we’ll ever be; the economy is in a modest recovery. Is there a better time to grapple with these perplexing and unpopular problems? Or do we gamble that we can drift along indefinitely?