Fiscal Cliff Update

Because of the timing, I’d like to expand on a previous post about the fiscal cliff, seen here.

The CBO has released a new report about how terrible the fiscal cliff will be unless congress acts to prevent it. The basic story is the same, but there are a few key details worth dwelling on. The figure below provides a nice summation of them. The column on the left is dollars of GDP lost per dollar cut; the column on the right is essentially how many full time “equivalent” jobs will be lost per million dollars of cuts. 

The first thing noticeable is that the spending cuts that were part of the deficit ceiling deal will be the most damaging to the economy and employment. This is because discretionary spending (spending subject to the annual appropriations process in congress) is below its 40 year average, each additional cut will damage the economy more. The mirror of this is that tax increases will have less damaging effects per dollar of the deficit reduced. This is because taxes are below their 40 year average.

Furthermore, when “Extend Most Expiring Tax Provisions and Index the AMT to Inflation” is compared to the same policy “Except for the Lower Tax Rates on Income Above Certain Thresholds” (or, let the Bush Tax Cuts expire for the rich) there is little effect. In terms of GDP, the average difference in growth will be $0.10 per tax dollar forgone – notice though that the estimated range for increasing or not increasing taxes on the rich is the same. In terms of employment, increasing taxes on the rich is estimated to have no effect. It’s almost as if “the Job Creators” will keep working even if they keep a few percent less of their incomes each year. 



To be fair, in 2013 letting the Bush Tax Cuts expire for the rich will raise $43 billion, not nearly enough to close he deficit (over $1 trillion in 2012). And attempting to close the deficit with either all spending cuts or all tax increases will not be the least harmful method. The figures in the CBO report are just a snapshot; in the next decade both spending and taxes will rise above their long term averages. Generally speaking, the deficit will only be responsibly closed with a mix of reducing future spending and preventing future tax increases.