Post by: Benjamin Landy , on October 12, 2012
Originally called "taxmageddon," it is revealing that policymakers and journalists eventually settled on the less apocalyptic "fiscal cliff" to describe the $607 billion of tax cuts and stimulus spending scheduled to expire at the end of the year. The image of a cliff—literally something that you either fall off or walk away from—is oddly appropriate for Washington, where Republican obstructionism has made it increasingly likely that Congress will kick the can down the road rather than take the plunge and negotiate a timely compromise.
Andrew Fieldhouse, a fellow at The Century Foundation and the Economic Policy institute, and Josh Bivens, also at EPI, are somewhat more optimistic. They suggest Congress could approach the expiring provisions like a "fiscal obstacle course," with several separable policies. Some, like the Bush-era tax cut for high income households, add hugely to the deficit while contributing little to overall economic growth. Others, like the payroll tax cut and expanded unemployment insurance, have a much more positive impact on GDP and employment levels while costing comparatively little. The report concludes that policymakers could achieve the best of both worlds—deficit reduction and sustained economic growth—with just $415 billion of well-targeted stimulus, rather than the $732 billion cost of extending 2012 spending levels.
Economists agree that we must begin to stabilize the growth of our national debt, with a long-term plan to increase taxes and lower spending. But allowing all of the tax cuts and spending provisions in the fiscal cliff to expire as scheduled would undoubtedly send the United States into a recession, with disastrous spillover effects for the world economy. So how is it possible that Fieldhouse and Bivens find savings of $318 billion (43.4 percent) without shrinking GDP or increasing unemployment?
The short answer is that each component of the fiscal cliff stimulates the economy to a different extent. Emergency Unemployment Compensation, for instance, is a federal extension that provides additional weeks of unemployment insurance after workers have run out of their usual benefits. Because the unemployed are more likely to go out and spend each additional dollar of income (economists say they have a high "marginal propensity to consume"), it is estimated that the economic output increases by $1.52 for every dollar the government spends on unemployment insurance. The "fiscal multiplier" for policies that benefit people with higher incomes, like the capital gains tax or the estate tax, is lower because the wealthy tend to save a greater percentage of each additional dollar they earn.
The graph above shows how the impact of the fiscal cliff breaks down across the income distribution, with different policies benefiting the bottom 80 percent of Americans and the richest 20 percent. The top quintile, for instance, benefits disproportionately from the upper-income Bush tax cuts and the low estate tax. EPI estimates that those provisions alone cost the government $64 billion a year in lost revenue, while providing a meager $14 billion boost to the economy (0.1 percent of GDP). Tax credits and stimulus programs that benefit lower and middle income households, meanwhile, generate substantially more growth than they cost.
The only program that falls outside this simple rule is the $1.9 trillion "sequester," which is divided equally between cuts to defense and discretionary domestic spending over the next ten years. According to EPI, repealing sequestration would have a multiplier effect of 1.4, the second highest of all the policies listed in the graph below.
Based on the figures above, Fieldhouse and Bivens argue that a sensible compromise to lower the budget deficit while maintaining economic growth and employment would include the following provisions:
The only danger for EPI's progressive approach is that it will be seen as partisan for supporting lower and middle income households, rather than the wealthy. But the math behind the multipliers is sound: benefits for the upper end of the income distribution are of comparatively little worth at a time when the country needs to begin lowering its debt. With a smarter, more targeted stimulus in place of the fiscal cliff, we don't have to choose between deficits and recession.
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